Finance after the crisis

Vigilante on the move

In the first in a series of profiles of financial institutions after the crisis we look at PIMCO, a giant fund manager

NEWPORT BEACH, CALIFORNIA

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BILL GROSS has a dual passion for philately and philanthropy. In 2007 he gave to Doctors Without Borders the $9.1m he earned from an auction of his collection of British stamps. He has said he is happy to part with “old friends” for a good cause. But the 66-year-old shows no sign of parting ways with the company he co-founded in 1971, Pacific Investment Management Co (PIMCO), one of the world’s largest bond-fund managers and, since 2000, a unit of Allianz, a German insurer. As co-chief investment officer, he manages PIMCO Total Return, the world’s largest mutual fund with $234 billion of assets. It is as successful as it is big, returning an average 7.5% over the past five years—better than 98% of its peers, according to Bloomberg.

PIMCO itself, however, is changing. Having long marketed itself as “the global authority on bonds”, it recently switched to “your global investment authority”. It is too early to claim that crown. But the asset-management industry is sure to feel the effects of any effort by its most respected—and, by many, most feared—member to diversify its portfolio of offerings into equities, exchange-traded funds, risk hedging, valuation services and more.

PIMCO has emerged from the financial crisis stronger. It has continued hiring as others pause or pull back. It is set to receive the lion’s share of investment spending by Allianz Global Investors, the division it sits in, this year. PIMCO’s assets under management have grown steadily, to $1.2 trillion. It enjoyed stronger net inflows than any other large American bond-fund firm in the 12 months to the end of June.

As a vast repository of government debt, PIMCO is the de facto spokesman for the “bond vigilantes”—investors who drive up yields by selling the bonds of countries they deem profligate. A change in its stance makes waves. No wonder Spain’s finance minister paid a recent visit to the firm’s disarmingly modest headquarters in Newport Beach, California.

PIMCO’s power also stems from its ultra-rigorous approach to investing. It has a big team of managers, any number of whom would be stars around which other firms could be built, says Eric Jacobson of Morningstar, a fund-research company. They are called together no less than four days a week, for three hours at a time, to debate the issues of the moment. In each discussion, one group is given the task of offering ideas, a “shadow” group that of shooting them down. It is, says Mohamed El-Erian, Pimco’s chief executive, all part of “a culture of constructive paranoia.”

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The firm’s top brass are keen to lead public debate, too. Mr El-Erian and Mr Gross make regular appearances in newspapers and on TV. In his popular monthly Investment Outlook, Mr Gross has coined or promoted many a catchy idea, such as the “new normal” (subdued growth in developed countries, caused by deleveraging, reregulation and deglobalisation) and the “ring of fire” (debt-saddled countries on Europe’s fringes). The “shadow banking system” is another PIMCO coinage.

Equity returns could suffer in such economic conditions, too. But the cloudy outlook for fixed income has turned PIMCO’s managers into advocates of the diversified portfolio. Hence the firm’s ambition to push deeper into equities, which currently account for just a small, undisclosed fraction of its assets under management. It has launched a batch of equity funds this year under the Pathfinder brand.

From bonds to anywhere

They are putting their money where their mouths are. The new normal, they believe, implies the end of the long bull market for bonds. Returns “stand at the threshold of mediocrity,” Mr Gross recently opined. Underpinning this thesis is a belief that interest rates will march higher over the next decade, reversing an almost 30-year period of generally falling rates. When bond yields rise, their prices fall, eating into any gains from the security’s coupon. A combination of rich-world overindebtedness and insufficient consumption in developing countries could also dampen returns, Mr Gross argues. Bear markets in bonds tend to be less spectacular than those in equities, but what they lack in depth they compensate for in length. In the 1960s and 1970s, when interest rates crept steadily upwards and prices sagged, bonds were dubbed “certificates of confiscation”.

The firm is bringing in new faces to help drive this expansion. The equity funds will be managed by two investing veterans hired from Franklin Templeton. They, in turn, will report to Neel Kashkari, the former head of the Treasury’s Troubled Asset Relief Programme, who joined in December. PIMCO also has high hopes for a unit that helps institutions to value their investments, and for another that offers them protection against low-probability, high-impact “tail” risks.

The end of the bond party is, in fact, just one of several reasons for the diversification. Mr El-Erian thinks investors will lean increasingly towards those managers that can offer “all-out” investment solutions, assembled around broad risk factors, rather than expertise in particular asset classes.

Some outsiders see the move as a reaction to BlackRock’s emergence as the world’s largest fund manager. PIMCO’s organic growth stands in contrast to that of its rival, which jumped to top spot with its $13.5 billion purchase of Barclays Global Investors last year. Acquirers usually have to “pay twice”, says Mr El-Erian: once for the franchise and once to retain its people. PIMCO’s cohesive culture also gives it more reason than most to worry about the impact of splashy deals.

Another possible reason for the diversification is Mr Gross himself. With $50 billion of net inflows in the year to June, half of the group-wide total, his Total Return fund remains so popular that some at PIMCO fear the firm has become too reliant on the bond world’s elder statesman (see table). Pushing into new territories is one way to reduce this risk.

Some colleagues might welcome a lower profile for Mr Gross, whose utterances occasionally backfire. In a typically punchy commentary in January he recommended avoiding British government debt, which was “resting on a bed of nitroglycerine”. But gilts failed to explode, and PIMCO was forced to reverse course.

He is also synonymous with the controversy PIMCO courted during the financial crisis. Its dual role as private investor and manager of government bail-out programmes left some asking if it was hopelessly conflicted. Some even muttered that PIMCO itself posed as great a systemic risk as large banks, so important had it become to the fabric of markets.

Though the fuss has since died down, Mr Gross remains defensive, calling suggestions that PIMCO overstepped the mark “total BS”. The firm may enjoy a certain “bully advantage”, given its heft, he admits. But he insists that when he advocated specific government policies, those views were genuinely held.

Whatever PIMCO’s motives, its power looks set to grow. Investors are increasingly inclined towards large managers with long track records and strong brands. But there are risks, too. If market returns fall, as the firm predicts, it will face pressure to cut its fees, which can be high relative to peers—sometimes strikingly so, given its economies of scale. The transition to full-service investment-solutions provider could be bumpy. It would require PIMCO to recommend others’ products as well as its own, an approach that “hasn’t sat well” with the industry in the past, says Mr Jacobson.

Some insiders are said to be queasy about tinkering with a winning formula. One fixed-income diehard describes bonds and equities as “oil and water”, adding that “equities people are by nature optimists, bond people pessimists.” Another worry is that size could start to work against PIMCO. For a cautionary tale, look no farther than BlackRock, some of whose clients are withdrawing funds to avoid being overexposed to one manager. Mr El-Erian is unfazed. “As long as we deliver performance”, he says, “we’ll get larger.”