Closed Live session — Pimco: Net of Gross

Bill Gross has left Pimco, the firm he co-founded in 1971 to join Janus Capital; statement here. Lex is very interested in what this means for Allianz, Pimco’s owner, and the future of the big bond house itself.

This is a live format in which we’ll share our thoughts on a note we’re writing in real-time, and readers will be able to weigh in too on the right. So don’t be shy!

Hello, and welcome to Lex Live. And before anyone asks, no – we don’t know if Andrew Balls (a former Lex writer, now Pimco deputy CIO) gets the job…

We are, however, keen to find out what the prompt exit of Bill Gross from Pimco on Friday means for Allianz, the bond market — and the bond house itself.

Let’s begin with the statement from Janus Capital announcing it’s hired Gross.

There are some interesting details in it (which I’ve bolded)…

Mr. Gross’ employment will be effective September 29, 2014 and he will begin managing the Janus Global Unconstrained Bond Fund and related strategies effective October 6, 2014….

“I look forward to returning my full focus to the fixed income markets and investing, giving up many of the complexities that go with managing a large, complicated organization,” said Mr. Gross. “I chose Janus as my next home because of my long standing relationship with and respect for CEO Dick Weil and my desire to get back to spending the bulk of my day managing client assets. I look forward to a mutually supportive partnership with Fixed Income CIO Gibson Smith and his team; they have delivered excellent results across their strategies, which deserve more attention.”

So, from the bolded parts:

- This is a prompt exit, apparently without a non-compete clause. Is Pimco surprised he is off?

- Gross implies Pimco’s complexity was an issue preventing him focusing fully on bond trading.

- This last part also implies that Gross WASN’T spending the bulk of his day trading, either.

When Bill gross started the Pimco Total Return Fund in May 1987, 10-year treasury yields were at 8.4 per cent. Today, as he announces he is leaving Pimco for Janus Capital, they are at 2.5. He and the fund with which he is identified have had the wind at their back. But he made the most of it. Since inception, the fund’s average annual return was 7.91 per cent. Its benchmark (the Barclays US aggregate) returned 6.85 per cent. Not much of a difference? Compound the difference over a little over 27 years and you’ve about 30 per cent richer with gross.

Actually, Californian state law on non-complete clauses seems rather complicated.

So let’s pass over that and note Janus Capital’s share price at the open. It’s up 40 per cent (at least that’s the first print).

Allianz, Pimco’s owner, is meanwhile off 6.7 per cent. And it’s a €58bn company.

Recognize that chart? That’s the generic 10-year yield over the life of the Total Return Fund. Good times to be running a big ol’ bond fund.

A quick question arises from the $71bn in assets which the Total Return Fund has lost in the last 16 months (leaving it with $221bn).

Has Bill Gross left Pimco, or Pimco left Bill Gross?

And a second question – how many assets will be left in the long term for Gross’s successor to manage once the dust settles. After all, $221bn sounds – go back to Gross’s quote in the Janus statement – like it was still complicated to run, despite having dropped from $292bn.

Two comments highlight one of the main questions here:
Sven: Allianz share price suggests Gross was worth 4billion Euro. Note, that’s Gross’s worth, not Pimco. Some might suggest that’s an over-reaction.
Sherlock:It’s great news for Allianz, Gross’s repeated mishaps and repeated incorrect readings of this weird new world were laughable at first then it all got a bit sad.

Just for the record, the Total Return Fund has had a very good performance record against at least one benchmark, the Barclays US Aggregate Total Return Index. Of course, he would probably not want to be compared to any index. Here’s three years:

Meanwhile, #PIMCOnewCIOguesses has got off to a good start on Twitter…

However, he’s had a harder time of it this year. Note that the benchmark does not include income (bit weird, yes) but it does give some indication of how performance has begun to trail peers this year:

“Fundamental differences about how to take Pimco forward.”

That’s the rather harsh explanation from Pimco for why Gross has left, by the way. Thus to repeat: would those differences include the $71bn loss in AUM over those 16 months?

Gross had made some bad calls, and he had been the focus of a lot of political heat and distraction. At the same time, the market says he was worth a lot of money – even if it is overreacting, as Sven points out. Assessing when a manager has lost his touch is above Lex’s pay grade. The questions for us are:
1. Where does this leave Alliance? Is this the push they needed to separate Pimco – something Lex recently argued, in some detail, that they need to do.

2. Where does this leave Pimco – in a low-yield world, what is the fate of the great big bond house? The points in both the Janus release and in Pimco’s about complexity and conflict suggest something about personalities, but also about the challenges of running big money, especially in fixed income.

Just to expand on our previous argument for why Pimco should be separated – from Oliver’s piece:

Yes, Pimco manages a lot of money for Allianz. But it does so on an arm’s length basis – that part of the relationship has nothing to do with ownership. Companies do not have to own their suppliers. The operational arguments for keeping the two businesses together might be more convincing if they were integrated. But they are not. Pimco’s California base is 6,000 miles away from Allianz’s Munich headquarters and there is little operational crossover. In 2011 the German group gave Pimco even more autonomy, handing it more control over areas such as marketing and distribution.

And more:

The valuation looks compelling even if the market demands a discount for Pimco. Say Pimco can only attract a valuation of 11 times forward earnings, a 20 per cent discount to the fund management sector. That would make it worth €18bn. Added to the €50bn valuation for Allianz’s insurance business, the combined valuation remains 19 per cent above the current market capitalisation.

It’s interesting that Janus has decided to go into fixed income. It was the 1990′s equity tech player. One thing, will Bill Gross really report to Fixed Income CIO Gibson Smith? Second, Bill Gross’ personal wealth ($1.8bn, according to Bloomberg) worth a large proportion of Janus’ market cap ($2.9bn). Team player?

Sujeet raises a good question: “Thoughts on Janus jumping into fixed income based on where we are in the credit cycle?” Pimco was trying to shift to equities in recent years. I suppose that at Pimco Gross could have felt trapped in bonds, and at Janus he can allocate more freely across categories. Just speculating.

CNBC says Gross was going to be fired tomorrow.

A little bit more on immediate reaction (though for me, this just to serves to underline the point about sizer and complexity) — FastFT:

It is a particularly big holder of Brazilian bonds – holding over $14bn of the local bond market, according to Bloomberg data.

The benchmark 10-year local Brazilian bond yield soared over 20 basis points to 12.1 per cent soon after the announcement was made.

Drago sums up what a lot of people are thinking: “Long Allianz, short Janus.” I guess the counter argument is that Gross will probably pull a lot of assets in his wake, even if he has lost his touch. And in the asset management business, the main determinant of profits is how much you manage, not how well you manage it. So Janus will benefit.

Pancakes: “Am sure Gross will be happy to be likely managing a more nimble fund as well.” Amen to that. Trying to outperform while managing $221bn in assets must be unfathomably difficult.

But I think this is a very good point by Ian Smith:

Worth noting that not all the investor reaction will be immediate. Pension funds with three-month or even sixth-month investment committee meeting cycles will be making the decision to stick/split well into next year.

Even if a CIO is anointed within hours, it will take time to settle on how many assets (of those $221bn in the TRF, say) go over with Gross.

Although it’s also worth noting the core bond investment (including the TRF) is about a third of overall Pimco AUM.

In such a big fund, even minor portfolio weighting tweaks would be a potential nightmare. A 1% shift is over $2bn. Presumably trying to get traders to take on risk for one of their larger shifts in the fund, 3% or 4% of the portfolio, would have caused headaches. Particularly as banks have cut traders’ balance sheets back over the past five years. Really it’s a miracle, and a testament to his skill as a manager, that Total Return did as well as it did for so long.

Sven, They are talking about “erratic behavior” on CNBC. Who knows what that means. We have lots of nice he said she said to look forward to.

“Erratic” or not – if it is clear that the drop in AUM pushed Allianz to jettison Gross, then that supports going long Allianz, no? It’s cold, but it’s pragmatic. You can’t have that bleed forever, especially when bond trading itself is changing considerably.

(Rob and Alan furiously working out the amount of fees Gross could be bringing in into Janus. Which is priced at 17 times earnings)

James Mackintosh has popped over meanwhile and noted that Janus’s share price is still half what it was at peak!

So maybe this is the way to think about it. The market cap of Janus has risen by about $700m on the announcement. It trades at 17 times earnings. That implies roughly $41m in new earnings. Assuming fees at 1 per cent, that implies roughly $4bn in assets following Gross to Janus. Seems like the market is not being excessively exuberant.

That would suggest less that 2 per cent of Pimco money follows him.

Considering that he ran over $200bn at one fund at Pimco, it’s not too much to ask of him, is it?

But wait. James tells me that the fees at Janus are closer to 60 basis points. That moves the implied new assets up above $6bn.

pancakes the 17 multiple is the 12 months forward estimate from Bloomberg, as of right now

Golly

Many of the big SWF’s and other mutual/pension/institutional funds have automatic ‘Change of Manager, we redeem’ clauses too. They will take 8-12 weeks to execute. <

Yes. This is a case where the effects will trickle out over time.

Change of manager clause won’t be necessary, Golly Galoshes. Think key man issues for Pimco as a whole. Anyway, we need to see how Allianz and Pimco spin this.

Drago

Maybe Gross leaving has something to do with Pimco’s recent investigation by the SEC? I didn’t look much into it.<

Our read on the SEC investigation — based on the rather modest amount of information we have — was not that big a deal. It seems that it was a matter of buying odd lots of bonds at a discount and marking them at the higher, round lot price. And its not clear how much choice there is in that matter. Out note: http://www.ft.com/…-00144feabdc0.html

Virginie Maisonneuve, who has recently joined from Schroders to boost Pimco’s global equity effort, may not have realized that she had moved to a soon-to-be boutique house.

sherlock

Your point well-taken. But see post below.

Totally sick burn, Alan. Yes, I doubt very very much the SEC probe had much of anything to do with this. But it does cover a business – active ETFs – in which the Pimco elephant has been dipping its toe, as a way to diversify away from the TRF itself.

Sherlock

Every strategy has a max level before your alpha ability is crushed. Institutions deserve what they get with massive funds (gross’s fund badly lagged most peers over the last 5 years). Dean left Schroders, i wonder if that was to do with fund size. Woodford too. There is a wider theme going on in fund management, the rise and rise of boutique over asset gathering machines<

But what are the monster pension people supposed to do with their money? Cut it into 10,00 buckets? Invest passively? Buy whole companies?

Allianz shares have rebounded a tad: now down 5 per cent.

We continue to think that Allianz should get rid of Pimco. This may make that harder (or maybe easier?) but the basic point remains. Quoting from our Oliver Ralph (tragically out on vacation today):

The best reason for a Pimco spin-off is that it could make Allianz’s shareholders €15bn richer. The maths looks like this. Assume, based on Barclays’ estimates and a US tax rate, that Pimco makes about €1.6bn of net income in 2015. At 14 times those earnings – the average for a fund management peer group – Pimco is worth €22bn. That would leave the rest of Allianz (mostly life and property and casualty insurance) making net income of about €5bn. Put that on an insurance sector multiple of 10 times earnings and there is a value of €50bn. Add those together and the €72bn result is a very healthy premium over the €57bn at which Allianz trades today.<

Now, some of those number are a bit old (published on July 8). But the basic point is there.

Bananalyst

Yes! But just shifting positions around for the next manager to “express” his/her views will be time-consuming.

Ok, I think we are going to wrap the discussion here. Thanks or all the comments. Gross can make a Janus a much bigger company by moving a relatively small slice of Pimco assets with him. Alliance should take this opportunity to assess Pimco’s role within the company. And Pimco, as a still-huge bond house, has a chance for a strategic rethink – and likely needs one. Note to come. Cheers