MOHAMED EL-ERIAN: PIMCO’s heir-apparent goes missing

The noisiest recent CIO turnover was at a sell-side firm, but one which is closely watched by many institutions.  PIMCO’s CEO and Co-CIO Mohamed El-Erian has been replaced — or at least succeeded by — a whole roomful of folks.  El-Erian, who reportedly earned $100 million in 2011, announced his departure in January and was gone by March 1^st.  He has no job in prospect except a part-time gig as a consultant to PIMCO’s German parent Allianz SE.

Douglas Hodge (a non-portfolio manager) will be the new CEO.  And no fewer than six new deputy CIOS have been minted, although it’s not clear whether the whole half-dozen add up to one El-Erian.

Mr. El-Erian was regarded as a peer — or nearly so — to founder and co-CIO Bill Gross, someone who could go toe-to-toe with the Bond King in hammering out PIMCO’s overall strategy.  Also, being 14 years younger, he was the obvious successor to the 69-year-old founder.  The six new DCIOs are all accomplished portfolio managers, but none look to us like a real backup or counterbalance to Mr. Gross.

And the media, being the media, found or fomented as much controversy as possible.  In years past, the two men have praised each other fulsomely in public.  But, as Mr. El-Erian went out the door, the Wall Street Journal produced a piece which was critical of Mr. Gross’s leadership style.  Mr. Gross took it amiss and, according to Reuters, told a reporter that he had “evidence” that El-Erian “wrote” the Journal piece and said “I’m so sick of Mohamed trying to undermine me.”

Well, this is all good fun, but what does it signify for PIMCO’s customers?

It’s all about the AUM:

PIMCO’s AUM is nearly $2 trillion and their long-term performance, especially in their core bond funds like the Total Return Fund (personally managed by Mr. Gross), has been very good.

But no investor wants to see management turmoil in an external manager; that alone raises red flags.  And even before losing Mr. El-Erian, PIMCO’s recent performance has been non-terrific.

Bonds in general didn’t do well in 2013.  That explains some shifts away from PIMCO funds, but they have recently fared even worse than their peer bond-managers.

Barclay’s Aggregate Bond index was down 2.02 percent in 2013, the first negative return in ten years; and PIMCO’s flagship Total Return Fund did slightly better, down 1.9 percent.  But that ho-hum performance is not what investors have come to expect from the Bond King.  Mr. Gross seems to have been wrong-footed by Mr. Bernanke’s on-again, off-again tapering project late in the year and turned in TRF’s worst returns in 20 years.

As we go to press, mutual-fund performance data for the first quarter of 2014 is (almost) complete.  According to the Wall Street Journal on March 28 (reporting Morningstar stats), the Total Return Fund has a year-to-date return of 1.28 percent.  But that misses the U.S. Agg Bond index return of 2.03 percent.  Worse, it has TRF trailing 87% of its peer bond mutual funds.

Every manager wants to beat his benchmarks, but mutual funds live or die by AUM.  And PIMCO has been bleeding AUM for many months.

Among the top ten U.S. mutual-fund families, only two had net outflows in 2013, including PIMCO, which lost $40 billion, according to Morningstar.  In the latest monthly stats only one top-ten fund family lost funds in February: that’s PIMCO again, with an outflow of $2.5 billion.  The outflow came as U.S. bond mutual funds and ETFs overall attracted $18.6 billion for the month, the biggest inflow since March 2013, according to TrimTabs Investment Research.

An embarrassing example was on PIMCO’s home turf.  The Orange County ERS pension (Orange County includes PIMCO headquarters in Newport Beach) decided in November to hand a new $100 million bond mandate to Swiss firm GAM Holding, instead of to PIMCO, their long-time largest bond manager.  A GAM manager says they’ve been actively targeting PIMCO customers and that their hit ratio has been high.  PIMCO has had to scramble its sales force to re-connect with its customers and resist defections.

Also, we’re told, a flock of CIOs from across the country has been summoned to Newport Beach this week to get a read on PIMCO’s prospects from Mr. Gross and his new leadership team.

The pervasiveness of PIMCO:

We thought it would be interesting to look at some of the largest U.S. public pensions and see how much business they actually do with PIMCO.  A daring reader might extrapolate from these big funds to get a sense of how PIMCO pervades institutions generally.

In the institutional investment universe, only public pensions generally report their assets and fees by external manager in any detail, and even they don’t do it uniformly.

There are about 35 pensions with AUMs over $20 billion (per latest available annual reports for FY2012 or 2013).  In aggregate, that’s about $2.4 trillion, with a “T,” and it accounts for over 90 percent of all U.S. public pension assets.  (The National Association of State Retirement Administrators found a total of $2.64 trillion for FY2012 in their latest survey, which includes almost all significant public pensions).

Twenty-one of those funds – about 60 percent – had significant PIMCO-managed assets.  We found hard numbers for 13 of them, including (in most cases) fees paid to PIMCO in the latest reported fiscal year (either 2012 or 2013).  Here are those 13, ranked high to low by PIMCO-managed assets:

U.S. public pensions with significant PIMCO-managed assets

In a few cases we estimated the fee based on size and type of assets.  We think our estimates are in the ballpark, but they shouldn’t be taken too seriously.

For an additional seven pension funds we found significant PIMCO-managed funds but couldn’t extract a hard number for either assets or fees.

We’re pretty confident each of them has a PIMCO mandate between $500 million and $1.5 billion.  We think total PIMCO-managed assets for this group are about $7 billion, generating about $13 million in annual fees.  These seven major PIMCO customers include Iowa PERS, Oregon PERS, Mississippi PERS, Los Angeles County ERA, Minnesota SBI, Ohio STRS, and Indiana PRS.

The total 20 pensions referenced above have an aggregate AUM of about $1.2 trillion, of which PIMCO manages over $20 billion and pockets more than $60 million in annual fees.

This exercise reminded us that PIMCO is more than just Mr. Gross’ Total Return Fund.  Those basis-point fee numbers range from 8.5 at the NYC Retirement System to 97.2 at Illinois Teachers.

This is partly because PIMCO purveys a variety of products.  A lot of institutions use them as a manager of core bond funds, with fees in the 10-to-20 bps range.  But PIMCO also offers hedge-fund-like LP vehicles focusing on distressed-debt and other exotica with a higher fee structure.  They also have expertise in emerging-market debt (which was Mr. El-Erian’s specialty).  They will be glad to manage some of your equity portfolio, too, although that’s not thought of as their strong suit.  You can even keep it simple and buy their exchange-traded ETFs and CEFs, which purport to mirror some of their retail and institutional funds.  We found a smidgeon of these items in a couple of pension funds.

The fee variance is also partly performance-based and a function of how individual funds negotiate a fee schedule.  Any fund who can offer a billion-dollar mandate has a lot of negotiating power.

For example, at CalPERS, most of the PIMCO-managed funds are classified as Global Fixed Income.  In 2013 they paid PIMCO a management fee of about 7.7 basis points.  But they paid an additional 26 basis points in performance fees, bringing the overall fee up to 33.6 basis points.

The world’s most under-paid money managers?

According to the New York Times, Mr. Gross and Mr. El-Erian made $200 million and $100 million respectively in 2011.  And, with PIMCO in the news, those big numbers have drawn the usual unwelcome attention.  Are they worth it?

In 2012, when those numbers were reported, Marc Prosser, writing at Forbes, made the bold claim that Bill Gross was “the most underpaid money manager in the world.”  He actually made a pretty good argument, and it could be extended, pro rata, to Mr. El-Erian.

First, he points out that those salaries don’t really matter to PIMCO customers.  PIMCO charges a competitive AUM-based fee.  If the execs are overpaid, it comes out of the profits of the owner — German insurance company Allianz — not retail or institutional customers.

Next, he notes that Mr. Gross (and, latterly, Mr. El-Erian), aren’t just portfolio managers.  They are also media figures and spokesmen.  That is: they are marketers and very effective ones.

The highest-paid money managers are hedge-fund founders who charge 2-and-20 fees.  For instance, Ray Dalio of Bridgewater made $3 billion in 2011 and James Simmons of Renaissance Technologies made $2.1 billion.  But they manage far less money than PIMCO.

Mr. Prosser (himself an accomplished sell-side marketer) notes that several actively-managed core bond funds (e.g., TCW and Loomis Sayles) have performed as well or better than PIMCO Total Return Fund, but have achieved only a fraction of TRF’s AUM.  They’ve got just $6.3 and $1.2 billion, respectively.

Whether he’s opining on CNBC, teeing off at Pebble Beach, or churning out his widely-read investment letters, Bill Gross has been a ubiquitous media presence.  And the genial Mr. El-Arian hasn’t been far behind as networker and pitchman (including his recent appointment by President Obama to his White House Global Economic Council).

Mr. Prosser says that many firms put around 8-12 percent of their revenues toward marketing.  PIMCO’s estimated revenues for 2011 were $14 billion.  If just 6 percent of that had been paid to the co-CIOs they would have split $840 million that year, not a mere $300 million.

We think Mr. Prosser’s argument is extravagant, but not crazy.  People are compensated for the measurable value they add, and it’s undoubtedly true that leaders like Mr. Gross and Mr. El-Erian are salesmen and communicators as much as they are investors and managers.

Their ultimate boss, Allianz CEO Michael Diekmann over in Munich, earned only 7.2 million Euros in 2013.  He’s reputedly a very effective CEO.  But no one ever entrusted their money to PIMCO because they have confidence in Mr. Diekmann, whom no one outside the insurance industry has ever heard of.

Mr. Gross has said that he still has forty more years in him and, while we admire his optimism, we think institutions are more impressed with PIMCO’s due-diligence-proof consistency.  On a 15-year basis, PIMCO’s investment results have been outstanding and long-term investors should give that due weight.  But, going forward, that consistency will depend more on a realistic succession scenario than on Mr. Gross’s fine track record and can-do spirit.

Timing is everything:

As for Mr. El-Erian, we recall the exquisite timing of his departure from Harvard Management Company.  He had arrived in February 2006, closely following the successful run of Jack Meyer.  Then he left (to return to PIMCO) in December 2007, six months before the end of the 2008 fiscal year.  So, he got credit for two very good years, with Harvard earning 23 percent and then 8.6 percent, beating their peers and benchmarks.  But, après lui, le deluge.

He was safe in California when HMC lost billions and hit an epic liquidity crunch in late 2008.  When Ms. Mendillo, the fifth Harvard chief in four years, showed up in July 2008, she faced a mess from which she’s still digging out.  Whether Mr. El-Erian’s timing was luck or foresight, it left his resume untarnished and, as a great American once said: what difference, at this point, does it make?

At age 55, Mr. El-Erian still has a golden resume and many friends in high places.  It may turn out that his timing has again been perfect.