Friday, January 24, 2014

Moving Parts at PIMCO

Moving Parts at PIMCO

Mohamed El-Erian, PIMCO’s CEO and co-CIO, announced his resignation earlier this week, setting off a media frenzy about the world’s largest bond mutual fund.  Was Mr. El-Erian pushed out because of poor investment performance?  Who will eventually replace Bill Gross, PIMCO’s president and founder?  Since Mr. El-Erian was the heir-apparent to Mr. Gross, these are logical questions.  I certainly don’t have any great insight into the situation, but I would doubt that his departure is as abrupt as the media suggests. The Financial Times had done the best job so far of speculating on his departure.[1]
 
Equity Overhaul (1996)
I thought his resignation was a good opportunity to illustrate a few of the challenges of running a huge mutual fund business.  First, I’ll share my uninformed view on his departure.  I’m betting that Mr. El-Erian had simply had enough of the day-to-day pressures of managing the fourth largest mutual fund complex in the U.S., especially after seeing about $30 billion or 5% of assets walk out the door.[2]  While the PIMCO’s mutual fund complex of $516 billion receives a lot of attention[3], the company manages just under $2 trillion[4] when you include all of its investment activities across the globe.

This isn’t the first time Mr. El-Erian has left PIMCO.  He went off to manage Harvard’s endowment in 2005, returning to PIMCO in late 2007. He’s always shown an interest in academic pursuits, so his departure isn’t all too surprising.  Furthermore, I would bet that working with Bill Gross is challenging.  Mr. Gross will turn seventy this year, and it is hard to see him withdrawing from the business any time soon.  In fact, he recently tweeted, “PIMCO’s fully engaged. Batteries 110% charged. I’m ready to go for another 40 years!”[5]

The standard for judging PIMCO has been the performance of its Total Return Fund (PTTRX), which ended the year with $237 billion under management.[6]  The fund lost 1.9% last year, which ranked it in the 60th percentile among similar bond funds according to Morningstar.  To read the financial press you’d think this is an awful result.  While it’s not up to PIMCO’s historic standard, Total Return is still well above average over longer time periods, and it had a much tougher year versus the competition in 2011 when it ranked in the 87th percentile.[7]

According to Morningstar, Total Return lost $40 billion in assets[8] (the rest of the complex must have gained $10 billion) in 2013, a good part of it in the fourth quarter.  This figure only captures the net loss of assets.  In other words, some investors were still buying the fund, while others redeemed.  Even in favorable markets the amount of buying and selling within any given mutual fund is enormous.  According to the Investment Company Institute, the average redemption rate among all mutual funds is roughly 25% of average assets.  Therefore in order to increase assets, the average fund has to find at least 25% in new investment assets every year.[9]  Using Total Return’s semi-annual report filed with the SEC, I was able to estimate that Total Return’s redemption rate was 39% through the end of September.  At that rate all of PIMCO’s existing investors would be gone in just 2.5 years without new inflows.

PIMCO doesn’t just market the fund to retail investors or institutions.  It markets in just about every investment channel.  Moreover, it is available through full service and discount brokers, and for 401(K) plans and IRAs.  As a result there are eight share classes, each with its own marketing and distribution teams.  As you can see from the table below, Mr. El-Erian faced the daunting task of seeing $102 billion flow out of Total Return, while his marketers had found $79 billion just to stanch the bleeding.  Of course, these figures got worse as the year ended.  The annual flows in and out of Total Return were larger than the total size of most mutual funds.

Source: PIMCO Funds, Semi-Annual Reports (September 31, 2012, 2013)[10]

 On the business side, Mr. El-Erian clearly faced monumental challenges in slowing the outflow of investors from PIMCO’s flagship fund.  However, the mutual fund, in which the investments are held, is also complex.  In the past five years, the annual turnover of assets has been between 300% and 584%.[11]  According to Morningstar, portfolio turnover is currently running at 380%, and the portfolio consists of 19,994 bond positions, 30 short bond positions, 514 other positions (various derivative contracts), and 96 other short positions.[12]  While all of this trading was a bonanza for Wall Street, it meant that Mr. El-Erian was overseeing one of the more rapidly trading machines in the world.  And don’t forget, Mr. El-Erian also had to worry about dozens and dozens of institutional accounts managed similarly to the Total Return Fund, which were also experiencing redemptions, as well as massive portfolio turnover. 

It’s easy to imagine that Mr. El-Erian decided it was time to do something else.




[3] Ibid. p. 5

2 comments:

  1. Perhaps -1.9% for PTTRX should not be a disaster; your point about its long-term return is well taken. That said, some investors are already on edge about the uncertain impact of rising interest rates, and in that context it's an unfortunate time for PTTRX to have a down year. I wonder what percentage of PTTRX holdings is traceable to retirement savings, for which investors are disproportionately concerned about preservation of capital. They thought PTTRX was just like a bank CD, but better.

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  2. A large portion of the institutional, administrative and R shares are 401(K) and similar accounts. Anyone who takes a quick look at PTTRX's holdings ought to have a very good idea that this is not a CD.

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