Unlocking Real Value Blog

AK In The News: Morningstar Downgrades Pimco’s Stewardship Grade

While the bad news continues for Pimco in the wake of CEO Mohammed El-Erian’s departure two months ago, I continue to believe that the outlook for the firm and Chairman Bill Gross is positive. I am quoted in an article in today’s Ignites (A Financial Times Service) about Morningstar’s downgrading of Pimco’s Stewardship Grade.

I don’t make much of this action to be honest. Morningstar is not the first firm to put the firm on watch, it took them two months to do so, and frankly it could have been worse. I think they are really just covering themselves in the event the turmoil continues.

To quote from the article: “But Morningstar is not the first “to essentially put Pimco on watch,” Andrew Klausner, founder and principal of AK Advisory Partners a strategic consultancy, says in an e-mail.  However, he is not too worried about the future of the firm. “The key is going to be if performance suffers and if there are major defections in the coming months,” Klausner writes. “Further downgrades to ‘sell’ from ‘watch’ by large pension plans or consultants, based on future moves, would be of concern.””

I did a longer opinion piece for Ignites, which was published on March 4, 2014. The title was “Bill Gross Should Stay Right Where He Is.” It is included below and provides a more detailed analysis of my thoughts on the matter:

The resignation of Pimco CEO Mohamed El-Erian, the expected successor to Bill Gross as head of Pimco, has sparked a lot of chatter over Gross’s own future at the firm.

A recent Wall Street Journal article titled “Inside the Showdown Atop Pmco, the World’s Biggest Bond Firm” recounted bad blood at Pimco ahead of El-Erian’s exit. Some pundits have predicted or even called for Gross’s resignation, as reported.

Reacting to the Journal piece,  Reuters columnist Felix Salmon wrote that “if Gross cares at all about the long-term fortunes of the company he built, the best thing he can do right now is simply retire.”

Despite all the noise, the reality of the situation is that Gross can and will continue to lead the firm. Thoughts of forced resignation or retirement are shortsighted and highly unlikely.

Let’s review some of the arguments that the “Gross must go” proponents are making and dispel them:

Poor recent performance and outflows in the Total Return Fund in particular. It has been a tough time for bond managers as anxiety about rising interest rates intensifies. But Pimco is certainly not alone in this respect, and it seems unfair to single out the company on this account.

After all, 14 Pimco’s bond mutual funds ranked in the top third of their category in 2013 and several had very strong performance. For example, Pimco’s New York Municipal Bond Fund stood in the top 1st percentile of all funds in its category based on its annual returns. Further, Pimco’s Emerging Markets Corporate Bond Fund (Institutional) performed in the top 9th percentile in its category peer group, according to Morningstar.

To be sure, some results have been disappointing; for example, the double-digit losses suffered by at least four bond mutual funds in 2013. However, given the difficult environment for bond funds across the board, there is nothing in Pimco’s 2013 performance that should set off serious alarm bells, particularly when the long-term returns of its bond funds are considered.

There have also been some complaints from various industry voices about Gross’s strict asset allocation policy, especially during a period of increased bond market uncertainty. However, highlighting one investment decision during a tough market sounds a lot like armchair quarterbacking.

What about Gross’s steady long-term performance and success in creating the world’s largest bond fund and bond manager? Morningstar named Gross Fixed Income Fund Manager of the Year three times (1998, 2000 and 2007) and the Fixed Income Fund Manager of the Decade for 2000–2009.

Let us not confuse the exit of El-Erian with normal market cycles. Certainly Gross and the rest of the firm deserve more time to orchestrate a performance rebound before we write his Pimco obituary.

Concerns over a lack of succession planning. Certainly when any firm loses a major contributor and heir apparent people will raise questions. But in this respect, Pimco has reacted quickly and aggressively. The firm has clearly communicated who the six new deputy CIOs are, including the last two winners of Morningstar’s Fixed-Income Fund Manager of the Year award, Dan Ivascyn (2013 co-recipient along with portfolio manager Alfred Murata) and Mark Kiesel (2012 winner).

The firm also quickly appointed a new CEO, Douglas Hodge; a new president, Jay Jacobs; and a new head of strategic business management, Craig Dawson.

One could argue that Gross has built a very impressive organization with talented investment professionals even without El-Erian. His departure also frees up a large pool of capital to compensate current employees and recruit new ones. Multiple media outlets have reported that El-Erian’s annual compensation was in the $100 million range.

People at any organization always hate to lose quality employees and leaders, but it happens and firms can certainly overcome it with savvy hires and promotions.

I am not defending executives who use domineering behavior to achieve results; it is just a reality at many asset management organizations. Historically, employees in this industry are compensated very highly, in part to make up for the stressful work atmosphere. Few people were calling for Bill Gross to retire before this event. So what has really changed?

Pimco and Bill Gross will survive El-Erian’s departure. While it is far too early to predict the long-term effects of the resignation or how the firm will perform as the bond market recovers, the firm has reacted quickly and decisively. It still has the infrastructure and the vast majority of employees that have made it successful in the past.

I would bet on Pimco in the future, not against it. And the smart wager is that Bill Gross will be around as long as he wants to be.

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