To say PIMCO has had a bumpy year is an understatement. In January, Mohamed El-Erian, the firm’s then-CEO and co-chief investment officer (CIO), announced he would be stepping down in March, with Gross continuing to serve as CIO. The firm’s flagship bond fund, Total Return, was shedding noteworthy amounts of assets each month under Gross’ oversight, which continued for a straight year and a half before Gross announced on Friday his departure from the firm he founded in 1971. (See “Investors Flee from Bond Funds in August.”) According to Morningstar, net outflows from the fund totaled almost $70 billion since May 2013.
The Securities and Exchange Commission (SEC) began investigating PIMCO over a year ago to determine whether the firm inflated returns of the exchange-traded Total Return bond fund managed by Gross, according to reporting in the Wall Street Journal and other outlets, and the investigation was made more widely known just ahead of Gross’ announcement.
In the defined contribution (DC) world, the speculation about how retirement plan sponsors and participants will be impacted by Gross’ departure is mixed. “We are anticipating unprecedented outflows [from the impacted PIMCO fund],” said Michael Kozemchak, managing director of Institutional Investment Consulting, in Bloomfield Hills, Michigan.
Pointing to forecasts by Bernstein Research analysts that predict investors could still yank up to as much as 30% of the fund’s assets, Kozemchak says the event puts him in mind of the fund scandals that took place over market timing late in 2000. As to what the event means for retirement plan investors, he reminds plan sponsors of the Department of Labor’s (DOL’s) guidance about their duty of inquiry. In other words, plan sponsors need to be sure they evaluate the fact pattern, evaluate their options and document decisions about plan investments. In the case of the Total Return Fund, he says, “The guy who has run it for 40 years is gone. These massive outflows will translate to underperformance for PIMCO, which will exacerbate their underperformance for the year.”
Without being able to give precise statistics about adoption, Kozemchak says that “many DC plans” have some exposure to PIMCO’s Total Return Fund, so Gross’ departure is a very big shakeup, and one that recalls another top asset manager departing from a fund—Jeffrey Vinik, who stepped away from Fidelity’s Magellan Fund just after reports the SEC would be investigating the fund for unfair stock-picking practices.
“It’s definitely news that this very visible and enormously successful person in asset management is going to another company—from a company he founded no less, but ultimately that’s all water cooler talk,” says Denise Valentine, a senior analyst at Aite Group, which provides research to the financial services sector.
Since the industry is really paying attention to the pricing on exchange-traded funds (ETFs), this is an important development, feels Valentine. “Gross is noteworthy, and everyone is interested in where he is moving and why,” she says. “In the end, though, it’s one person moving from a firm, and there were strong people behind him at PIMCO, and plan sponsors for the most part go to great lengths to avoid key man dependency. So the impact won’t be so big for sponsors, ultimately.”
Managers leave all the time, agrees Jennifer Flodin, DC practice leader and senior consultant of Plan Sponsor Advisors, a division of Pavilion Advisory group in Chicago. The issue is how much of an impact Gross’ departure will have on the fund. Plan sponsors ultimately have to keep an eye on all the risks involved, so obviously in this case there is headline risk, as well as some discussion of whether others at PIMCO will follow Gross to Janus. “What are the outcomes, when PIMCO makes changes?” Flodin asks. “That’s a concern for plan officials.”
Flodin says on an earlier visit this week to PIMCO she saw no signs of this coming. Gross has a substantial track record in bonds, and Flodin points to the wealth of reputable people who have worked alongside and under him.
“The concern is more from an outflow of assets from the fund and potential liquidity issues,” Flodin says. DC plans are heavily invested in the fund, Flodin says, which she feels is probably the No. 1 holding in retirement plans, meaning plan participants could feel some direct impact. Flodin estimates the percentage of DC plan sponsors that use some PIMCO funds at about 70%, with at least some of that number having some exposure to PIMCO Total Return.
More important is that the SEC is spending a lot of time looking at large organizations, Valentine says. “They’re probing more deeply into the business practices that transpire,” she says. “As an industry we want to follow what the SEC is looking at, and whether the type of thing they are investigating is a common practice across the industry, because issues around asset valuation are obviously of critical importance across the entire markets.”
Valentine explains that the SEC is looking at whether PIMCO priced discounts they were getting on certain asset purchases into the net asset value reported for the Total Return ETF. “The details really aren’t all out there yet,” she says. “The way things are done in this business, oftentimes we see common practices becoming ‘best practices’ over time. But it’s quite possible that some of the things that the biggest firms are doing, the leading firms, like PIMCO, need to be reevaluated.”
There’s no way to know exactly what the SEC may have found or what they’re looking for, she adds. But because valuation is used to set the management fees, and so much else stems from that in the asset manager-to-client relationship, valuation is always a critical issue. “Getting the valuation accurate is uppermost in all the regulators’ minds,” she says. “I don’t want to say anything frivolous at this point—we need more information, and we need to know how widespread this type of behavior is, or indeed if PIMCO was engaged in any wrongdoing in the first place.”
This event will be spun in opposing ways by active and passive proponents, feels Kozemchak. “If you are an active shop, you’re going to say this bolsters the case for being with a great active manager,” he says. “On the flip side, proponents of passive management will say, ‘Aha! This is why you don’t want to be in an active fund!’”
Fundamental differences between Gross’ view and parent company Allianz could have played a part, Kozemchak says. “If you look at the Janus press release, he’s interested in managing money for his clients and [there’s been] speculation that he’s been spending a great deal of his time in meetings about the SEC’s investigation and not managing money,” Kozemchak says. The internal environment of PIMCO was a distraction, in Kozemchak’s view. “He wants to get back to his roots buying and selling bonds, and not managing a bond company.”
-- John Manganaro & Jill Cornfield