As Pimco bleeds assets, Bill Gross shows risk of star culture6 min read . Updated: 02 Oct 2014, 12:58 PM IST
Gross's flagship Pimco Total Return Fund lost money every month from May last year, totalling nearly $70 billion by the end of August
London: Bill Gross’ exit from Pacific Investment Management Co. Llc (Pimco) has seen billions of dollars leave the fund group and even more value wiped off the share price of its parent company, offering a warning both to firms who rely on star managers and the investors who chase them.
Gross’s flagship Pimco Total Return Fund lost money every month from May last year, totalling nearly $70 billion by the end of August, Lipper data shows. More money has left since he was escorted to the door of the firm he co-founded in 1971.
With much of a mutual or hedge fund firm’s value tied up in the brain power of its employees, as opposed to bricks, mortar and other hard assets, the loss of an important employee—known in the trade as “key man risk"—exposes the firm to asset flight which can even force it to sell holdings at a loss.
From the corporate blow dealt to Invesco Perpetual after it lost high-performing fund boss Neil Woodford earlier this year to the investors forced to move after hedge fund Highbridge Capital closed its Asia fund when its regional head left in 2011, the risk is industry-wide and notoriously disruptive.
Some have sought to protect themselves by fostering a “team culture", while others, such as hedge fund Brevan Howard, have used employee non-compete clauses and turned to the courts in a bid to limit the impact of important staff leaving.
“Fund firms are caught in a delicate balancing act," said Julian Bartlett, a partner at consultants Grant Thornton.
“They realise that star managers sell, but that they also create a vulnerability if the firm over-promotes the fact that the success of a strategy is down to an individual," he added.
Better to stay?
Pimco’s parent company Allianz saw its shares shed $5 billion in a panic selloff on the day Gross left, a fall that implied a drop in assets at Pimco of nearly twice the amount managed by Gross.
While the share reaction was “massively overdone", a London-based European fund manager said on the day, analysts at Morningstar nevertheless downgraded Pimco’s Total Return Fund to “Bronze" from “Gold" citing uncertainty around just how much money would follow Gross out the door.
By contrast, Gross’s new employer, Janus Capital, saw its shares soar nearly 40% as investors bet Gross would act as a magnet for investor funds.
But those who stay put may have played the better hand.
Lipper data shows that the heir to the throne of the “Bond King", Dan Ivascyn, has been a more successful manager in recent years, making nearly three times the gains recorded by Gross over three and five years, and was on the way to beating him again in 2014, although at a much lower asset base.
Nick Dixon, investment director at Aegon, the Dutch pensions, life insurance and asset manager, said that pattern was far from uncommon.
“Those removing their money from high performing funds purely because the key man has departed, could be missing out on what remain benchmark-beating returns," he said.
“The greatest fund managers and companies share their knowledge with the aim of fostering a culture that leads to continuous outperformance, passing down expertise to understudies who will one day become protégés."
Among those to do it well were Henderson’s EU Select Opportunities fund, which chalked up outperformance of 3.8% in the 17 years that Roger Guy was at the helm, while successor John Bennett managed to beat by 2.2%, he said.
While funds may have succession plans in place, history shows it can be hard to persuade investors to stay.
Neil Woodford, for example, left Invesco Perpetual, a unit of US firm Invesco, earlier this year to start up on his own and took billions of pounds with him.
From the time Woodford said he planned to leave, $4.9 billion has left Invesco Perpetual High Income Fund, while Woodford’s new firm has grown to manage £2.7 billion since launch in June this year.
Even though the Invesco fund has outperformed its benchmark by 2.75 percentage points in the six months since he left the firm, investors voted with their feet, given his performance over more than 25 years career at Invesco Perpetual.
Woodford’s Invesco fund had returned more than 2,200% while the FTSE All-Share Total Return index rose 868% during the period, Lipper data showed. By the time he left, he managed nearly half of Invesco Perpetual’s total assets.
Hedge the hedge
For all the headlines grabbed by Pimco and Gross, and the various examples of asset outflows at mutual fund managers which can be particularly bad for listed firms, the biggest concentration of “key man risk" for investors is in the $3 trillion hedge fund industry.
Typically founded by a person or small group of people, hedge funds often use borrowed money to make big bets in quite illiquid markets to generate outperformance—all of which leaves them even more vulnerable to changes in management.
Even though many of the largest fund firms are looking to diversify and become more like mutual funds, the vast majority rely on a single product generally dependent on a single manager, with all the investor risk that implies.
Nearly nine out of every ten hedge fund firms tracked by Eurekahedge have no more than two products, while three quarters of the 3,736 companies have just one product.
Pressure from institutional investors such as pension funds to protect against key man risk have led some hedge funds to deepen team expertise and bring in an independent risk manager, with the power to step in and liquidate portfolios if needed.
Alan Howard, owner of top European hedge fund Brevan Howard, resorted to an onerous five-year non-compete clause in an attempt to limit the impact of star trader Christopher Rokos from leaving—a shackle he is currently trying to break in the high court.
At the most cataclysmic end, the exit of an important figure can mean the end of the fund itself, such as when Highbridge Capital was forced to liquidate its Asia fund in 2011 after regional head Carl Huttenlocher left to start his own fund.
While investors can always choose to move their money elsewhere, not all are aware of the dangers of being forced to.
“There are a lot of newer investors into hedge funds who have not fully factored that (key person risk) in," said Chris Hawkins, a portfolio manager at fund of hedge funds Gottex.
“I think that type of investor probably doesn’t price correctly the risk of key man and consequently it’s more of a box having been checked rather than really thinking about what it means, what rights we should be able to have in the event if there is a problem," he said.
Mandate contracts between investors and hedge funds usually have a “key man clause", which can lay out protections and rights to withdraw money if a manager leaves or is incapacitated.
But it is not a panacea, said Steven Clark, founder of Omni Partners, pointing out that other factors besides departure or death can affect a fund manager’s performance, and investors may not always be able to get money back as quickly as they want.
“It’s not just the case of the guy getting hit by a bus. Other things can go wrong with your key man that are not necessarily covered in any document," he said. Reuters