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TCW Makes Strides Toward a Healthier Culture

The firm takes meaningful steps to remake itself after painful divorce from a star manager.

Sonya Morris, 06/09/2010

TCW took its lumps after it fired star fixed-income manager Jeffrey Gundlach in December 2009. Since that time, the firm's culture has been transforming. While the picture isn't quite clear yet, there are some encouraging signs that suggest that the firm is becoming more shareholder-focused than it was before.

The impetus for this change began with Gundlach's dramatic ouster. Fearful that he would jump ship and take a significant portion of the firm's clients and assets with him, TCW made a preemptive strike: It sacked Gundlach and accused him of stealing proprietary client and investment information. Over the next few days, the vast majority of Gundlach's team followed him to a new firm that he set up very quickly after his dismissal.

Immediately upon discharging Gundlach, TCW announced that it would purchase Metropolitan West Asset Management and that MetWest's bond team would take over the fixed-income side of TCW's business, including the management of the firm's flagship bond fund, TCW Total Return Bond TGLMX.

Investors reacted to the news of Gundlach's dismissal by yanking $5.8 billion out of the fund over the month following the announcement. Although outflows have slowed considerably since then, TCW Total Return Bond's total net assets have declined from just less than $12 billion in November 2009 to $5 billion at the end of May 2010. The announcement had an impact on TCW's institutional business as well. According to some reports, total redemptions out of all accounts formerly managed by Gundlach reached $18 billion.

Clearly, the stakes were high for TCW, and it's fair to question the firm's handling of the situation. Dismissing a talented and experienced manager who had delivered outstanding results for investors hardly seems like a shareholder-friendly move. Moreover, one could see the firm's actions as an attempt to protect its asset base rather than fund shareholders.

Officials at TCW and its parent, French bank Societe Generale, argue that they took responsible steps to address key-man risk both at the firm and at the fund level. If Gundlach were to leave abruptly, as TCW legitimately feared, that very likely would have provoked even more massive withdrawals, forcing the firm to make distressed sales in order to meet redemptions, which in turn would have hurt fund shareholders.

While some might question the firm's ultimate motivation, it's difficult to argue with TCW's choice for Gundlach's replacement. MetWest's investment team is successful and experienced in its own right, and it was one of the few shops with the degree of mortgage expertise necessary to take over TCW Total Return Bond. The handover to the team was seamless and immediate.

In addition, it's hard not to see TCW as a healthier place without Gundlach. Now that they have come out from under his shadow, the firm's equity managers are more involved and appreciated. There's more interaction between the equity and fixed-income sides of the business and more sharing of ideas. The MetWest team has always been a close-knit, collegial bunch, and it quickly reached out to TCW's equity managers. Now, fixed-income CIO Tad Rivelle and equity CIO Michael Reilly meet weekly and encourage the sharing of ideas between teams.PAGEBREAK

This represents a meaningful break with TCW's past. Since its founding in 1971, TCW has operated as a collection of autonomous investment teams, with each group of managers negotiating separate fee-sharing arrangements with the firm. As a result, the equity side of TCW has formed into a disparate group of managers, some located in Los Angeles and some in New York. This arrangement kept the equity managers (many of whom have lengthy tenures at the firm) isolated from the turmoil on the fixed-income team, but it also inhibited communication between investment staff and didn't link the managers' fates directly with that of the firm.

In the wake of the Gundlach imbroglio, the firm has taken steps to adjust its model. It has encouraged more cooperation between investment teams, and CIO Reilly views it as his primary responsibility to facilitate conversation and idea-sharing among and between the various investment groups at TCW. In addition, TCW has taken formal steps to share firm ownership with the investment staff. In early May 2010, the firm announced that it had launched an equity-ownership plan that would provide key personnel with restricted stock in TCW that vests over a five-year period. These moves seem designed to better align the managers' fates with that of the firm and to make the investment staff a more cohesive group.

There's reason to believe that the acquisition of MetWest can help forward that cause. The founders of MetWest have worked together for years, first at PIMCO in the early days of their careers, then briefly at Hotchkis and Wiley, then finally at their own firm, which they founded in 1996. And throughout the firm's history, they've fostered a sociable and collaborative environment.

MetWest has already had a positive influence when it comes to shareholder communication. TCW has long provided an informative and active website that includes regular manager commentaries, white papers, and webcasts. However, the volume of output has increased meaningfully since the MetWest managers have been on the scene. Moreover, some of the fund strategies at TCW are complex, and the fund managers make an extra effort to provide investors with the background necessary to understand the strategies and interpret the results.

Given TCW's strong communication efforts on its website, the management discussions in its funds' annual reports are strikingly cursory. Many cover just one page and concentrate primarily on performance attribution, rather than providing detailed rationale for portfolio changes. Here again, TCW could learn from MetWest, which provides more-detailed and forthright management letters in its annual reports. MetWest also presents better portfolio summary detail (such as sector and quality positioning) for its funds than TCW does.

We hope the MetWest team will also have a positive influence on fees at TCW. While TCW's biggest funds (most notably TCW Total Return) charge reasonable fees, many of its equity offerings are pricey, particularly on the N share class, which is distributed via fund supermarkets. To be fair, the firm has brought some fees down to more competitive levels recently. For example, at the end of April 2010, the expense ratio for TCW Growth Equities was capped at 1.20%, down from 1.47%. That's not exactly cheap for a no-load mid-cap fund, but it's more in line with what its typical competitor charges. Still, TCW has plenty of room to bring expense ratios down further. That would go a long way to improving the overall shareholder experience across the complex.

TCW clearly wants to grow its business, motivated both by the ambitions of firm management and parent Societe Generale's desire to generate a profit from its investment in the firm. The company is likely to pursue growth both domestically and internationally. Here again, MetWest could provide a positive model. The firm managed its growth at a deliberate and moderate pace by gradually adding new strategies that meshed with its investment process and that could be adequately supported with firm resources. That said, TCW's growth plans are likely still taking shape, as the firm is in the process of digesting the major changes it has been through.

Indeed, TCW is still in the early stages of life after Gundlach. So far, many of the signs are encouraging. The MetWest team has brought a spirit of cooperation and collegiality to the firm, and it has also brought a long record of shareholder-friendly behavior that will hopefully bleed over to the rest of TCW. Still, while there are some definite positives here, this new partnership is only recently forged and the combined culture is still being formed. In addition, while equity ownership may help the firm retain key investment personnel and avoid a repeat of the Gundlach episode, it can also breed conflicts, as certain actions that are beneficial to money-management firms--such as growing assets and raising fees--are not always in the best interest of fund shareholders. Given TCW's past, we can't be entirely confident that the firm will always settle such conflicts in favor of fund shareholders, but the recent changes hold promise and suggest that TCW's culture is heading in a healthier and more positive direction.

Sonya Morris is an associate director of fund analysis with Morningstar.

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