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Inside PIMCO's Intellectual Pressure Cooker

Bill Gross and company keep their edge with fierce debates.

Eric Jacobson, 04/14/2010

In most ways, PIMCO has long had a standout corporate culture, despite originally being the product of an insurance company--a lineage that has produced many far less successful and less investor-friendly asset managers. Cochief investment officer Bill Gross is the founder around whom PIMCO was built, though, and his essential nature as an investor, above all else, has been a critical anchor for the firm.

The tone was set early on by Gross who favored a total-return approach to bond investing, which has since become de rigueur, but which was novel as recently as the early 1990s. By contrast, most bond funds were sold almost entirely on the size of the yield they could advertise, which invariably led to risk-taking, unexpected volatility, and losses that often surprised investors who otherwise thought they had purchased "safe" investments. Those investing with Gross have often found themselves looking at comparatively modest income payouts, but total returns that have almost always been much better than average.

Risk Control, Inside and Out
Although the complexity of its strategies, tactics and favored investing tools is often taken for aggressiveness, a fierce attention to risk is built into every element of PIMCO's investment and operational processes. The workings of PIMCO's investment committee illustrate the relationship between its approaches to performance and risk control. The committee is composed of a handful of PIMCO's most senior portfolio managers who meet no fewer than 4 times per week, for hours at a time, to debate matters of the market and economics. They invite colleagues to come and present ideas, while some rotate through for stints on the committee in order to encourage a diversity of views. Critically, dissent is prized, and managers have incentive to second guess the investment committee. Outsiders are also invited to make presentations, with the exercise intended to force PIMCO's smartest decision-makers to, in the words of CEO and co-CIO Mohamed El-Erian, see the world from the perspective of others.

That may sound odd given popular perceptions of PIMCO shaped by Gross' prolific writing and appearances on television, but there is in fact a legion of truly brilliant managers and analysts toiling behind the scenes. Any number of them would be stars around which other firms were built if they weren't at PIMCO. The firm's ideal hire has sometimes been described metaphorically as an all-around star athlete, with less emphasis on whether a new arrival will fill a very specific need or role. And while many firms were pressured to cut staff by circumstances of the 2007-08 financial crisis, PIMCO made numerous impressive hires to beef up its managerial ranks. One of the most recent was former interim assistant secretary of the treasury Neel Kashkari. Despite that pedigree, as well as time spent at Goldman Sachs, Kashkari came to PIMCO with no notable experience in the fund industry. Given his reputation is consistent with the "star athlete" model, however, the firm was anxious to hire him even before a decision was made to have him head up efforts to build out PIMCO's new equity investing capabilities.

It's Hot in the Kitchen
All of that brainpower and second-guessing is indicative of an incredibly competitive and pressurized culture that is not hospitable to all. There is a large cadre of bond managers in southern California, and east coast bond market hours mean that they all get up early. Even in that group, however, Gross is known to hit the office well before dawn and on weekends, and to fire off e-mail queries at all hours. He's not the only one either. Mark Kiesel, PIMCO's global head of credit, reportedly gets in at 3:30 a.m. It's not just an issue of face time, either. Everyone is expected to contribute ideas frequently and at a high level. In fact, a small handful of managers and analysts--some with big reputations of their own--has either left or been pushed out in recent years, and that crucible of an environment has been a key driver of those exits in some cases. But while such departures have naturally drawn the scrutiny of Morningstar and others, there is scant evidence to suggest the organization has been materially weakened as a result. Even those who left have rarely had anything but positive things to say about the excellence of PIMCO's money management.

The deliberate style with which PIMCO has historically introduced new funds has been, and continues to be, indicative of an investor-friendly culture. The firm has certainly at times been aggressive about introducing new offerings. But while some of them have benefited from reasonably good timing of inception, PIMCO does not have a record of rolling out niche funds simply to take advantage of popular trends. Rather, most have been driven by ideas and developments in institutional management, or in some cases developments in financial markets that have made one strategy or another newly feasible. The firm's real-return lineup has expanded into an industry juggernaut, for example, but PIMCO Real Return PRRIX was launched almost immediately after the introduction of what are now referred to as Treasury Inflation-Protected Securities more than 12 years ago. PIMCO was confident that it was a game-changing development for investors, yet other companies were skeptical.

The Blind Side
One area with which Morningstar has some concern is size. PIMCO Total Return PTTRX now has more than $200 billion and is the world's largest mutual fund. That girth has by Gross' own admission made managing the fund more challenging, but he has continued to argue that the fund's size has yet to warrant closing it off to new investors, and he points to performance as the ultimate measure of that question. It's clear that Gross has adapted better than almost any other manager ever has before to massive asset growth, certainly among bond funds, and he has continued to produce peer- and index-beating results. His command of big-picture macroeconomic and sector themes has clearly been at the root of that success, and there is good reason to believe he can persist--it's unclear how long, however, or whether there might be limits above which the fund's size becomes too burdensome. It's a question Morningstar continues to ponder and research.

Arguably more important is the cost picture for investors in PIMCO's non-institutional share classes. Several are priced high relative to similarly structured peers, and sometimes emphatically so relative to the economies of scale the firm enjoys. It's difficult to pin down why this issue has failed to gain more attention within PIMCO, particularly given Gross' occasional public comments about the headwind of high fund costs, most recently in a 2009 column that referred to 0.75% bond fund expense ratios as an "extreme absurdity." Other PIMCO representatives have offered that the world-class caliber of its management is ample justification for its fees. There is some merit to that argument, but non-institutional share classes sometimes carry fees that are simply too high to recommend, no matter how good the management. And that's really the ultimate issue, especially for a fund group that has some of the best economies of scale of any in the world.

There's no question that PIMCO's overall culture, and what it has produced for investors, deserve significant recognition. On so many levels, this firm approaches or achieves best-in-class status. The aforementioned cost issues, however, are enough to keep it from earning Morningstar's highest grade. Its Corporate Culture score is therefore a B.

Eric Jacobson is a fund analyst with Morningstar.


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