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Rekenthaler Report

PIMCO's Perils

How serious are they?

Taking a Body Blow
The Wall Street Journal created a buzz with last week's feature story on PIMCO. The article was business reporting at its finest--inside coverage of a major organization at a crisis point. When Mohamed El-Erian, the company's former CEO, announced in January his resignation from PIMCO, it raised suspicions among industry observers. El-Erian was 14 years younger than his boss, chairman Bill Gross, and was viewed as his successor. The Journal's Gregory Zuckerman uncovered the personality clash that led to El-Erian's departure, in a colorful and well-written account.

PIMCO is tough on its employees. Newport Beach, Calif., might evoke the image of Jeff Spicoli, but just as Sean Penn was wired far more tightly than was his surf-loving character, so too is Bill Gross' PIMCO a less sunny place than its oceanfront office suggests. Per The Wall Street Journal's account, employees can anger Gross merely by speaking to him, or looking him in the eye as he walks by. Adding to the stress caused by personal intimidation are long work hours (investment professionals are expected to work from 4:30 a.m. until at least 5 p.m., as well as be available on weekends as required), the expectation of consistently good investment performance, and a climate that encourages internal competition. It is not what one would call a collegial workplace.

For senior employees, goes the story, matters are worsened by Gross' mercurial leadership. Lieutenants jostle for approval, are rewarded with praise and Gross' attention, and then are shuttled aside for new favorites. According to one former PIMCO executive, Gross "routinely grew tired and wary of those closest to him … the chosen one's halo would turn into a crown of thorns where interactions with Bill would turn adversarial, short, and unpleasant."

So PIMCO isn't much fun; it has a revolving door of senior management; and founder Bill Gross, at age 69, has not established a succession plan. What should be done? 

Felix Salmon of Reuters says that the founder must go. In "It's time for Bill Gross to retire," Salmon writes that after the publication of The Wall Street Journal's "downright brutal article … neither Gross nor PIMCO will ever be seen in the same way again." Gross should step aside so that the company can be managed professionally. His "natural tenure at PIMCO has come to an end."

I have a different take.

First, I don't think that PIMCO's institutional owners will be all that surprised. The investment world is small enough, and PIMCO large enough, such that the core of this story was known to outsiders before the article was published. We could not say for certain that El-Erian left the company feeling discontented--but we strongly suspected. Nor had we heard that Gross stated in front of PIMCO employees that he could run all the company's money himself, because he is "Secretariat." But such is the nature of successful portfolio managers; humility does not run with the breed. As for PIMCO's difficult work environment, Morningstar analysts have been aware of that. So too, I suspect, have been the company's institutional clients.

That PIMCO continues to be run as a (giant) boutique, dominated by the personality of its founder, is revealed by Bill Gross' shareholder letters. They are quirky, seemingly unedited affairs--clearly the work of an individual who does not answer to anybody. (Which could be said for these columns as well, but I am a research blogger, not the chairman of a multi-billion-dollar operation.) They do not suggest a corporate machine.

Second, while I agree with Salmon that institutional investors care more about governance than do most financial advisors and fund shareholders--Morningstar's stewardship grades have always attracted more attention from institutions than from a retail audience--the investment business is still first and foremost a number's game. Managers who perform well receive the benefit of the doubt on all other items, governance included.

Note, for example, that this story came out not when PIMCO's funds were riding high, but instead after a disappointing year. It's not that governance doesn't matter, exactly. It's instead that governance issues inevitably become colored by the company's performance. If PIMCO funds are doing well, that is because Gross demands higher standards than other fund-company chairmen. Yes, his approach isn't for every employee, as only the very strongest survive--but aren't the very strongest those who you want in charge of your money? Would you prefer those investment managers who can't handle the pressure?

You can see the spin. It's not that PIMCO would put the matter directly with its institutional customers. It might not even allude to its corporate culture in its discussions. But those who hold the funds would know how PIMCO operates, and that would be the narrative that they would tell themselves.

Now, of course, institutional investors are singing a different tune. PIMCO's numbers have been mediocre, its founder's professionalism has been challenged, and thus it is a time for concern. PIMCO is under watch. I think the key issue for this watch, however, is not the changes that PIMCO makes to its management structure, including Gross' possible departure, but rather the performance of its funds. If they recover, so will PIMCO's reputation. The narrative will be rewritten.

In short, I agree with Salmon that PIMCO suffered a public-relations blow--it would be hard to argue otherwise!--but we differ in the severity of the blow. He believes it to be fatal. I believe instead that although the story shortens the time that the company will be granted to improve its investment results, all will be (mostly) forgotten if the numbers improve. 

This column followed Salmon's in being written from the perspective of an industry observer, not of an investor. However, I am also the latter, owning three PIMCO funds in Morningstar's 401(k) plan. My view as an owner is similar. Bill Gross has run PIMCO in this fashion for a quarter century now. The process has worked. It is possible that something is different now, and that perhaps the past success cannot translate into future results. It is also possible that Salmon is correct and I am not, and that PIMCO will be under immediate and severe pressure from clients that will affect its ability to deliver the investment goods.

However, I think it likelier that the company will right the investment ship, the criticism will quiet, and things will return to something approaching normalcy. 

I have no desire to work at PIMCO. But would I own the company's funds? Yes, sure. 

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.