PIMCO's Biggest Outsider Talks Inside Baseball

Rob Arnott is perhaps more closely tied to PIMCO than any other outsider. As manager of  PIMCO All Asset and  PIMCO All Asset All Authority , his firm, Research Affiliates, is PIMCO's only subadvisor. While running these two funds of PIMCO funds for 12 years, he has met monthly with PIMCO employees, including portfolio managers. This has given him greater access and insight into the firm's inner workings than most others outside of PIMCO.

Joined at the Hip
Given these close ties, it perhaps isn't surprising that Arnott professes greater faith in PIMCO than ever following the Sept. 26 departure of founder and co-CIO Bill Gross. After all, the $59 billion that Arnott manages in the two All Asset funds represent about a third or more of Research Affiliate's assets, and an even greater percentage of the firm's revenues. Plus, Arnott was named a comanager of PIMCO's nine Fundamental/RAFI strategies on the day Gross left. (Arnott's Research Affiliates constructs the underlying fundamental indexes that these funds track through derivatives. PIMCO then manages the collateral backing the derivatives.) These appointments acknowledge an arrangement that already existed, but they further cement Arnott's relationship with PIMCO.

So, Arnott's hardly a disinterested observer. But his success depends, in particular, on the more than 40 underlying PIMCO funds in which his All Asset funds exclusively invest. And he says that he still sees this as a competitive advantage rather than a burden.

In fact, he builds the success of these PIMCO holdings into his return expectations. He assumes his PIMCO funds will generate about 1% or so of alpha annually on average, and so far, the PIMCO funds in his tool kit have delivered. This is critical for hitting his return goals of the Consumer Price Index (CPI) plus 5% for PIMCO All Asset and CPI plus 6.5% for PIMCO All Asset All Authority.

PIMCO Ex-Total Return
While dependent upon PIMCO, Arnott's All Asset funds weren't that affected by Gross' departure. Gross' funds never claimed a big share of either All Asset fund's portfolio--just 6.5% combined of PIMCO All Asset and 9.8% of PIMCO All Asset All Authority as of June. Flagship  PIMCO Total Return (PTTRX) topped out at 8.0% of PIMCO All Asset's portfolio way back in December 2005; as of June, it was 3.1%. It was 14.5% of PIMCO All Asset All Authority's portfolio in December 2009, but was 3.8% in June.

So, unlike for the typical Total Return fund shareholder, PIMCO for Arnott is less about Gross and more about the rest of the team. He says his faith in that group remains rock-solid. Few, if any, of PIMCO's team are likely to join Gross, although other firms could poach talent. Those that remain have been responsible for the PIMCO funds that have outperformed 75% of their category peers on average during the past three years. Plus, as Arnott points out, PIMCO still boasts the last two Morningstar Fixed-Income Fund Managers of the Year in Dan Ivascyn and Mark Kiesel. (Ivascyn's  PIMCO Income was 10.3% of All Asset's portfolio in June and Kiesel's PIMCO Long-Term Credit (PTCIX) was 4.2%.)

Furthermore, Arnott says that Gross' departure simply pulled forward an event that was inevitable anyway, given that he is 70 years old. True, Gross' timing caught everyone off guard, but PIMCO had been planning for this event since Mohamed El-Erian announced his resignation in January. Thus, new group CIO Ivascyn and his team had eight months of preparation before Gross left. Ultimately, Arnott believes this could be a good thing for PIMCO. While he feels the way in which Gross left was unfortunate, it removes a source of uncertainty and allows the firm to begin its next chapter. Truth be told, Arnott says he was more concerned about the firm a year ago than he is today.

Liquidity
Amid fears of mass redemptions, liquidity has been one of the main concerns in the wake of Gross' departure. But here, too, there seems to be a big dividing line between Gross' three main charges, PIMCO Total Return,  PIMCO Low Duration , and  PIMCO Unconstrained Bond , and PIMCO's other offerings. It's still early days, but of PIMCO's $23.5 billion in September outflows, the vast majority came from those three funds. While consultants and advisors who have recommended Gross' funds in the past may feel compelled to sell first and ask questions later, that likely won't happen with the firm's other offerings. As always, though, PIMCO's funds will ultimately need to perform well to retain assets.

Given that the All Asset funds are such large shareholders in a number of PIMCO offerings, there has been concern as to how shareholders in Arnott's own funds might respond. This was a particular concern with PIMCO All Asset All Authority, given its use of leverage and subpar results in 2013, which had already led to significant outflows. During the past 16 months through September, that fund has had an estimated $13.4 billion in net outflows, equal to more than a third of its May 2013 asset base.

However, the shareholder reaction in the All Asset funds was fairly mild in September alone. PIMCO All Asset had net outflows of roughly $330 million, while PIMCO All Asset All Authority had an estimated $590 million go out the door. Those amounts aren't insignificant, but they're hardly catastrophic for funds with $59 billion in combined assets, and neither is large enough to stress the underlying PIMCO funds from which they draw on, particularly since market conditions have been fairly benign.

Overall, PIMCO will remain under intense scrutiny in the months and years to come, but at least as far as Arnott is concerned, his partner firm's future remains bright.