Category Archives: bond market

massive redemptions at PIMCO? …I don’t think so

September 30, 2014 By in bond market, Getting financial advice, How your broker gets paid, mutual fund holders and financial advisors, securities markets Tags: , , , , , Leave a comment

Late last week, bond guru Bill Gross, founder and public face of PIMCO, resigned from that firm to go to work for a much smaller rival, Janus.  This has led to speculation that the departure of Gross, who crafted the superior long-term record of the PIMCO flagship Total Return bond fund, would cause the loss of as much as 30% of the $1.8 trillion PIMCO has under management.

I don’t think the outflows will be anywhere near this bad, for a number of reasons:

1.  PIMCO deals in load funds, meaning that retail investors must pay a fee to buy them.  Two consequences:

–owners find the fact of the fee, not necessarily the size of it, a psychological barrier to sale.

–the load-fund client typically places a sell order through his broker.  The fact he can’t just go online in the middle of the night and redeem is another barrier to sale.  When called, the financial adviser can make reasoned arguments that persuade the client to hold on.  The broker may also convince the client to move to another bond fund in the PIMCO family, so that money leaves the Total Return fund but stays in the group.

What’s to stop a broker from using the Gross departure to call all his clients and tell them to take their money from PIMCO and place it with a different family of load funds–thereby generating another commission for him/her?  Generally speaking, such churning is illegal.  The transactions might even be stopped by the broker’s own firm.  Worse yet for the broker, this kind of call is pretty transparent as a fee grab.  It might also invite questions about where the broker was when the Gross performance began to deteriorate.

2.  My experience in the equity area is that while no-load funds can lose a third of their assets to redemptions in a market downturn.  Under 5% losses have been the norm with the load funds I’ve run.  Even smaller for 401k or other retirement assets.

3.  Money has already been leaving PIMCO for some time.

–Bill Gross’s performance has been bad for an extended period.

–He’s been acting like a loose cannon.

–Mohamed El-Erian’s leaving PIMCO was particularly damaging.  I think most people recognize that Mr. El-Erian is a professional marketer, not an investor.  But he was being paid a fortune to replace Gross as the public face of PIMCO.  Why leave a sweet job like that  ..unless the inside view was frighteningly bad?

At some point, however, PIMCO will have lost all the customers who are prone to quick flight.

PIMCO will try hard to get clients to stay.  It will presumably concede that it waited much too long to rein Mr. Gross.    But, it will argue, a seasoned portfolio manager at PIMCO, Dan Ivascyn, has now taken over the Total Return fund.  Supported by the firm’s broad deep research and investment staff of more than 700 professionals, Ivascyn will stabilize performance.  So the worst is now over.  In fact, Gross’s departure may have been a blessing in disguise.

4.  Arithmetic.  About $500 million of PIMCO’s assets come from its parent, Allianz.  Presumably, none of that will leave.  Third-party assets total about $1.3 trillion.  A loss of 30% of total assets would mean a loss of over 40% of third-party assets.  That would be beyond anything I’ve ever seen in the load world/

5.  Although individuals are prone to panic, institutions act at a more measured pace.  It would certainly be difficult to persuade institutional clients to add more money now, but it should be easier to persuade them to allow the assets they now have at PIMCO to remain, while keeping the firm on a short leash.

In sum, I can see that in the wake of the Gross departure, PIMCO could easily lose 10% of the third-party assets it has today.  I think, however, that the high-end figures are being put out for shock value and without much thought.

Bill Gross, PIMCO and Janus

September 29, 2014 By in bond market, Portfolio management, Recent Market Action, securities markets Tags: , , , , , Leave a comment

Bill Gross is the (until recently) extraordinarily successful  lead portfolio manager for the bond titan PIMCO, which he co-founded and which he sold to the European financial conglomerate Allianz in 2000.

Late last week, Gross abruptly resigned from PIMCO to join Janus Capital, a much smaller, equity-oriented firm with a checkered history.  The apparently hasty departure seems to have come after Gross learned he was about to be terminated.

My take:

1.  The PIMCO brand has been built on two ultimately unsound pillars:

–a customer should buy PIMCO products because they would always outperform every other alternative, and

–the brilliant portfolio manager, Bill Gross would supply the returns..

2.  The problems with this brand strategy have certainly become apparent to Allianz in recent years:

–although retail investors don’t think of age as an issue with a portfolio manager, institutions do.  They worry that once a manager reaches, say, 60–and certainly when he/she reaches 65–that the manager will soon leave, that either retirement or illness will force a change.  So for institutions a key question is who the star manager’s successor will be.  It seems to me that, despite a deep, talented bench at PIMCO, Mr. Gross never permitted a successor to be designated.

–Mr. Gross’s string of stellar performance years appears to have come to an end at around the same time interest rates reached their lows.  Since then, my cursory observation is that Gross upped the risk level of his flagship fund, in an attempt to boost returns.  The strategy hasn’t worked, but it has added another level of worry.

3.  Allianz addressed the succession issue, not by selecting a skilled insider with a strong performance record, but by bringing in marketing celebrity Mohamed El-Erian as Mr. Gross’s successor.  This was a weird choice.  Yes, Mr. El-Erian had once been a PIMCO employee   …but he had limited portfolio experience and no public record of successful management.

It’s unclear to me whether Allianz did so because it didn’t know any better or whether the-appearance-of-a-successor-without-there-actually-being-one was all Gross would accept.  The idea may have been that El-Erian would take over many of Gross’s marketing duties, leaving him more time to concentrate on his portfolio.

4.  Mr. El-Erian resigned from PIMCO early this year.  It’s unclear why, although I can imagine several reasons:

–he was unsatisfied with his role as spokesmodel for PIMCO,

–he realized he would be held to blame for PIMCO’s continuing underperformance, even though he had no power to influence it, and

–Allianz came to understand–perhaps with help from PIMCO’s senior investment staff–that Mr. El-Erian was not a particularly good pick to become PIMCO’s lead portfolio manager.  It’s interesting to note that Mr. El-Erian, although still on the Allianz payroll, plays no role in the post-Gross restructuring.

5.  My guess is that the leadership transition at PIMCO has been completed with the appointment of a skilled veteran PM to lead PIMCO, and that the outcome is a lot better than it could have been.  It remains to be seen whether Mr. Gross can reestablish his performance record at Janus.

 

 

the SEC is investigating PIMCO’s pricing of its Total Return (BOND) ETF

September 24, 2014 By in bond market, Industry Analysis, Investment firms, securities markets Tags: , , , , , 1 Comment

Another day, another PIMCO problem.

The Wall Street Journal reports the SEC is investigating whether the bond fund giant used its clout with brokers to get them to steer favorable investments to its Pimco Total Return (ticker = BOND) ETF, artificially inflating its performance in its early days.

I suspect the issue is a little more complicated than that.

background

We all know, or should know, that Wall Street likes to erase its mutual fund mistakes.  Underperforming managers get fired.  An investment management company’s week-record funds get disappeared by being merged into better performing ones, keeping the assets in house but eliminating the ugly track record.

When I entered the business, investment firms routinely used other practices, now considered unethical/illegal.

For example:

–many investment management companies used “incubator” funds, that is, they would create a bunch of mutual funds, seed them with small amounts of money and run them in-house–but not offered for sale to outsiders.  After a year or two, those with strong records were opened to the public and supported by marketing campaigns touting their sterling performance.  The laggards were simply shut down.  Fidelity Magellan, for instance, was originally one of these.  The practice is now illegal.

–big investment firms would also sometimes give a new or weak-performing fund a boost by allocating to them a disproportionately large amount of the “hot” IPO flow it, as a big commission generator, would get from brokerage houses.

I knew of a fund manager (brokers and traders love to gossip) from another organization who ran a mid-sized fund and had decided to go out on his own.  He persuaded the brokers he dealt with to feed him with large IPO allocations for several months.–in return, presumably, for future favors when he hit it big.  His performance skyrocketed–and he got Schwab to tout the fund he subsequently created.  Without constant shots of IPO adrenaline, his performance was never the same, hwever–and he was finally undone in an asset mispricing scandal during a severe market downturn.

The practice of selective IPO allocation within asset management firms was generally abandoned in the 1990s.  I’m not 100% sure why, although I can’t believe regulatory pressure wasn’t the main factor.  Hair-splitting:  I’m not sure the practice itself was the problem or the fact that fund management companies didn’t disclose what they were doing.

the PIMCO case

According to the WSJ, the issue here revolves around “odd lots” (meaning small amounts, or tag ends) of some thinly traded bonds.  They’re regarded as more of a nuisance than anything else–like you or me having 0.36 shares of a stock–and trade at a discount because of this.

PIMCO’s trading desk apparently let its brokers know that it was interested in buying any odd lots they might be able to find.  These were then funneled into BOND.

Since the junk bond collapse of the late 1980s, the daily pricing of bond funds has been handled by third parties, not by the investment management companies themselves.  The outside pricing services apparently don’t distinguish between odd and round lots.   So at the end of the day on which an odd lot was bought for, let’s say 98, it would be priced at, say, 100 or 101.

Bam!  …a “magic” jolt to performance.

That’s even though the odd lot could only be resold for 98 or so.

Pretty clever.

However, the trick can only move the needle for a small fund.  The extra returns the move appears to generate can’t be sustained as the fund grows.  So performance numbers achieved in this way are arguably deceptive.  They don’t really represent the kind of performance holders should expect as time goes on.

what’s wrong with doing this?

I can think of two possible SEC concerns, assuming the WSJ has the facts right about PIMCO’s conduct:

–that PIMCO didn’t disclose that is was using odd lots  to exploit a quirk in the ETF’s pricing rules and thereby boost returns

–all investment management firms have trading compliance rules that determine how buys and sells get distributed among the many pools of money it is managing.  PIMCO may have overridden its own rules if it diverted to BOND all/most (?) of the odd lots it bought.

why?  or what sparked SEC interest?

On the second point, what was  apparently going on would be immediately evident to any bond portfolio manager who looked at BOND’s SEC filings.  I presume a rival complained.  Or course, it may be that a disgruntled broker or trader notified the regulator.

In any event, this odd lot activity was bound to be noticed, and fairly quickly.

Why would anyone risk professional embarrassment or regulatory sanctions?   I have no idea.

 

 

 

evaluating stocks vs. bonds

August 5, 2014 By in bond market, securities markets, stock market, Strategy Tags: , , , , , 1 Comment

In theory, there’s no demand for stocks.  There’s also no demand for bonds.  There is, however, a demand for liquid forms of saving, a category that includes stocks, bonds and cash.

Each of us will choose a basket containing a somewhat different proportion of the three, depending on factors like age, wealth and risk tolerance.  But for all of us, a change in price of any of the three will probably persuade us to shift away from the more expensive investments and toward the now-cheaper one.

Given that the Fed has been signalling for some time that a rise in interest rates–meaning a change in the price of cash–is on tap for next year, the question of how this will affect the price of the other two, bonds and stocks, is probably the most important near-term investment issue for you and me.

One way of starting to look at this issue is to look at what the current price relationship between stocks and bonds is.  The typical way this is done is to compare the interest yield on Treasuries (either the 10-year or the 30-year) with the inverse of the PE on a market index like the S&P (academics call 1/PE the “earnings yield,” because it measures the portion of total profits that each share has a claim to, divided by the share price).

Over my investment career, Wall Street has taken stocks and bonds to be at roughly equivalent value when the interest yield = earnings yield.  (During the 1950s bonds traded at a considerable premium; during the Great Depression, dividend yields exceeded coupon payments on bonds.  But I don;t think either period is relevant today.)

As I’m writing this, the S&P 500 stands at about 1930.  EPS for the index in 2014 will probably come in at about $110.  Thus, the PE of the market on 2014 earnings is about 17.5x.  This means the earnings yield is 5.7%.

EPS for the S&P in 2015 will likely rise to $125+, implying a market PE of 15.4x and an earnings yield of 6.5%.

In other words, the S&P already seems to be discounting a 250 bp increase in the yield on the 30-year Treasury.  Arguably, this is more than the long bond yield is likely to rise in the coming normalization of interest rates by the Fed.

I don’t think this guarantees that stocks will have smooth sailing throughout the interest rise process.  But I do think it argues against the idea that stocks will either mirror the fall in bond prices–or simply collapse.  During the Great Recession and the subsequent recovery, equity investors badly underestimated the severity and the duration of the downturn.  As a result, Wall Street was always on guard against the possibility of imminent interest rate rises.  It never fully discounted the actual interest rate lows–something that will serve stocks well during the normalization process.

Two other points:

–this stock market behavior is not that unusual.  In past periods of Fed tightening, stocks have gone sideways to up.

–on my Current Market Tactics page, I wrote last month that I thought the market stall we’re in now is purely based on valuation and not on worries about rising interest rates.  If that were wrong, the first place to look for deterioration would be in income-oriented stocks, which are in effect quasi-bonds.

 

 

new money market fund regulations

July 24, 2014 By in Banks, bond market, Books, Industry Analysis, Investment firms, money market funds, securities markets, Uncategorized Tags: , Leave a comment

Yesterday, the SEC announced new rules for US money market funds, which in the aggregate hold $2.6 trillion in investors’ money.  Of that amount, two-thirds is in funds catering to institutions and high net worth individuals; one-third is in funds serving the mass market.

Why the need for new rules?  

Two reasons:

–today’s aggregate money market assets are large enough to be a risk to the overall financial system if something goes badly wrong, and

–the funds are typically sold as being just like bank deposits, only with higher yields.  However, like most Wall Street claims that  “x is just like y, only better,” it’s not really true.  The differences only become important in times of market stress, when normally sane people do crazy things, and when “yes, but…” is a sign for panic to begin.  So there’s a chance that “badly wrong” can happen.

The differences?    …bank deposits are backed by government insurance that insulates depositors from investment mistakes a bank may make.  Also, the Fed stands ready to rush boatloads of cash to a bank if withdrawals exceed the money a bank happens to have on hand.  Money market funds have neither.

Yet many holders are unaware that it’s possible for a money market fund’s net asset value to fall below the customary $1.00 per share, or that a fund might be overwhelmed by redemptions and forced to sell assets at bargain-basement prices to meet them.

the fix

Fixing this potential vulnerability has two parts:

–giving the finds the ability to halt or postpone redemptions during financial emergencies, and

–requiring funds to have floating net asset values, not the simple $1.00 a share.  This would mean marking each security to market every day.  …which would likely require hiring a third-party to price securities that didn’t trade on a given day.

The first of these would avoid the government having to step in the case of a run on a fund.  The second should reinforce that money market funds aren’t bank deposits.

the new rules

Of source, the organizations that sell money market funds have been strongly opposed to anything that would ruin their “just like…, but better…” sales pitch.  Their lobbying has blocked action for years.

So it should be no surprise that yesterday’s SEC action was a compromise measure:

–all funds will be able to postpone redemptions in time of emergency, but

–only funds that cater to big-money investors will have to maintain a variable NAV.

Personally, I don’t understand why money market funds that serve ordinary investors should be exempt from having to calculate a true daily NAV.  You’d think that this is the group that most needs to understand that the (remote) possibility of loss is one of the tradeoffs for getting a higher yield.  Arguably, sophisticated investors already know.  But the financial lobby is incredibly powerful in Washington, and this may have been the price for getting anything at all done.