Category Archives: Investment firms

Bill Gross: a wave of (self-) destruction?

October 10, 2014 By in bond market, Current Market Thoughts, Industry Analysis, Investment firms, securities markets Tags: , , , , , , , Leave a comment

As even casual readers of the financial press know, Bill Gross, the bond guru, recently left PIMCO, the firm he founded, for smaller (everything is smaller than PIMCO) rival Janus.  Two aspects of his departure strike me as particularly noteworthy:

–Gross has been saying very emphatically, both at PIMCO and Janus, that he has absolutely no intention of retiring or of ceding any measure of control over his portfolios to colleagues.  This is despite an extended period of poor performance.  If he’s thinking at all about the impact of his statements on clients, he surely believes he is reassuring them.  However, it seems to me that the opposite is most likely the case.

What clients are likely hearing is that although he’s been charting a losing course for his portfolio for an extended period, he refuses to consider any changes or even to take any input from his 700+ professional colleagues. The way he’s delivering his stay-the-course message also makes him sound like an adolescent having a tantrum.  It’s hard not to connect this unusual behavior with the fact of extended underperformance, raising further issues about his temperament and his judgment.  This it’s-all-about-me attitude is very scary for anyone how has bet on Gross’s management prowess.

–PIMCO as a firm clearly made a terrible strategic mistake in making the idea of continuous outperformance by a single manager the exclusive focus of its marketing to clients for so many years.  Yes, the message is powerful and simple to understand, but one that’s also very risky and that invests a huge amount of power in a single individual.

PIMCO would probably have imagined any possible parting of the ways with Bill Gross to be somewhat akin to Derek Jeter’s final season as a Yankees.   …that is to say, a nostalgic feel-good farewell tour for a player who may be a shadow of his former self, but which validates both personal and institutional brands and generates large profits for both sides.  What PIMCO got instead was the unflattering glare of tabloid coverage of a messy divorce.

Bad for PIMCO.  But bad for Gross, too, I think.

As a client, how eager are you going to be to hitch your star to an apparently erratic 70-year-old who has weak recent performance, no longer has access to PIMCO’s extensive information network and whose assets under management are too tiny to have much clout in the brokerage community?    The default reaction of the pension consultants who advise institutions seems to be:  PIMCO without Bill Gross isn’t good enough; Bill Gross without PIMCO isn’t good enough.  It seems to me that PIMCO has a much better chance of changing consultants’ minds than Bill Gross does–it already has infrastructure, other managers with strong records and huge assets under management.

If I’m correct, absent a return to his form through the long period of interest rate declines, Mr. Gross appears to be in a much more difficult position than his former firm.  Much of this is his own doing.

 

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.

 

 

 

comparing IPOs: Facebook (FB) and Alibaba (BABA)

September 22, 2014 By in Investment firms, Recent Market Action, securities markets, stock market Tags: , , , , , Leave a comment

J\Last Friday, just over two years after the IPO of Facebook (FB) in mid-2012, another major tech company, the Chinese internet conglomerate Alibaba (BABA), made its debut on Wall Street.  BABA received a warm reception.  This is in sharp contrast to the FB experience, which will certainly go down as one of the bigger stock market disasters of the decade (the century?).

The differences, as I see them:

the FB fiasco

1.  FB depended on a single lead underwriter, Morgan Stanley (MS).

2.  Morgan Stanley was unusual in that it had made a big effort to remain in touch with Silicon Valley after the collapse of the internet bubble in 2001.  It seems to me to have believed FB was its last best chance to cash in on more than a decade of visits and phone calls.  It also thought there was no follow-on business to be had.  Therefore, its tech investment bankers appear to me to have been more concerned about maximizing their fee income on FB than on ensuring that the buyers had even a mildly profitable experience.

3. Subsequent media reports, presumably based in considerable part on information provided by the underwriters, make it clear that the management of FB was obsessed with the idea of not “leaving any money on the table.”  The CFO, David Ebersman, seems to have badly misunderstood how the process of going public works–in particular, the negative effect on company morale of a failed IPO.  This is very odd, since most often a CFO is brought in precisely because he/she knows how going public works.

4.  Shortly before the IPO date,  the IPO price was boosted by about 12% and the number of shares on offer was raised by 25%.  In other words, at the last-minute the issue size was upped by MS and Ebersman by almost 50%–soaking up a ton of money that would otherwise have been available for buying in the aftermarket.  Virtually none of this went to FB; is all went to early investors, and some employees, cashing out.

5.  The FB offering was unusually highly reliant on (inexperienced) retail investors.  It appears many tried to “game” the IPO by asking for, say, 5x what they wanted to end up with (see my original post on the FB IPO).  Imagine their shock when instead of the $50,000 worth of FB they expected, $250,000 worth of stock–and the accompanying bill–plopped into their accounts.

6.  Then, of course, the NASDAQ trading computers broke down.  This made it impossible to trade, or even to get an accurate quote.  In fact, for at least several days, retail sellers didn’t know how many shares they may have bought or sold on the morning of the IPO, or at what price.

BABA is much better, so far

BABA used six lead underwriters, not one–although MS was included among them.

Retail exposure was minimal.

BABA listed on the New York Stock Exchange, avoiding NASDAQ.

BABA did price at about 5% above the high end of the announced range (apparently indications of interest were huge).  But the size of the offering wasn’t boosted, meaning plenty of buying power was still left for the aftermarket.  BABA was also arguably priced at a discount to comparable Chinese internet firms, while FB was priced at a premium–just as its business was beginning to slow.

 

CalPERS is exiting its hedge fund investments

September 16, 2014 By in hedge funds, Investment firms, Private equity Tags: , , , , , 1 Comment

the CalPERS decision

The California Public Employees Retirement System (CalPERS), the largest public pension system in the US and an early adopter of hedge funds, has announced that it will terminate its entire $4 billion in hedge fund investments over the coming year.

The decision comes after a review of CalPERS’ hedge fund performance by its investment staff following the death from cancer of the organization’s Chief Investment Officer, Joseph Dear.  Mr. Dear, a strong proponent of alternative investments such as hedge funds, took the reins at CalPERS in early 2009.  His appointment came in the wake of a sharp, recession-induced drop in the value of CalPERS’ assets–and as an alternatives-related “pay to play” scandal involving pension consultants and so-called “placement agents” was unfolding (see my post).

The stated reason for the move is that hedge funds are too complex and too high-cost.  Reading between the lines, this seems to me to mean that the hedge funds CalPERS used didn’t provide either the promised diversification or superior returns.  My guess is that the professional staff, who have the best understanding of the products, wanted to act quickly, before a new political appointee could arrive to muddy the waters.

In one sense, the CalPERS move should come as no surprise.  Although there are a small number of hedge funds run by superb investors, the average offering has pretty steadily underperformed the S&P 500 for over a decade.  In addition, the elevated fee structure results in most of what profits there are going to the fund manager, not the client.  These factors call into question the rationale for having made the investments in the first place–to reduce the underfunding of pension plans through superior investment performance, so that higher contributions to the plans by the corporation or government body that sponsors them can be avoided.  The evidence seems to me to be that hedge funds generally make the underfunding problem worse, not better.

On the other hand, it takes a substantial amount of courage to fire managers who have strong local political connections.

investment significance

CalPERS is a trend-setter.  It may well be in this instance, too.  A lot depends on whether the next CIO supports the investment staff decision to end hedge fund exposure or overrides objections.  In the former case, this could signal the gradual return to less speculative trading-oriented, more fundamentally driven securities markets.

 

 

 

a Fall stock market swoon?

September 9, 2014 By in Current Market Thoughts, Dividends, ETFs Vs. Mutual Funds, Industry Analysis, Investment firms, Securities regulation, yearly distributions Tags: , , , , Leave a comment

Over the past thirty years, the US stock market has tended to sell off from late September through mid-October, before recovering in November.  That historical pattern has some brokerage strategists predicting a similar outcome for this fall.

Why the annual selloff?

It has to do with the legal structure of mutual funds/ETFs and the fact that virtually all mutual funds and ETFs end their tax year in October.

1.  Mutual funds are a special type of corporation.  They’re exempt from income tax on any profits they may achieve.  In return for this tax benefit, they are required to limit their activities to portfolio investing and to distribute any investment gains as dividends to shareholders (so the IRS can collect income tax from shareholders on the distributions).

2.  All the mutual funds and ETFs I know of end their fiscal years in October.  This gives their accountants time to get the books in order and to make required distributions before the end of the calendar year.

3.  For some reason that escapes me, shareholders seem to want an annual distribution–even though they have to pay tax on it–and regard the payout as a sign of investment success.  Normally management companies target a distribution level at, say, 3% of assets.  (Just about everyone elects to have the distribution automatically reinvested in the fund/ETF, so this is all about symbolism.)

4.  The result of all this is that:

a.  if realized gains in a given year are very large, the fund manager sells positions with losses to reduce the distribution size.

b.  If realized gains are small, the manager sells winners to make the distribution larger.

c.  Because it’s yearend, managers typically take a hard look at their portfolios and sell clunkers they don’t want to take into the following year.

In sum, the approach of the yearend on Halloween triggers a lot of selling, most of it tax-related.

not so much recently

That’s because large-scale panicky selling at the bottom of the market in early 2009 (of positions built up at much higher prices in 2007-07) created mammoth tax losses for most mutual funds/ETFs continue to carry on the books.  At some point, these losses will either be used up as offsets to realized gains, or they’ll expire.

Until then, their presence will prevent funds/STFs from making distributions.  Therefore, all the usual seasonal selling won’t happen.

how do we stand in 2014?

I’m not sure.  My sense, though, is that the fund industry still has plenty of accumulated losses to work off.  As a general rule, no-load funds have bigger accumulated unrealized losses than load funds;  ETFs have more than mutual funds, because of their shorter history.

This would imply that there won’t be an October selloff in 2014.

Even if I’m wrong, the important tactical point to remember is that the selling dries up by October 15 -20.  Buying begins again in the new fical year in November.