By Dan Hallett on October 17, 2014
So-called ‘Bond King’ Bill Gross made headlines with his recent decision to leave PIMCO – the firm he founded more than 40 years ago – to join Janus Capital Group. How best to deal with manager changes and whether investors and advisors should follow the departed stars or stick with incumbent funds have long been debated. In light of Gross’ departure, investors and advisors need to remember a few key things when dealing with manager changes.
Size negatively impacts firm culture
There is a long list of examples of investment management firms that had something special, only to see it drowned in a sea of growth. A Canadian example is Sprott Asset Management because it began as a focused, small, bold and very successful money management firm. But they have grown toward the very culture from which they once proudly stood apart.
PIMCO manages $2 trillion on behalf of its clients – i.e. double the size of the entire Canadian mutual fund industry. A lot of bureaucracy comes along with this kind of largesse, some of which was documented in the coverage of Bill Gross’ departure.
What was once a bond-focused money manager tried to become a lot of things to a broad array of clients. And PIMCO grew to a size that prioritized growth and profitability above optimal performance and execution. The result is an inevitable cultural shift that changes the firm’s identity. PIMCO has lots of company on that note.
It’s important to highlight that Janus Capital – Gross’ new home – is no boutique firm. Janus and subsidiaries manage nearly $200 billion. But they run relatively little in bonds so investors like the idea of Gross starting over at a large firm with a small bond portfolio.
Big asset growth can hinder fund performance
Size was negatively impacting PIMCO’s Total Return Bond’s execution and success. The fund has been suffering a bout of underperformance in recent years – and redemptions this year. PIMCO Total Return Bond Class P (sold in the U.S.) sports the same expense ratio as the PIMCO Total Return Exchange Traded Fund (BOND/NYSEarca). The ETF’s $2.8 billion in net assets pales in comparison to its mutual fund sibling’s $221.6 billion in net assets.
The ETF has significantly outperformed its much larger mutual fund sibling. With size being the main difference between the two funds, it’s intuitive to blame the mutual fund’s lower returns on its huge asset base. While bonds can benefit from a larger asset base, the law of diminishing (or negative) returns kicked in at some point.
In more capacity-constrained mandates like concentrated small cap portfolios, this effect is more pronounced – with size becoming a detriment at a much smaller threshold. (It is this kind of situation that first caught my eye with Sprott Canadian Equity, my analysis of which was documented in a May 2007 research report. Size also negatively impacted Dynamic Value Fund of Canada, which was managed by David Taylor until three years ago.)
It often pays to sit tight
Lead manager changes don’t get any bigger than Gross’ departure from PIMCO. Early this year I wrote about the results of my admittedly selective look at manager changes. I tracked 14 star managers that left investment funds to launch or run 16 new funds over the past dozen years. I found that about 40% of star managers’ new funds outpaced their old funds. Updating those results recently showed that those results have flipped (60% of stars’ funds have so far outperformed).
But when isolating the funds whose managers left at least six years ago – half of those studied – more than 71% of stars’ new funds lagged their former funds. Tracking performance from peak to peak is more meaningful – though sweeping conclusions can’t be based on a sample size of seven.
Still the fact that over the past 6-12 years a strong majority of ‘star’ managers underperformed their former funds – e.g., Allan Jacobs (Canadian small caps), David Winters (global value), Matt Haynes (global value), Kim Shannon (Canadian value) and EdgePoint (Canadian stocks) – was surprising to me and many others who read my January blog post.
So far, PIMCO appears to be suffering some major outflows, hot on the heels of Gross’ departure. But the past has shown that it often pays to sit tight for the long term. So at the very least, manager changes shouldn’t result in knee-jerk redemptions. History suggests that investors can and should take the time needed to figure out if following a departed star manager equates to following an investment celebrity or the superior money manager.
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