Teachable Moments from Bill Gross’ Run as the ‘Bond King’

Janus Henderson Investors announced Monday morning that William H. Gross, known to those in the investment industry as Bill Gross and “the Bond King,” is retiring from the firm in order to focus on managing his personal assets and private charitable foundation.

Gross is best known for his role as founder of PIMCO in 1971—where he served as managing director and chief investment officer for more than four decades. Following a rocky and much-publicized exit from PIMCO, Gross joined Janus Henderson in 2014 (then Janus Capital) to manage the Janus Henderson Global Unconstrained Bond funds and related strategies, including the firm’s institutional total return strategy.

Given Gross’ stature in the investment industry as one of the most successful bond managers in history—and perhaps one of the most successful business founders of any type—the business- and investment-focused media immediately picked up on the announcement from Janus. Similar to the response to the recent death of Vanguard founder Jack Bogle, who was considered to have revolutionized the world of index-based investing, analysts and observers offered up a wide variety of interpretations about what it means that the long-running “Bond Kind” is leaving the marketplace.

For their parts, both Janus and Gross are saying this exit decision was mutual, striking quite a different tone compared with Gross’ earlier exit from PIMCO.

“While the Unconstrained strategy Mr. Gross manages has underperformed its 3-month Libor benchmark since Mr. Gross joined Janus Henderson in late 2014, nominal performance has been positive over the time period,” the firm said in a statement announcing Gross’ pending retirement. “In addition, and in-line with Mr. Gross’s career success as a bond investor, his currently existing Total Return strategy has outperformed its U.S. Aggregate benchmark by 89 basis points, net of fees, through 12/31/2018.”

The firm shared some other immediately practical information about the transition. Portfolio management responsibilities for the Global Unconstrained Bond funds and related strategies will be assumed by the Global Macro Fixed Income team that has been supporting Gross for the past four years. This team reflects the capabilities of Kapstream, acquired by Janus Henderson in 2015, and has, according to the firm, “been in place to facilitate an orderly transition of the strategies at such time as Mr. Gross chose to retire.”

Nick Maroutsos, co-head of global bonds and portfolio manager at Janus Henderson, will become portfolio manager of the Global Unconstrained Bond funds effective February 15, 2019, to assist with the transition associated with Gross’s planned departure on March 1, 2019.

“Mr. Gross will work closely with Mr. Maroutsos and the team to ensure a smooth and seamless transition,” Janus says. “Effective February 15, 2019, the Global Unconstrained Bond funds domiciled in the United States and Ireland will be renamed Absolute Return Income Opportunities, which better reflects the strategy name of existing Kapstream portfolios managed in a similar fashion. There will be no change to the funds’ investment objective or guidelines.”

The “King’s” Court Carries On

This is not the first time Gross’ employment status has sparked industry introspection about what it means when a single individual has so much influence over an investment firm that serves a huge number of clients.

Back in September 2014, it was revealed that Gross was effectively being pushed out of PIMCO, the company he co-founded. The revelation came during something of a bumpy year for PIMCO. Previously, in January 2014, Mohamed El-Erian, the firm’s then-CEO and co-chief investment officer (CIO), announced he would be stepping down, with Gross continuing to serve as CIO. The firm’s flagship bond fund, Total Return, was shedding noteworthy amounts of assets each month under Gross’ ongoing oversight, which continued for a year and a half before Gross announced his departure from PIMCO.

Before Gross exited PIMCO, the Securities and Exchange Commission (SEC) had started an investigation to determine whether the firm inflated returns of the exchange-traded Total Return bond fund managed by Gross, according to reporting in the Wall Street Journal and other outlets, and the investigation was made more widely known just ahead of Gross’ departure announcement. In early 2016, PIMCO agreed to pay $20 million to resolve federal claims that it misled investors and mismarked securities.

In the defined contribution (DC) world, the speculation about how retirement plan sponsors and participants would be impacted by Gross’ surprise departure to Janus was mixed. At the time, one investment consultant told PLANADVISER they expected “unprecedented outflows from the impacted PIMCO funds.”

Other sources were more demure in their expectations, including Robert Lawton, founder and president of Lawton Retirement Plan Consultants. Even after several months of outflows, Lawton said it was “too early to hit the PIMCO panic button.” He stressed that the moderate outflows from PIMCO in no way resembled a true threat to the sustainability of the business or the ability of the management teams to continue to meet performance goals.

Ultimately, more than $20 billion flowed out of the flagship Total Return Fund Gross managed within a month of his departure, but over the longer term there proved to be no protracted mass exodus impacting other funds sold by the firm. In fact, many advisers attributed some of the subsequent challenges faced by the firm more to the fact that former CEO and co-CIO Mohamed El-Erian left the business, and to Gross’s own behavior in that unique situation—described by Lawton and others at the time as “vengeful and even erratic.”

Gross was listed as lead portfolio manager on 18 funds, but there were also strong day-to-day portfolio management teams in place on all of the funds. Thus, little likely changed in the real management effort of those funds—a fact borne out by the performance profile of PIMCO investments today compared with earlier times when Gross remained at the helm.

Can Individuals’ Influence Be Overstated?

A 2017 analysis published by Morningstar shows that, on average, there is generally speaking no appreciable change in future performance expectations following a lead fund manager change; yet, investors commonly overreact and pull money from these funds at just the wrong time.

The findings suggest that the fund industry “handles succession planning far better than investors react to such changes.” When it comes to defined contribution (DC) plans, the analysis finds, this phenomenon is partly driven by the fact that plan sponsors’ decisions are often tightly controlled by an investment policy statement (IPS) prescribing certain actions that must be taken when specific triggers are met.

As demonstrated by the latest PLANSPONSOR DC Plan Benchmarking Survey, more than 65% of all plans manage their investment exposures according to a formal, written investment policy statement. This figure jumps to 88% for plans with more than $100 million invested, showing that the significant majority of DC retirement plan assets are invested according to the tenants of an IPS. While investment policy statements are far from standardized, the research shows many mention in some capacity the plan’s general objectives and investment structure/criteria. The IPS also usually outlines the ongoing investment monitoring and evaluation processes, and often a fund manager personnel change serves as a trigger, leading the plan sponsor to put a fund with a recent manager change onto a watch list. Once on a watch list, it may only take one or two quarters of below-benchmark returns to lead to a funds’ dismissal. 

The Morningstar research shows this widespread approach is probably not necessary and in fact may be counterproductive from the standpoint of maximizing returns. The research finds “no relationship between any type of management change and future returns.” In fact, the highest-performing funds are those “given the benefit of the doubt by investors when there is a management change or another transitory issue.”

Interestingly, it seems to be only the largest brand-name funds which experience substantial outflows when there is a manager change, but the loss of the fund manager’s industry experience seems to have no effect on either returns or growth rates in the longer term, according to Morningstar.

Powerful Individuals Bring Firms Success, But Also Challenges

At the time of his departure from PIMCO, Gross made it clear that he felt he was being wronged, culminating with threats of litigation. In the end, according to a joint statement issued in 2017 by both Gross and PIMCO, the parties agreed to settle the allegations out of court. The monetary terms of the settlement were not disclosed, but media reports at the time pinned the number around $81 million, anonymously citing individuals close to the agreement. In the joint statement, PIMCO said it would dedicate a new “Founders Room” at its headquarters to be crated in honor of Gross and others who launched the firm in 1971. PIMCO also named him as a director emeritus of the firm’s charitable foundation.

Within a year of Gross’ departure from PIMCO, the firm faced a separate private lawsuit, filed by an investor named Robert Kenny, claiming there was excessive compensation received by the investment company through the PIMCO Total Return Fund. Among other ends, the suit sought to recover “any improper compensation retained by PIMCO in an alleged breach of its fiduciary duty under Section 36(b) of the Investment Company Act of 1940 (ICA).”

The lawsuit called into question compensation paid to former co-chief investment officers and co-chief executive officers Mohamed El-Erian and William H. Gross. According to the complaint, as the increase in assets in the fund led to larger and larger amounts of compensation being paid to the PIMCO and its executives, the fund’s performance suffered. In 2012, the fund failed to outperform its benchmark, and 60% of the fund’s peers outperformed the fund. In 2013, the fund lost 1.92% and trailed 70% of its peers in its worst performance since 1994. In calendar year 2013, for example, shareholders in Class A of the fund saw returns of -5.97% before taxes, while shareholders of Class B shares saw returns of -6.36% before taxes.

The lawsuit alleged that despite this poor performance, the compensation PIMCO received for its work for the fund and fund complex “remained excessive and led to extraordinary payments to its executives.” In their final year of employment, PIMCO paid more than $1.5 billion in bonuses and compensation to Gross and El-Erian.

PIMCO responded at the time by saying its compensation “is designed to pay competitive compensation and reward performance, integrity and teamwork consistent with the firm’s mission statement.” The lawsuit said that, for context, no other executive officer of a peer publicly-traded financial company came close to either of these bonuses on an individual level. It noted that one must aggregate the compensation of the CEOs of 20 publicly-held peer finance companies to come close to the amount of money Gross took home in his last year.

Ultimately the lawsuit was dismissed in district court after the parties agreed to rescind the suit, offering little detail about exactly how or why the claims were dropped. Case documents show PIMCO fought to keep a number of sealed documents out of the eyes of the public. Those documents included employee performance self-evaluations for three of PIMCO’s most senior executives; information about compensation paid to PIMCO managing directors and portfolio managers; documents that reflect sensitive business strategy discussions among PIMCO’s most senior executives; documents implicating the confidentiality interests of PIMCO clients who have no role in the current action; and documents reflecting the deliberative process of the Board; among many others.

PIMCO argued these documents qualified for protection because of the risk of competitive harm from disclosure.

The New Bond King Is Ready

Apart from results having to do with Gross, a Google search of the term “Bond King” also brings up results mentioning Jeffrey Gundlach, chief executive officer and chief investment officer for DoubleLine Capital.

Gundlach was in fact involved in his own high-tension career move at one time; he was fired from his long-term employer, Trust Company of the West (TCW) and moved on to found DoubleLine Capital. The saga of his departure from TCW has similarities to Gross’ departure from PIMCO.

As recalled in a New York Times DealBook blog post from the time, “TCW sued Mr. Gundlach, its former chief investment officer, in 2010 for hundreds of millions of dollars in damages, accusing him and several associates of stealing trade secrets and breaching their fiduciary duty in order to set up a competing firm after he was fired from TCW in 2009. Mr. Gundlach countersued, arguing that he was entitled to hundreds of millions of dollars in lost fees from the funds he oversaw at TCW.”

In the end, Gundlach won a sizable settlement from his former employer. And, unlike what was seen after Gross’ PIMCO departure, more than 40 TCW employees eventually followed Gundlach to DoubleLine.

Today, Gundlach continues to publish market commentaries, in addition to running Doubleline. At the beginning of 2018, Gundlach suggested the next 12 months would represent a “don’t lose money year.” He said he expected U.S. Treasury yields to rise, volatility to increase and equities to have a down year as quantitative tightening continued ramping up in the U.S. and the Federal Reserve looked to forge ahead with its rate hike agenda.”

While other managers were predicting that strong global growth data would prevail and lead to improved equity market conditions, Gundlach proved to be correct. U.S. Treasury rates reached levels that had not been breached in years, while the global equity market, as measure by the MSCI ACWI Index, finished the year down 8.95%, despite being up more than 7% just 18 business days into January.

For 2019, Gundlach has projected that U.S. yields will continue to rise but that bonds on the front end of the yield curve will remain an important cornerstone in any multi-sector portfolio, due to the high quality and liquidity they provide. Additionally, he recommended going underweight on U.S. investment grade corporate bonds due to their long duration profile and the large amount of issuance that has occurred in the space since the financial crisis.