Mohammed El-Erian, who departed PIMCO as CEO in January, gave his first television interview since his departure. In the interview with Bloomberg, El-Erian said he primarily left to spend more time with his daughter. It seemed clear to me that he was burned out from the intense schedule he was required to keep in his role at PIMCO and didn’t want to run the firm alone once Bill Gross reduced his hours at some point in the future. The tempest over El-Erian’s departure indicates that while PIMCO remains an excellent investment manager it isn’t as good at public relations. Both Gross and El-Erian have said they were surprised at the attention paid to El-Erian’s departure and the reaction of many investors and the media.
“I have had the privilege of watching him in action and he is just a great investor,” El-Erian, chief economic adviser to Allianz SE (ALV), said today in an interview with Betty Liu on Bloomberg Television. There’s a deep talent pool and an “enormous bench at Pimco and that is key for the firm,” he said.
El-Erian, 55, said he left Newport Beach, California-based Pimco after 14 years to do something different. His departure from the world’s biggest bond manager sparked media reports of tension with Gross as the firm struggled to staunch outflows. Gross, who manages the $232 billion Total Return Fund, said April 10 on a Bloomberg Television interview that El-Erian’s resignation was a mystery to him and he may have been premature in anointing him as his sole successor.
I was told a few weeks ago that the folks at PIMCO were finished talking about the departure of Mohammed El-Erian and would focus on managing money and doing business. But this week Bloomberg Businessweek has an extensive interview with Gross, devoting a lot of space to El-Erian’s departure and all the stories around that. The major take away is that those remaining at PIMCO are surprised that El-Erian hasn’t made any public statements about his departure. It’s a puzzle to outsider and apparently a puzzle to many PIMCO insiders. None of it matters as long as it doesn’t distract from the firm’s investment performance, and it will take a while before we have the answer to that. You also might be interested in this video.
When you ask people who know Gross and the company he built to describe its atmosphere, “intense” comes up a lot. Sometimes the words used are much stronger. Virginie Maisonneuve, the firm’s new head of equities, calls it a “refreshingly direct” culture, one where people are busy and generally get straight to the point, skipping over the chitchat and niceties, something she says she appreciates. “Everything seems to suggest that Bill is extremely hard to work with—he’s an emotional guy, he’s very competitive and tough-minded,” says Bill Thompson, who was CEO of Pimco for 15 years and remains Gross’s close friend. “I think that’s all true. But anyone who’s any good as a trader in the markets has got to have some pretty unusual skills. There’s nothing new about that. That’s what it takes, and he’s got it big time.”
In the April issue of Retirement Watch I tell readers that it’s usually a warning sign when a number of quality high-yield bond mutual funds close to new investors, as has happened recently. Here’s another warning, actually several warnings. In it several money managers, including Jeffrey Gundlach of DoubleLine Capital, state why they believe high-yield bonds no longer have a margin of safety. They’re concerned that once investors decide there’s too much risk or there are better yield opportunities, there will be a steep decline in prices.
Buyers demanded 3.78 percentage points more than similar-maturity Treasuries to own U.S. junk bonds on March 5, the least since 2007, the data show. That’s not enough, according to Martin Fridson, chief executive officer of FridsonVision LLC, a New York research firm specializing in high-yield debt.
“We’re at an extreme over-valuation,” he said in a telephone interview. “When you’re not compensated adequately for the risk, you do tend to get punished for it. If the Fed is still sufficiently energetic about it, they could keep it at an over-valuation through all of 2014.”
One of my longstanding investment rules is that investors who want to buy individual bonds (instead of bond funds) should buy only treasury bonds and only newly-issued bonds. You also can consider buying tax-exempt bonds if they are new issues. The reason for this recommendation is that the market for individual bonds isn’t nearly as efficient as it is for stocks. You’re likely to pay both markups and commissions on the bond purchases. It likely is cheaper to pay a mutual fund its fees and let them negotiate bond purchases.
Here’s the latest evidence, a survey by The Wall Street Journal. (Subscription might be required.) It found that individual buyers of tax-exempt bonds pay far more to brokers than they do for purchases of corporate bonds, and those are considerably more than brokers receive for corporate stock. Yet, individuals are the biggest buyers of tax-exempt bonds. If you buy individual bonds, hold them to maturity. You’ll lose quite a bit if you sell them to a broker.
Individual investors trading $100,000 in bonds of a municipality, such as Washington state, in December paid brokers an average “spread” of 1.73%, or $1,730. That compares with 0.87%, or $870, paid on a comparable corporate bond, such as one issued by General Electric Capital Corp., the data show.
Brokers of stocks and corporate bonds must disclose market pricing and give individuals “best execution” on trades, ensuring they receive the best prices possible. In the municipal-bond industry, those protections are absent, allowing brokers to pocket higher spreads by buying the bonds low and selling them high.
Individual investors, especially retirees, have long been attracted to municipal debt as a relatively safe investment whose interest payments aren’t taxed. They own 45% of all municipal bonds directly and another 28% through mutual funds, amounting to a combined $2.7 trillion, according to data from the Federal Reserve.
Economists think everyone should convert most of their retirement nest eggs into annuities and receive a stream of income that’s guaranteed for life. Very few people actually do that. They want to keep control and have the hope of achieving a higher return, even when they don’t invest aggressively or have a good investment track record. Justin Fox of Harvard Business Review takes a look at annuities and why people don’t buy them for retirement. He doesn’t break any new ground, but it’s a good review of all the angles and has some good quotes and links.
The sustainability of Social Security is a topic for another day. When it comes to annuity puzzles, though, there’s one more factor worth mentioning. In the Palliser novels of Anthony Trollope, which have constituted most of my bedtime reading for the past month, there’s endless discussion of how much money people have. These 19th century fortunes, however, are almost always described in terms of the annual income they produce, not the lump sum.
Hardly anybody talks about investments that way now. Part of it is just that most of us expect to live from our jobs, not the inherited wealth still so crucial in Trollope’s world (and even more so in Jane Austen’s half a century earlier) — so whatever fortune we may have built or inherited isn’t expected to produce income just yet. But I also wonder if asset values have come to play such a big role in modern economic life that we’ve forgotten what those assets are for. In countless ways, financial discourse in the Western world in general and the U.S. in particular has shifted from a focus on income to a focus on assets or net worth.
The Wall Street Journal caused a lot of turmoil this week with its behind-the-scenes report of the big change at PIMCO, when Mohammed El-Erian resigned and the firm promptly promoted six new deputy chief investment officers to assist Bill Gross. El-Erian had been heir apparent at the firm. A subscription might be required to view the WSJ report. If you can’t access it, consider this summary at Bloomberg.com. There’s also this rejoinder from Gross.
I don’t know how accurate the report in the WSJ is, especially since it apparently has no input from El-Erian or Gross. It’s easy to string together a few anecdotes to support a point of view, especially when there no conflicting evidence is reported. I’m also not sure how much it matters if the entire story is true. El-Erian was a very good spokesman but didn’t distinguish himself as a money manager with the funds he was running at PIMCO or in his brief stint as the head of the Harvard Endowment. We also can’t tell from the outside if he was good at being CEO of the firm. What matters to investors is the investment returns. Many of the funds at PIMCO are fairly autonomous, and I’m sure Gross always has made his own decisions at the funds he manages. What the recent changes really mean are that after Gross leaves, PIMCO no longer will be identified with one person. The plan was to have a transition from Gross to El-Erian as the public face of the firm. Now, it will be like the other large mutual fund firms in that he would be clearly identified with only one person.
Some at Pimco have been told to leave the firm but stuck around instead, waiting for Mr. Gross’s anger to ebb and for him to change his mind, according to these people.
Bill Powers, a former Pimco senior executive who left in 2010, says Mr. Gross “routinely grew tired and wary of those closest to him who had assumed significant responsibility, power, and compensation. After a four to five-year honeymoon period, the chosen one’s halo would turn into a crown of thorns where interactions with Bill would turn adversarial, short, and unpleasant.”
When Mr. Gross establishes an investment thesis, he usually doesn’t appreciate dissenting views, employees and former Pimco traders say. Once, when a senior investment manager said a bond in Mr. Gross’s fund appeared to be expensive, Mr. Gross responded: “OK, buy me more of it,” according to a Pimco executive. The purchase was made.
Recently co-CIO and CEO of PIMCO, Mohammed El-Erian announced he would be leaving the firm. The departure raises a lot of questions for investors. Here’s a good review of the key questions and some answers from Morningstar. The answers are mostly speculation and guesswork. We have to figure out how El-Erian’s departure will affect the decisions made by the firm’s daily investment committee meetings and other intangible things. My recommendation after such changes at a large firm is to wait before taking action but watch things more carefully than usual. I don’t expect big changes in the firm’s actions or results, but one never knows.
That situation has been exacerbated by significant departures from the firm in recent years. In 2010 it was Paul McCulley, mainly known outside the company as a Fed watcher but one who was very involved in the investment committee and ran PIMCO’s cyclical forums. His input was clearly crucial, and it was evident that he played an important role in challenging and debating other members of the group, especially Bill Gross, Chris Dialynas, and El-Erian. Dialynas has been another important voice on the committee, but he, too, has stepped down, at least for now. He had been the portfolio manager of PIMCO Unconstrained Bond (PFIUX) as well as a very senior, long-tenured manager with a strong, opinionated voice on the committee, and it was clear that he, too, played a balancing role in the group. He announced a sabbatical late last year that is now slated to begin in April. And though PIMCO has hinted that it could be for only a year or so, he took a much longer leave in the 1990s, and it hasn’t been said whether he would rejoin the investment committee, if and when he does return to the firm.
Periodically I try to make the point that forecasting the economy or an investment doesn’t matter unless you make the forecast both accurately and before it is priced in to the markets. Sometimes markets are surprised by events or changes. Other times markets are ahead of the curve, so the actual events don’t stir markets. One good example of markets pricing in changes before they occur is the bond market.
This post describes a new study that found the bond markets tend to price in changes in Fed policy about six months before the Fed actually makes a change. Speeches by and interviews with Fed officials apparently are followed closely by bond traders and cause them to change their portfolios.
Traders and investors start pricing in changes in the central bank’s overnight target rate as much as half a year before the change takes place, according to a National Bureau of Economic Research paper published this week.
“The market prepares for [Federal Open Market Committee] announcements much farther in advance than had previously been demonstrated” in prior studies, Danish researchers Dick Van Dijk, Robin Lumsdaine and Michel van der Wel wrote. “We find strong evidence of anticipatory set-up, going back as far as six months prior to an FOMC meeting,” they noted.
Tax-exempt bonds crashed earlier in 2013. First there was all the talk of the Fed reducing its bond buying, known as tapering. Then, there was the bankruptcy of Detroit. I said in Retirement Watch that the crash created opportunities and recommended a portfolio position to capture them. Now, James Tisch, CEO of Loewe’s, said he agrees. He thinks tax-exempt bonds are worth considering now by almost all investors because prices declined so much.
Tax-exempt revenue bonds rated AA and maturing in 30 years yield about 4.6 percent, according to data compiled by Bloomberg. The interest rate is up from as little as 3.04 percent in January. The $3.7 trillion municipal market has lost about 2.4 percent this year, according to Standard & Poor’s data.
Loews’s insurance subsidiary CNA Financial Corp. (CNA) said in July that it was buying state and local-government debt for its $46 billion investment portfolio. The strategy was a reversal for Tisch, who said earlier this year that interest rates were so low that bonds were competing in an “ugly contest.”
The markets went into panic mode in the spring when Ben Bernanke said the obvious, that quantitative easing and zero interest rates wouldn’t be around forever. The markets also were surprised when the Fed didn’t change its policy at the September meeting. Bill Gross of PIMCO sets everyone straight in his latest monthly essay. Gross says to expect low interest rates for some time. He points out there is a difference between QE, Fed policy, and a higher “policy rate.” For a range of reasons, low short-term interest rates are going to be with us for a while, and that will keep a lid on other interest rates, though they’ll probably rise faster than short-term rates. PIMCO is looking for the short-term rates to stay low (and go below today’s rates) until 2015 or so.
It’s the policy rate, both spot and forward, that prices markets and drives economies and investment decisions. QEs were simply a necessary medicine for rather uncertain and illiquid times. Now that more certainty and more liquidity have been restored, it’s time for the policy rate and forward guidance to assume control. Janet Yellen, future Fed Chairperson, would agree, as would oft-quoted Michael Woodford, Columbia University professor and 2012 Jackson Hole speaker, who seems to have become the private sector’s philosophical guru for guidance and benchmarks, that will now attempt to convince an investment public that what you hear is what you get.
But if QE is soon to be out, and guidance soon to be what remains, I think investors should listen and invest accordingly. Not with total innocence, but sort of like a totally hyena-aware lion cub – knowing there’s bad things that can happen out there in the jungle, but for now enjoying the all clear silence of the African plain. In bond parlance, the all clear sign would mean that the Fed believes what it says, and if their guideposts have any credibility, they won’t be raising policy rates until 2016 or even beyond. The critical question to ask in terms of the level and eventual upward guide path of the policy rate is how high a rate can a levered economy stand? How much wood can a woodchuck chuck? How high a rate can a homebuyer handle? No one really knows, but we’re beginning to find out. The increase of over 125 basis points in a 30-year mortgage over the past 6–12 months seems to have stopped housing starts and importantly mortgage refinancings in its tracks. It was the primary “financial condition” that Chairman Bernanke cited in his September press conference that shifted the “taper to a tinker to a chance” that maybe they might do something next time.