In the parable of Bill Gross and investors who chase the financial equivalent of rock stars, there are clearly a few lessons for investors. My colleague Imogen Rose-Smith warns in a recent post that star managers rarely deliver on their shiny promises of outperformance, no matter how many times they appear on television. She concedes, of course, that stars will always appeal to investors — we all love a good story, after all — even if few of the exalted truly generate fat returns over long periods of time.
During Peter Lynch’s high-profile tenure at Fidelity Investments, the firm’s Magellan Fund went from $40 million to $10 billion of assets. When I was writing “Beating the Market Has Become Nearly Impossible” last year, Credit Suisse’s head of global financial strategies Michael Mauboussin pointed out that Lynch generated, on average, 2 percent of gross alpha — risk-adjusted returns over a benchmark — each month for investors during his first five years. During the last five years, Lynch delivered only 0.2 percent of gross alpha a month.
My point would be that if you’re always drawn to the charismatic rock star, do it and have fun, but just know you’re going to be disappointed.
Of course, that raises the question of whether you will be merely disappointed that your boy has gone on without you or will be badly hurt. How much has Gross’s inelegant departure from PIMCO late last month hurt investors as the firm has sold off securities at less-than-ideal prices? Many of the institutional investors I met at a governance conference a few weeks ago in Los Angeles were worried that they would bear the brunt of PIMCO’s forced selling and unwinding of derivatives contracts if they held on. Whereas it’s still early days for PIMCO sans Gross, there’s little historical evidence that shareholders have been significantly hurt by the short-term volatility caused by a single fund manager. Take the example of Jeffrey Gundlach and TCW Group. The TCW Total Return Bond Fund exhibited little volatility during the first six months after TCW fired Gundlach, its manager, in 2009 despite losing half of its assets during that period.
A star’s exit primarily hurts asset managers. That’s where the real pain and key man risk lie. PIMCO was synonymous with Gross, and the firm is now bleeding assets. Although I have no doubt PIMCO will survive its co-founder’s departure, this is a key question for many traditional and alternative asset managers. Can they thrive after the loss of a great team or a big personality? Is their firm more than a one-trick pony?
A couple years ago the founders of Pine River Capital, a relative value credit hedge fund firm headquartered in Minnesota (where I grew up), wanted to talk to Imogen and me about their plans to “institutionalize” their business. They wanted to make sure that the firm would continue to thrive after they were gone, as well as reassure potential investors that the firm — whether they were there or not — was in it for the long term.
But on the way to their offices in New York, Imogen and I discussed why this even mattered. “Hey, when these guys say they’ll retire, investors can pull their money and look for other opportunities,” I quipped. Of course, few investors think this way, and Imogen quickly pointed out that firms need to constantly attract talented people to keep fresh ideas flowing. Few young and hungry managers would sign on to a firm that had no plans to grow. The Pine River folks were right to think hard about succession.
Still, investment management firms, just like technology companies (think Apple and Steve Jobs or Facebook and Mark Zuckerberg) will always be dependent on a few brilliant people, no matter how deep their bench. Giving key people equity stakes and greater autonomy can help keep them, but, of course, it can’t eliminate risks like death or craziness. Maybe asset management firms should just enjoy their good fortune while they have it. Whereas investors were no longer getting particularly rich during Lynch’s last five years of managing the Magellan Fund, Fidelity was. It was earning fees on $10 billion, rather than on the $40 million when he started.
Follow Julie Segal on Twitter at @julie_segal.
