Questioning El-Erian

By Felix Salmon
July 30, 2012
Geraldine Fabrikant decided to write a rather odd and meandering profile of Mohamed El-Erian for the NYT, she made sure to bury the lede, deep in the article's sixth paragraph.

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When Geraldine Fabrikant decided to write a rather odd and meandering profile of Mohamed El-Erian for the NYT, she made sure to bury the lede, deep in the article’s sixth paragraph. But Clusterstock knew where the news value was (“KA-CHING: PIMCO’s Mohamed El-Erian Got Paid $100 Million Last Year”), while Bloomberg led with the revelation about El-Erian’s co-CIO: “Pimco’s Bill Gross Paid $200 Million Last Year, N.Y. Times Says”.

Fabrikant’s source for both numbers is a single individual, “a person with knowledge of Pimco’s finances”. The whole thing was rather reminiscent, to me, of what happened last February, when Reuters reported that Pimco’s top partners are making an average of $33 million each, and Pimco responded by calling those numbers “wildly inaccurate”. So I asked Pimco what it thought of Fabrikant’s reporting, and got this back from a spokesperson:

The article contains numbers that are seriously inaccurate, as well as other factual errors.

Fabrikant spent a lot of time on this article — she says that her joint interview with El-Erian and Gross took place “earlier this year” — and so I suspect that she’s pretty confident in printing those numbers. That said, however, Gross, who’s already a multibillionaire and really doesn’t need the money, would have had to be utterly tone-deaf to pay himself $200 million in 2011.

2011 was the year, remember, in which he published a 3-page note entitled “Mea Culpa”: “I’m just having a bad year,” he said. “This year is a stinker.” He continued:

This is big league ball, where your ticketholders come to the park expecting not a circus Willie Mays catch but more wins than losses and a yearend performance that places your bond assets near the top of the standings.

That didn’t happen. Instead, Gross placed in the bottom 10% of bond-fund managers for 2011. Given that, it’s hard to see how he could justify extracting $200 million from Pimco’s investors, or three times the record $68.5 million that Lloyd Blankfein was paid in 2007.

Certainly that kind of payday is within the realms of possibility, given that his firm manages $1.8 trillion, and his Total Return Fund has $263 billion under management: $200 million is just 0.01% of the former, or 0.08% of the latter. On the long-only buy side, the way you get paid for performance is that your performance attracts new money, and the new money pays management fees. And so long as Pimco’s assets under management are going up rather than down, I can see how Gross’s pay might do likewise. But still.

I can’t say that the rest of the article makes it seem particularly reliable, either. Fabrikant lays out the case against El-Erian on two fronts: firstly that he isn’t much of a bond trader; and secondly that his tenure running Harvard’s endowment was “somewhat controversial”. Overall, she says, “his track record for managing money is mixed”.

But I can’t work out how Fabrikant comes to that conclusion. El-Erian has managed money at two places: Pimco (twice), and Harvard. In his first stint at Pimco, between 1999 and 2005, he managed emerging-market bonds through the Russian and Brazilian crises and the Argentine sovereign default; he ended up making an annualized return of 18.4%, which was very much, in Gross’s words, “near the top of the standings”. What’s more, he amassed a much larger emerging-market bond portfolio than any of his competitors: he was just as good at attracting funds as he was at generating alpha.

At Harvard, El-Erian also did well, at least in terms of published returns. Of course, there’s more to managing an endowment than maximizing annual returns: you also need to be assiduous about liquidity management. And after El-Erian left Harvard, the endowment ran into massive liquidity problems. Fabrikant says that “several experts on endowments”, none of whom are named, blame El-Erian’s investment strategy for those problems, along with his abrupt departure. But I see things differently: I think the real problem at Harvard was leadership, or rather the lack thereof.

El-Erian’s departure was indeed abrupt — but I suspect that had he been managed better by the university’s grandees, including Larry Summers and Robert Rubin, they could have done a better job of persuading El-Erian to put in place a considered succession strategy. And then, after El-Erian left, the endowment was left effectively headless for the best part of a year before Jane Mendillo was hired in July 2008. That’s not his fault.

Asset allocation is something endowments do on a very long timeframe: once El-Erian had worked out where he wanted the endowment’s money to be invested, it was probably OK to keep that same allocation until a new head could be found. But liquidity management is another thing entirely: that kind of thing can’t be run on autopilot, and has to be actively managed. Especially when Summers is busy losing $1 billion of the university’s money elsewhere. Remember this?

Through the first half of this decade, Meyer repeatedly warned Summers and other Harvard officials that the school was being too aggressive with billions of dollars in cash, according to people present for the discussions, investing almost all of it with the endowment’s risky mix of stocks, bonds, hedge funds, and private equity. Meyer’s successor, Mohamed El-Erian, would later sound the same warnings to Summers, and to Harvard financial staff and board members.

“Mohamed was having a heart attack,’’ said one former financial executive, who spoke on the condition of anonymity for fear of angering Harvard and Summers.

In other words, El-Erian was having a hard enough time on the liquidity-management front when he was in the office every day, thanks to the internal politics of the university; he can’t really be blamed for failures after he left.

Finally, El-Erian started managing money directly at Pimco again in 2009; since then, his funds’ returns, in Fabrikant’s words, have been “relatively lackluster”. But these are small funds, with just $10 billion between them — a rounding error, at Pimco. As CEO and co-CIO of the whole company, El-Erian should be properly judged on the whole company’s performance, and Pimco seems to show no deceleration whatsoever when it comes to the pace at which it is accumulating assets under management. Not that you’d learn that from Fabrikant’s story.

Instead, we get very silly stuff like this:

Mr. El-Erian was headed east and people were buzzing. Some wondered if he was taking the job to cultivate a relationship with Lawrence H. Summers, a former Treasury secretary who was then Harvard’s president, in the hope of finally landing atop the I.M.F.

Who are these “some”? We’re never told, of course. But since when has the president of Harvard had any say at all in who becomes the next head of the IMF? Summers did return to government eventually, but that was by no means a foregone conclusion, or even likely, in 2007. What’s more, even once he was in government, I don’t think that Summers played any real role in selecting the next head of the IMF — a choice which is made by Europeans, not Americans.

And what we don’t get, from Fabrikant’s article, is any real substance on the task facing El-Erian. If you’re writing a profile of him, here are some questions I look forward to you trying to answer:

To what degree is El-Erian in the process of replacing Gross, and to what degree is he doing something completely different? What will happen to the Total Return Fund when Gross retires? Does Pimco need to replace Gross with another great bond trader, or is it now a very different animal to the company that Gross founded, in need of someone who thinks on a more macroeconomic level? And how is El-Erian, who is CEO as well as CIO, as a manager?

How much time does El-Erian spend appearing on television, writing op-eds, and otherwise cultivating the media? Is that all part of some Pimco marketing push? To what degree does it distract from his day job? Same questions for Gross, too.

Finally, and most interestingly, how did Larry Fink manage to amass twice Pimco’s assets under management despite the fact that Bill Gross, the greatest bond investor of all time, had a more than 15-year headstart on him? What is the story of Blackrock vs Pimco, and how is it likely to play out in future? In order for Pimco to effectively compete with Blackrock, will it too have to go public? (Incidentally, Fink was paid $21.9 million in 2011.)

El-Erian is an interesting character, but it seems to me that the most daunting job facing him is the fact that he is being asked to run an enormous buy-side institution which he didn’t found. Many people have been asked to do that; very few of them have ever succeeded. What will it take to buck the trend? And will the world’s institutional investors stick around long enough to find out? Or will El-Erian finally get that IMF job, and move to Washington, before it comes to that?

But yeah, it would also be fascinating to find out how much he’s really being paid.

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