How Pimco works

By Felix Salmon
July 31, 2012
anonymous troll on the internet who doesn't like my latest Pimco post.

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There’s an anonymous troll on the internet who doesn’t like my latest Pimco post. And frankly it’s really hard to take any post seriously when it’s tagged “born last night, clown questions, gmafb, horseshit, STFU”. This kind of macho bullying posturing is everything I hate about Wall Street — a place which is still home to far too many overconfident frat boys with overstuffed paychecks.

So, why am I rising to the bait? Mainly because some people I respect are taking the post seriously. And also because, hidden behind the sophomoric grandstanding, there are actually a couple of substantive points being made.

To take them in order, then:

Firstly, does Bill Gross pay himself, or is he “paid by the parent company that bought his firm”? I haven’t seen a lot of reporting on this, but everything I know about Pimco says that it’s a very arm’s-length, largely independent unit of Allianz. It certainly dividends profits up to its parent, but I don’t actually believe nor have I ever seen it reported that Allianz executives make granular decisions on how much Bill Gross, or any other Pimco employee, gets paid on a year-to-year basis.

Is there a formula governing Gross’s remuneration, based on some combination of Pimco revenues, Pimco profits, and the performance of the funds he manages? I’m sure there is. And if you want to reverse-engineer a way for Gross to have been paid $200 million in 2011 despite massively underperforming that year, then that’s surely the way to get there. Pimco doesn’t want to encourage short-term gambling among its employees, and so its pay is based on long-term performance rather than year-to-year fluctuations; Gross’s long-term performance remains excellent, and he manages an astonishing amount of money. And on top of that, Pimco is attracting spectacular inflows these days.

Still, Pimco told me that the numbers in the original NYT article were “seriously inaccurate”, and I’m quite sure that Gross, given his position in the company, does have a certain amount of discretion when it comes to divvying up the remuneration pool. He might not “have to answer to congress or a goofball parade of Occupy Wall Streeters”, but he’s still a leader — and even if we don’t know for sure how much he got paid last year, a lot of big-time money managers in the company know exactly what example he is setting. If they would risk getting fired after turning in such dismal performance, then it would be downright hypocritical — and bad for the cohesion of the senior management team — were Gross to accept a $200 million paycheck in such a bad year.

And how about the people whose money Pimco is managing? Yes, it’s easy to say that they’re sophisticated investors who “pay an agreed upon and transparent management fee up front” — but that doesn’t mean they’re happy with the fees they’re paying, especially not if they start reading about $200 million paychecks. And in a world moving swiftly away from the fund model and toward the lower-fee ETF model, it behooves any long-only money manager to keep a very close eye on fees and costs. The level of money-skimming which maximizes your payday this year is not necessarily the best way to keep on building your company’s franchise over the long term, especially in a world where index investing is becoming increasingly popular.

As for the assertion that long-only “buy siders that actually run portfolios north of 200 billion are paid at this level” — well, name some names. It’s a very short list, of course. But if you can find one or two other people who were paid $200 million a year for managing funds, and who weren’t hedge-fund managers collecting 2-and-20, then I’d be much more likely to believe that Gross is paid that much, too.

Next up comes a question about Mohamed El-Erian’s tenure at Harvard Management Company. I quoted an article about how “Mohamed was having a heart attack” while he was there, because Larry Summers insisted on taking Harvard’s spare cash and investing it in an endowment which was designed to have a virtually infinite time horizon. As a result, El-Erian’s job when it came to liquidity management was made extremely difficult. But now I’m told “this isn’t true”, on the grounds that all El-Erian needed to do was “explain” to Summers and others “that their allocation was inappropriate”, and then sleep well at night since the “allocation was made by Harvard officials not by Harvard Management.”

Maybe anonymous Wall Street trolls think that way, and wouldn’t worry about Harvard’s liquidity needs even if Harvard was effectively using them as a checking account. But a responsible money manager worries about liquidity every day, especially in a situation where Harvard can and will ask for large sums of cash on a regular basis. In any case, my larger point was that El-Erian can’t be blamed for liquidity problems after he left HMC, and there doesn’t seem to be any disagreement on that front.

Then there’s the question of the degree to which El-Erian’s ubiquity in the media is a Pimco marketing strategy, responsible for the large increase in assets that Pimco is seeing these days. I’m informed that the answer is a simple yes — but if that’s the case, that has interesting implications. A large chunk of Fabrikant’s article was based on the premise that Pimco’s investors wanted Gross’s bond-trading expertise, rather than El-Erian’s technocratic global-macro insights. But if indeed El-Erian’s regular TV appearances and various op-eds are responsible for the hundreds of billions of dollars which continue to flow into Pimco, then it seems that there’s a lot of appetite out there for a macro-led, rather than a trading-led, strategy.

On top of that, it’s notable that Gross, the great bond trader, has started to underperform Pimco as a whole, where investments are based very much on the global macroeconomic outlook. Pimco’s more than big enough for both Gross and El-Erian, of course. But the idea, in Fabrikant’s piece, that Pimco is effectively still Gross’s shop, and risks withering away were he ever to leave — that idea is pretty effectively demolished if in fact El-Erian’s media strategy is responsible for bringing in enormous amounts of new money. Certainly El-Erian never talks about trading strategies in such appearances.

Finally, there’s the question of Blackrock, a much bigger fund manager than Pimco, where, incidentally, the CEO, Larry Fink, was paid $21 million in 2011. How did Blackrock grow so big? In large part by buying a lot of index funds, thereby diversifying into one of the fastest-growing investment strategies in the world. And also, in part, by being a public company. And so I asked a question, and received an answer:

In order for Pimco to effectively compete with Blackrock, will it too have to go public?

No. How is that even a question? They are a wholly owned subsidiary of a firm that is significantly larger than Blackrock which allows them tremendously cheap financing if they need it. Allianz’s insurance assets also provides them with 23% of their AUM. Does JP Morgan Asset Management, SSgA, or Deutsche Bank Asset Management (all well over a trillion in AUM) need to spin off and IPO to compete with Blackrock?

I wasn’t suggesting that Pimco spin off from Allianz. But Pimco already has “shadow equity” which is traded among Pimco employees; there’s no reason that it couldn’t get listed as some kind of tracking stock. And that tracking stock could be a very valuable acquisition currency as Pimco seeks to diversify away from its historical core competence of actively-managed bond funds. There are many reasons why Pimco might well prefer to do things that way, rather than asking Allianz for “tremendously cheap financing” for an acquisition.

I’m sure that Pimco gets lots of value from having Allianz assets at its core. But Pimco is also reported to be “seeking more independence from its parent”, and in any case I don’t think it’s true that Pimco is wholly owned by Allianz, which bought only 70% of the company back in 1999.

My point about Blackrock is that by having its own stock and being master of its own strategy, it has managed to diversify, and grow, more quickly and effectively than Pimco has. Here’s a germane quote, from last year:

“The history of the asset-management business demonstrates time and time again that the most successful asset-management firms are those who are dedicated to investing rather than subsidiaries of banks and insurance companies where there can be lots of tension,” Burton Greenwald, a fund-consultant based in Philadelphia, said in an interview. “Fund companies tend to be entrepreneurial, while banks and insurance companies tend to be bureaucratic.”

There’s a case to be made that Pimco has in fact thrived under Allianz’s ownership — but it’s unclear whether that’s a function of Allianz being a great owner, or whether it’s a function of the fact that those years saw the greatest fixed-income bull market of all time. That bull market is going to come to an end at some point. And when it does, Pimco wants to be positioned much more evenly across various different asset classes and strategies than it is now. In order to do that, it’s not a completely horseshit clown question to ask whether it might want to take a leaf or two out of Blackrock’s book.

Update: David Merkel adds some very useful facts to the debate.

7 comments

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The Blackrock vs PIMCO diversification is an interesting one. You basically have to ask yourself a series of questions “Active or Passive” “Equities or something else” “Long-only or Alts” and “Buy vs. Build”. Blackrock clearly decided to buy a Passive/Quant business. Pimco is trying to build a long-only active equities business, and they are specifically doing it in a way avoids market sectors that are seeing large migration to passive. Now this might not work, but if you decide you don’t want to be in the passive business (maybe a reasonable choice purely because of fee compression, the economies of scale and almost zero marginal cost of managing incremental assets) you basically have to do a build approach. Buying asset managers is really really hard to do. Even when it works for a while it can then turnaround and completely implode (see Axa/Alliance/Sanford Bernstein.) For the strategy PIMCO has chosen having a publicly traded equity doesn’t help. Actually even if you chose a buy strategy given the small number of public Asset Managers out there you could probably get away with issuing more of the quasi-equity Pimco has now.

Posted by topofeatureAM | Report as abusive

Felix, I found a couple of your points nonresponsive. Do you really think the political risk of his pay being leaked (and how many would be in a position to leak it?) is more relevant to his compensation than the sheer size of AUM and management fees walking through the door? Do you think the macro v. bond strategy distinction is more relevant than the inflows that come in simply from having such a publicly respected leader?

Apart from the edge in those tags, I don’t find this ‘anonymous troll’ substantially more offensive than TED (and he’s far less pretentious).

Posted by absinthe | Report as abusive

“And frankly it’s really hard to take any post seriously when it’s tagged ‘born last night, clown questions, gmafb, horseshit, STFU’”

That same reasoning is exactly why I can’t stand Matt Taibbi and discount everything that he says, even if he may occasionally make a valid point.

Posted by realist50 | Report as abusive

Felix – small point, but important. ETFs may be cheaper than comparable mutual funds, but are almost always more expensive than institutional pooled funds. They do however offer a greater variety of indexes so more flexibility, but the majority of AUM at PIMCO, Blackrock and peers will be institutional in nature.

Posted by edlepicier | Report as abusive

My thoughts:

http://alephblog.com/2012/08/01/pimco-in -theory-and-practice-part-ii/

Contains data on PIMCO’s current bonus structure and ownership. Facts can be useful.

Posted by DavidMerkel | Report as abusive

Well, I’d like to take a stab at addressing the following three non-issues:

-Who cares how much money Bill Gross is paid? Are we on the “social justice” warpath here or are you afraid that Pimco shareholders, whose total return includes Pimco management compensation, can’t assess value on their own?

-Who cares if Harvard’s endowment isn’t being optimally managed? They’re loaded, there are a lot of sophisticated, interested parties involved here….and they’re big boys, they’ll figure it out the hard way or otherwise. Your time would be better spent illustrating how ZIRP is ruining the “endowments” of many ordinary Americans.

-Blackrock got so big through acquisitions, which, by accident or design turned out to be very timely. For better or for worse they are the Citigroup of the asset management business – we’ll see how that works out. And a good chunk of their AUM is via their (acquired) ETF business which happens to be hot stuff at the moment but nonetheless amounts to barely active management and is not apples-to-apples with Pimco’s business.
-Mercury

Posted by MercuryZH | Report as abusive

I think people focus on the “amount” that Bill Gross gets paid rather than the value that he brings to PIMCO / Allianz or Bill’s opportunity cost (how much he could be making elsewhere). By these measures, I calculate he significantly is underpaid at $200M or less per year. While I made a lot of big assumptions, my back of the napkin math suggests that Bill Gross should be getting paid in range of $700 – $1 billion per year. The math is described in the article:

http://www.learnbonds.com/bill-gross-com pensation/

Also, we have a poll – how much do you think Bill Gross should be paid?

http://www.learnbonds.com/bill-gross-sal ary/

Posted by LearnBonds | Report as abusive