SHOULD I STAY OR SHOULD I GO?
When a butterfly moves on, investors face an inevitable question: should I stay or should I go? The impact on those who decide to exit the fund is perhaps more obvious.
Interestingly, however, the vast majority of the money departing Gross’s Total Return fund did not follow him to Janus. By the end of June this year the Janus Global Unconstrained Bond fund Gross now manages had a relatively meagre AUM of $1.45bn, which Janus Capital Group CEO, Dick Weil, reportedly told CNBC was “not really enough to excite anyone”.
Pimco’s loss, although not Janus’s gain, benefitted a wide array of other fixed income managers and the consultants employed to assist clients with manager searches.
Mercer recently reported a massive pick-up in traditional fixed income manager searches in the fourth quarter of last year “following the high profile departure of a US fixed income portfolio manager”, according to a press release issued in May. Deb Clarke, Mercer’s global head of invest ment research says: “We typically see a pick up in manager search activity after the departure of a star manager. People often tend to do something slightly different rather than replacing like-for-like. Fixed income was the top search area last year with 188 searches for fixed income managers in the US in 2014 compared to 41 in 2013.”
The impact on asset owners as a collective of that level of manager search and portfolio reconstruction will undoubtedly be massive in terms of both financial and resource costs associated with exiting the fund, finding a new manager and efficiently transitioning the assets across, but also in the loss of a relationship with a skilled manager.
The impact on asset owners who decide to stay in the fund, which traditionally represents the majority of a fund’s AUM, is also significant and often less clear-cut. Among the most significant risks are those associated with the fund’s new management and the costs associated with the inevitable portfolio change that follows.
In the star manager universe succession is very difficult to deal with successfully. The stars of the last 20 years have been more likely to retire and return money to investors as they have generally not been able to bring the same level of skill on board. This exposes investors to new manager risk.
Stamford’s Gelber says: “A successor is likely to be less experienced – having most likely managed a significantly smaller amount of assets previously. We would contend that is quite a difficult move to make. The successor may be capable of managing much greater sums, but investors need to examine their capability in this regard.”
Mark Barnett took over control of the Invesco Perpetual High Income fund in March 2014 following the departure of Woodford. Although Barnett’s track record in managing his previous funds was impressive – outpacing his average peers in the Morningstar UK equity income category by 2.6% per annum – the move still created significant uncertainty, which caused Morningstar for one to downgrade the fund’s rating.
Morningstar’s report into the manager change issues in July last year refers in particular to the massive £20bn increase in Barnett’s AUM, saying: “It is therefore questionable as to whether he will be able use his investment process as freely going forward as he has in the past. For example, when managing Strategic Income, Barnett was able to allocate between 26-44% to mid- and small-cap stocks, given the lack of liquidity in such stocks that would be difficult to replicate currently on this fund.”
Staying in a fund under new management also exposes investors to other risks, not least that the portfolio would have to be positioned for potential redemptions, which Gelber says means it is likely to be “skewed away from the best investment ideas” to allow for the necessary liquidity to meet those redemptions. “The remaining investors end up with sub-optimal exposures,” he says.
Furthermore, there is the cost of transitioning the portfolio to reflect the new management’s convictions. This means at least some degree of rejection of existing portfolio exposures, although the rejection rate is often very significant, especially in more concentrated, high-conviction portfolios. Gelber says the rejection rate is typically in the order of 80%, meaning the vast bulk of the portfolio has to be traded, which can be a costly exercise.
THE FIRM-WIDE EFFECT
The butterfly effect of manager change can also hit those whose assets are not managed by that particular butterfly. There is often considerable disruption at the company- wide level. When a key figure leaves, firms go through a period of turmoil, which is often difficult to cope with in a credible way.
“It takes time and a huge effort by a firm to get their house back in order,” Gelber says. “The public rarely hears of these struggles though.”
In the case of Pimco, those struggles have arguably been more visible than they typically would have been. Press reports abound about the internal conflicts that ripped through the firm in the lead-up to Gross’s departure and the firm has since been very vocal about the considerable degree of expertise it is still able to bring to bear in its new leadership. However, that hasn’t stopped the asset outflow elsewhere in the firm. The flows out of the Total Return fund are dwarfed by the $450bn outflows the firm has seen. Pimco’s firmwide AUM stood at $1.52trn at the end of March, down 23% from $1.97trn at the end of June 2014.
Mercer’s Clarke says: “If the manager is a culture carrier, there will undoubtedly be an impact, although that impact is not always negative if there were cultural problems or tensions around the star before their departure. Where there is a big disruption though, investors need to look at how the whole firm works.”
This is easier said than done. Firms in turmoil will want to present a positive picture to the outside world.
According to one senior investment expert: “It’s like pulling teeth to get the real picture of what is going on as a firm will want to focus on the positives due to their fear of redemption. Getting to the bottom of what is really happening at the firm level is not easy.”
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