Challenges and Quandaries in Manager Research

In The Bond King, Mary Childs writes that a 2014 article by Greg Zuckerman in the Wall Street Journal

shocked those outside the bond market.  The infighting, Gross’s stringent rules on the trade floor, the crown of thorns?  It was a lot.  The Wall Street banks who covered Pimco knew how tightly wound things were in Newport Beach, as did competitors who’d hear the horror stories or who had interviewed there and run away in terror.  But outside of that, no one had had a clue, until now.

How about those investing with Pimco, those doing due diligence on it?  Did they have a clue?

Due diligence is the focus of this third in a series about Childs’s book.  (The first dealt with organizational dynamics at Pimco, the second with ideas and trades that illuminated its aggressive approach.)

If your organization has an archival research database that contains notes and reports about Pimco across the years, you should go back and look at them, whether they were internally generated or came from research firms that followed Pimco and offered advice to investors about it.

Can you find any comments about the toxic culture — or the “blame-seeking framework” (to quote Childs) that was at its core — before the WSJ article?  If so, when and why did they show up?  If not, why not?  Are there any concerns expressed in the notes that weren’t put into a formal report?  If so, why weren’t they published for others to read?

Questions for manager analysts

The subtitle on this section indicates that it is for “manager analysts,” but that should be interpreted broadly as anyone, no matter their title or role, who is charged with evaluating investment managers.

The referenced questions appear throughout the rest of this piece, indented and in italics.

Culture

The dominant thematic questions for consideration presented by the book are:

Does the culture of an asset management organization matter to you, or is it the results that count?

What kind of culture produces the best investment performance?

A recent survey found that “despite the widespread marketing jargon with respect to culture, it plays the least important role in manager selection” (of the factors that were studied).  It seems that all managers talk about their wonderful cultures — if you found some old reports in your archives, check out what Pimco said about its own — and manager selectors speak to its importance too.  Is that all for show (on both sides of the table)?

If the benefits of the aggressive moves by Pimco chronicled in the previous posting led to good performance, perhaps the costs of that corrosive environment were worth it.  But managers that trod that path can create an inherent instability that at some point leads to bigger problems.  Pimco has survived but many others with the same mentality have not.

Saint Augustine of Hippo is famously quoted as praying, “Give me chastity and continence, but not yet.”  Investors want the upside of winning in whatever way possible but not the downside — to be on board for the good years but to spot the problems before they become visible to others, show up in the numbers, catch the attention of regulators, or appear in the Wall Street Journal.

In recent years there has been a raft of studies about organizational behavior that promote principles which are often eschewed within investment firms.  Psychological safety?  Emotional intelligence?  Social sensitivity?  (Etc.)

Are asset management organizations different from other kinds of organizations when it comes to the methods for creating a culture that leads to sustainable success?

If so, why, and in what way?

These kinds of simple but important questions should be at the heart of discussions about culture, but they are usually not addressed.  Descriptions of culture, from managers and allocators alike, are typically full of hazy platitudes.

If culture does matter to you:

How do you further your knowledge of the attributes and indicators of organizational culture, in general and specifically for asset managers?

What tactics do you use to crack the narratives that are offered about culture by managers? 

Edges

Looking back, with the benefit of hindsight and years of reporting, Childs was able to provide examples that provided evidence of edges that Pimco had, some of which were relayed in the last posting.

How can you support or refute the “edge claims” of managers? 

Everyone says they have smarter people, better networks, and differential processes, but most managers are relatively equivalent to one another.  And performance isn’t proof of an edge, although it may be an indicator.

Key man

Despite Pimco’s heft (it likes to advertise the number of portfolio managers it has), Bill Gross so dominated the firm and the public perception of it that he was the embodiment of so-called key-man risk.

As became evident, that can be a blessing as well as a curse.

How do you weigh the potential pluses and minuses of having someone so singularly important to a firm?

What do you do to sort out the reality of his or her influence/dominance at the firm versus the public perception?

To what degree is your impression of the individual affected by their personality and observed behavior?

(Also, Gross’s move to Janus is a reminder that when a star goes off to another firm they often don’t live up to expectations.  They weren’t alone in making that track record.  Environments are hard to recreate.)

Decision making

According to Childs, “Traders grumbled that the Investment Committee meetings and forums, the deliberations and posturing — it was all theater, because in the end, they just traded what Gross already thought.”  Reality is often different than advertised (there was also a “shadow investment committee” at times).

And, if that’s the case when it is only employees in the room, what do you think happens when outsiders are invited to “see what the process is like”?

In what ways can you break through the theater and the process diagrams to get a sense of how decisions are really made?

Oversight

The head of the Pimco fund board’s governance committee “said the board had learned about the Gross/El-Erian drama when they read about it in the paper, like everyone else.”  He had been on the board for twenty-three years, but after the article he made public comments about Gross’s compensation, his “bullying” management style that had been revealed, and his “mediocre” performance at the time.  (He was off the fund board within three months.)

It was a reminder that mutual fund boards don’t control what happens at management firms; they are separate entities.  And in most cases they only know what they are told by the managers — and they don’t do any independent investigation or analysis of them, except as legally required, which doesn’t cover most of the issues that manager research analysts should care about.

Investors who rely on those boards — or other overseers or gatekeepers — often have misplaced expectations about the quality of reviews that they conduct.

Do you count on any outside entities, such as mutual fund boards, regulators, or investment research firms, to serve as watchdogs on your behalf?  In what ways?

Accolades and attention

Gross has talked about the importance of public relations to his success (including in this podcast).  The “Bond King” appellation was a powerful lever, as was Morningstar’s naming him the “Fixed Income Manager of the Decade” in 2010, but they were just part of an ocean of recognition and promotion.

It all has an impact, reinforcing consensus views, making it harder to form a contrary opinion and to have others act upon it.  That’s true for others too — like consultants and research firms — who are reluctant to back away from a portfolio manager who has been good to them.

How susceptible to these pressures are you and those who judge your recommendations about managers?

What strategies do you use to avoid the traps involved? 

The process of due diligence

Investors could hear Gross speak at a conference, and perhaps a few would have an opportunity to briefly rub shoulders with him there.  But most due diligence analysts didn’t ever get a chance to sit down with him to ask questions.  In fact, visitors to the Pimco trading room to “see how things worked” were sometimes admonished to not engage with him if he happened by.

As at many other large firms, there were layers of intermediaries who provided the information that was desired.  But, if it came to be that you had the opportunity to interview Gross, what would your questions be?  The power imbalance involved might result in a fawning question or two — or obvious, easy ones that could be dispatched quickly by him.

Now think about what Gross would do if the situation was reversed.  He would ask the hard questions, realizing the softballs that every one else tossed would yield nothing in return.

Many doing due diligence are too cautious with managers, and not just the famous ones.  They are concerned about future access, so they don’t want to ruffle feathers.  It’s not that you want to go in with both guns blazing, but you need to go where others haven’t gone.

If there is pushback, it’s useful to turn the tables and ask them what their own standards of due diligence are, how they would approach the investigative process if they were in your shoes.  That puts things in perspective.

That advice goes beyond your list of questions to the broader menu of tactics that you employ to get information and develop understanding about a manager.  If they squawk about one of your requirements or requests, relate your quest to their own.  Would they advocate for a more lax approach to due diligence?  You have them in somewhat of a box.

How willing are you to be innovative in your approach to manager analysis and in the process of due diligence, so that you are playing a different game than others in order to surface differential information?

What works for you and what doesn’t?

The end (for now)

The questions could go on; these are just a few of the ones spawned by The Bond King.  It is a worthwhile read that covers major events in the history of the investment business, paints portraits of the people at the heart of a fabled organization, and prompts consideration of what makes asset management firms special and how they should be analyzed.