TCW’s $50-Billion Sheen Tarnished by Losses
Trust Co. of the West, one of Los Angeles’ largest money management firms and one of the leading U.S. investors in Latin America, has suffered sharp losses as Latin stock and bond markets have plummeted in recent months.
But the $50-billion-asset TCW, long known for taking bigger risks and reaping similarly outsize rewards, appears to be in a much better position with most of its Latin debt than some of its peers, Wall Street sources say. That’s because TCW has avoided some of the worst-hit bonds.
Even so, the plunge in value of TCW’s estimated $4.5 billion investment in Latin stocks and bonds--particularly Mexican issues--has compounded losses that the firm endured in 1994 in its substantial portfolio of mortgage securities.
Rumors have dogged the bond market periodically over the past year that TCW’s mortgage investments had dropped severely, in part because the firm was known to be a large investor in so-called inverse floater securities.
Those issues--some of the same kinds of bonds owned by Orange County’s doomed investment fund--are structured to pay higher yields if market interest rates fall, but lower yields if market rates rise. Because rates surged in 1994, inverse floater bonds tumbled in value.
“TCW has been one of the biggest players in mortgage derivatives in recent years,” said one rival fund manager.
TCW officials, who are notoriously publicity-shy, declined to comment about their portfolios or about current strategy. But Wall Streeters familiar with the firm’s operations say only a relatively few unhappy institutional clients have defected from TCW to other money managers over the last several months.
Because TCW apparently has not used leverage, or borrowed money, to intensify its bond bets, it doesn’t face the kind of liquidity issues that fueled Orange County’s crisis. Moreover, the Mexican bonds in TCW’s portfolios are mostly dollar-denominated corporate securities, not the peso-denominated bonds that have experienced the worst losses as Mexico’s currency has been devalued.
“They have very little peso exposure and virtually no tesobono (short-term Mexican government bonds) exposure,” said John Liegey, whose New York-based Weston Group has advised TCW on emerging-markets securities.
So far, TCW’s problem is more one of a tarnished image with some of the firm’s high-powered clients, who now are swallowing deep losses in their bond accounts after enjoying three years of well-above-average returns.
TCW’s more pressing client problem may be with individual investors: Five of six mutual funds that the firm manages for brokerage Dean Witter Reynolds suffered 1994 declines far exceeding industry averages, a result of TCW’s bond strategy and its Latin investments.
One of those funds, the TCW/Dean Witter North American Government Income fund, slumped 15.6% in value, sparking a flurry of shareholder redemptions that drained $1 billion from the fund in just nine months.
The Dean Witter funds, only two to three years old, represented TCW’s first major foray into money management for small investors. The company historically has avoided that “retail” market, preferring instead to deal exclusively with institutional investors and high-net-worth individuals.
The institutional market suits TCW’s cigar-chomping, 47-year-old chairman, Robert Day, who founded the company in 1971 with $2 million.
Day, the blue-blooded Angeleno grandson of Superior Oil Co. founder William Keck, is an aggressive, no-nonsense money manager who divides his time among Los Angeles, New York and Martha’s Vineyard, and who shuns publicity like the plague.
In fact, the company’s public profile has traditionally been so low that some of Day’s peers were shocked a few years ago when he allowed the giant initials “TCW” to be emblazoned atop the company’s Downtown Los Angeles tower.
For most of TCW’s history, Day had no interest in small investors--and no real need for them. Between 1980 and 1990 TCW’s assets under management grew from $2 billion to $17 billion, as the company’s prowess as a global stock-picker, bond manager and real estate investor attracted dozens of huge institutional investors, including Boston College, Lockheed Corp. and Levi Strauss.
As the 1990s began, TCW was perfectly positioned for meteoric growth. Loaded with high-priced talent that Day recruited from other major investment firms, TCW offered expertise in such exotic markets as Latin American securities, convertible bonds and “distressed” bonds--all areas that promised higher returns to institutional investors scrambling to cope with plummeting interest rates.
And indeed, in the five years ended in 1992, TCW’s performance in many of its investment accounts was exceptional. The firm’s “concentrated core” stock portfolio gained 18.5% annualized in that period, versus a 15.9% return for the Standard & Poor’s 500-stock index; TCW’s mortgage-backed bond portfolio returned 15.3% annualized versus 11.4% for a popular mortgage bond index.
Most spectacular were TCW’s Latin American stock returns: 69% annualized from 1988-92, thanks in large part to Day’s early recognition of Mexico’s rebound in the late 1980s.
As TCW’s stature on Wall Street zoomed in the early 1990s, so did assets under management--to a stunning $35 billion by the end of 1992. By January of last year the total reached $50 billion, catapulting TCW to No. 37 on Institutional Investor magazine’s list of the Top 300 American money managers, up from No. 80 in 1989.
To the surprise of many in the investment community who knew Robert Day, TCW also began to hunt for an entree into the booming mutual fund business in the early ‘90s.
John Rekenthaler, editor of fund rater Morningstar Inc. in Chicago, recalls that in conversations with TCW executives a few years ago, “They felt that they didn’t have the knowledge necessary to get into the retail market,” a much more service-intensive business than dealing with savvy institutional clients.
Then along came Dean Witter, which like many major brokerages had struggled in managing some of its proprietary mutual funds. TCW struck a deal to launch a series of stock and bond funds that would be managed by TCW but sold and serviced by Dean Witter brokers.
The first TCW/Dean Witter fund, the “Core Equity” stock fund, was born in May, 1992, followed by the North American Government Income fund in July, 1992, and the Latin American Growth stock fund in December, 1992.
In 1993, all three of those funds produced terrific returns. The Latin American Growth stock fund soared 46.8%, according to fund tracker Lipper Analytical Services. While below the average Latin stock fund return of 57.1% in 1993, the TCW fund’s gain nonetheless made it the third-best fund in Dean Witter’s stable that year.
Meanwhile, the Core Equity stock fund jumped 19.2% in 1993, nearly twice the average fund return in its category of growth-and-income funds.
The most controversial TCW fund, the North American Government Income fund, returned 8.1% in 1993, also well above its category average. But that category--short-term world income funds, which invest in short-term bonds of various countries--had been criticized from the start by some industry experts.
Their argument was that the funds were frequently marketed to small investors as low-volatility, high-yield income funds, downplaying the potential risks entailed. Those risks included losses that could be generated by market interest-rate shifts, by potential defaults by bond issuers, and by fluctuations in the dollar’s value versus foreign currencies.
“These funds have been sold on the idea of a level of safety that they can’t deliver,” contends Morningstar’s Rekenthaler. “They’re not the low-volatility, cash-alternative product” they were made out to be, he says.
For the TCW North American fund, which invests in U.S., Canadian and Mexican government bonds, trouble began early in 1994 as the portfolio’s U.S. mortgage bonds tumbled, a victim of rising interest rates. By mid-1994 the fund was down 4.8% for the year.
But the biggest blow to the portfolio came in the final months of last year as Mexico’s financial crisis exploded, sending interest rates there sky-high and slashing the value of the Mexican peso.
Even though the TCW North American fund’s Mexican bond holdings comprised less than 20% of the portfolio, the combination of soaring rates and a plummeting currency walloped those bonds so severely that the fund’s value plunged 10.5% in the fourth quarter alone. For all of 1994 the fund’s loss was 15.6%, more than three times the 4.3% loss for the average short-term world income fund.
Many fund analysts believe the TCW fund’s position was worsened by a tidal wave of redemptions, as shareholders bailed out beginning early in 1994, forcing TCW fund managers to sell into a bear market. The fund’s assets, $2.8 billion a year ago, slumped to $1.5 billion by September.
The extent of shareholder desertion of that fund raises disturbing issues for TCW and its relationship with Dean Witter, some fund analysts say. Specifically, did Dean Witter brokers--who sold the fund in the first place--encourage shareholders to stay put, or did they actively advise their investors to exit? If so, will that give TCW pause in developing new funds with Dean Witter?
Dean Witter declined to comment on the North American fund or on its relationship with TCW. Analysts note that many similar funds suffered similar fates in 1994.
For TCW, the bigger question is whether the firm may be wishing it had abided Robert Day’s longstanding exclusive focus on institutional clients--while avoiding retail--on the theory that large investors are better equipped emotionally to ride out bad markets.
The generally poor performance of all the TCW/Dean Witter funds last year should be viewed in historical context, but that may be a hard sale for the funds’ inexperienced investors.
“TCW is perceived in the marketplace as an investor that takes bigger bets,” notes Geoff Bobroff, a mutual fund industry consultant in East Warwick, R.I. While those bets have generally paid off in the long run, the volatility that they generate in the short run may be too severe for smaller mutual fund investors, he says.
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TCW/Dean Witter Funds’ Turnabout
Stock and bond mutual funds managed by Trust Co. of the West for brokerage Dean Witter slumped badly in 1994 after strong gains in 1993. Here are the funds’ results and average performance figures for the industry:
Fund: TCW/DW Latin Am. Growth
Total return (1993): +46.8%
Total return (1994): -23.7%
Fund assets 12-31-93 (millions): $220
Fund assets 9-30-94 (millions): $458
Fund: TCW/DW N. Amer. Govt. Inc.
Total return (1993): +8.1%
Total return (1994): -15.6%
Fund assets 12-31-93 (millions): $2,853
Fund assets 9-30-94 (millions): $1,523
Fund: TCW/DW Balanced
Total return (1993): NA
Total return (1994): -9.7%
Fund assets 12-31-93 (millions): $113
Fund assets 9-30-94 (millions): $150
Fund: TCW/DW Core Equity
Total return (1993): +19.2%
Total return (1994): -7.8%
Fund assets 12-31-93 (millions): $666
Fund assets 9-30-94 (millions): $726
Fund: TCW/DW Small Cap Growth
Total return (1993): NA
Total return (1994): -4.6%
Fund assets 12-31-93 (millions): $60
Fund assets 9-30-94 (millions): $63
Fund: TCW/DW Income & Growth
Total return (1993): NA
Total return (1994): -3.3%
Fund assets 12-31-93 (millions): $58
Fund assets 9-30-94 (millions): $61
Fund: Avg. Latin Am. fund
Total return (1993): +57.1%
Total return (1994): -14.2%
Fund: Avg. short world inc. fund
Total return (1993): +5.4%
Total return (1994): -4.3%
Fund: Avg. growth & income fund
Total return (1993): +11.5%
Total return (1994): -0.9%
Fund: Avg. small co. fund
Total return (1993): +17.0%
Total return (1994): -0.7%
NA: no full-year return (fund was created in 1993)
Source: Lipper Analytical Services