Pimco May Be Test of Whether Investors Feel Scandal Fatigue
People seek fame and fortune in the stock market all the time.
But in the bond market, those two usually have been mutually exclusive. Investors whose goal is to master the extraordinary tedium of bonds typically don’t seek the limelight -- and that’s probably all for the best.
There have been two exceptions in the modern era, and both are Southern Californians. One is Michael Milken, the father of the corporate junk bond market, though his fame turned to infamy after he pleaded guilty to securities fraud in 1990.
The other is Bill Gross, the 59-year-old chief investment officer of Newport Beach-based Pacific Investment Management Co., better known as Pimco.
Over the last decade, Gross has become the most widely respected U.S. bond fund manager. He has achieved that status primarily by producing consistently stellar returns in the Pimco Total Return fund, the largest bond mutual fund.
But Gross’ fame also is a function of his love of the spotlight. He’s a fixture on financial network CNBC -- so much so that a small TV studio was built at Pimco’s headquarters to allow Gross speedy access to the camera and vice versa.
In his monthly commentaries on Pimco’s website, Gross is anything but the stereotypical bond wonk. He quotes Virginia Woolf, refers to Federal Reserve Chairman Alan Greenspan as Barney Fife and freely recounts personal experiences from high school, college and the Navy.
Gross’ latest letter to clients, however, has none of his usual bons mots. In an e-mail he sent Thursday and also posted on the firm’s website, Gross was compelled to defend Pimco after the organization was implicated in the scandal that has badly tarnished the fund industry’s reputation for the last six months.
The New Jersey attorney general on Tuesday filed suit against Pimco and affiliated companies, alleging that they committed fraud by permitting a favored investor to engage in market-timing trades in certain bond and stock funds, at the expense of other investors.
Gross wasn’t named in the complaint, but two funds he oversees -- Total Return and Low Duration -- allegedly were among those that were used as “parking” places when the favored investor’s money wasn’t active in the trading game.
The investor was Canary Capital Partners, the New Jersey-based hedge fund that was the central player in the first market-timing charges brought in the scandal -- the case by New York Atty. Gen. Eliot Spitzer in September. Canary’s relationship with Pimco allegedly began in 2001 and extended through most of last year.
Pimco, in its official corporate response to the New Jersey suit, has denied wrongdoing.
By now, millions of mutual fund shareholders understand the gist of the industry scandal. Investors who try to time short-term swings in stock or bond markets, using funds, can siphon away profit that would have accrued to long-term holders. Traders also can boost a fund’s transaction costs, which are borne by all investors in a fund.
But what sticks in the craw of many investors are the basic issues of trust and fairness.
Most fund companies have for years publicly trumpeted that they discourage or forbid market timing in their portfolios. What state prosecutors and federal regulators say they have found in their ever-broadening probe of the industry is that fund companies often talked tough, yet allowed timing deals for big investors who were willing to bring something else to the table -- for example, a special infusion of assets on which a fund company could earn additional management fees.
The industry has long portrayed itself as a level playing field for Ma-and-Pa investors, said Franklin L. Widmann, New Jersey’s chief securities regulator. “This kind of stuff is a betrayal of that,” he said.
Investors have heard that line repeatedly over the last six months, as some of the biggest names in the fund business -- Putnam Investments, Janus Capital Group and MFS Investment Management -- have been implicated in the scandal.
Those firms, and others, have suffered the consequences. They’ve lost the trust of some of their clients. That’s evident because cash has been flowing out of their funds overall, according to Financial Research Corp. of Boston, which tracks fund inflows and outflows monthly.
Pimco, by contrast, has been one of the beneficiaries of the woes of its rivals. The firm last year took in $23.4 billion in net new money to its bond and stock funds, the fourth-biggest inflow of any fund company, Financial Research data show. Total assets of Pimco’s long-term funds were $143 billion at year’s end.
Now, some fund industry analysts see Pimco as a key test case of whether the public is beginning to suffer from scandal fatigue. Have so many of these fund market-timing allegations been aired that the shock value is no longer there?
Bill Gross hasn’t been accused of any wrongdoing, but neither were most fund managers at other firms caught up in the scandal. Yet the guilt-by- association factor has taken a heavy toll on plenty of otherwise innocent fund personnel.
But interviews with financial planners and other professionals who manage money for clients, and who make decisions about which mutual funds should get those dollars, suggest they so far are loath to treat Pimco as they have some of its rivals.
“Pimco has been such a mainstay for bond investors,” said Rick Keller, head of Keller Group Investment Management in Irvine. “It would be a shame to deny investors access to those funds, unless it’s something really egregious.”
Scandal fatigue also surfaces in other responses from financial advisors and from average investors. There are suspicions that some state prosecutors may view the fund industry scandal as a way to make political hay. There’s a sense that this is becoming a pile-on.
And even if allegations of timing arrangements are proved, what was the cost to the investor? “Fund companies may be spending more on legal fees than the harm they did to anybody,” said Kurt Brouwer, a principal at advisory firm Brouwer & Janachowski in Tiburon, Calif.
That may not sway prosecutors, nor should it. Still, it’s understandable that many investors are tiring of these accusations. And as more big companies are pulled into the fray, investors’ choices among untainted funds are dwindling.
For their part, Pimco and its affiliates don’t appear willing to simply roll over in the New Jersey case. In a novel defense, they’re arguing that investors in three of the four stock funds that Canary timed actually benefited from the trades. How? The money from Canary was routinely kept in cash rather than invested, so it offset losses in a period of mostly declining stock prices, according to PEA Capital, the New York-based Pimco affiliate in charge of those funds.
As for the bond funds that were timed (Pimco High Yield and Pimco Real Return), the firm’s argument is that the trades were within the parameters that the funds’ prospectuses allowed.
Gross didn’t return a phone call last week. In his e-mail to clients Thursday, he sounded upset but also adamant that the franchise he has built up for 30 years didn’t deserve to be dragged through the mud. He came across as a man with a lot to lose -- which precisely defines his situation as the nation’s best-known authority on bonds.
“Is Pimco -- the bond manager -- really down there at the bottom of the barrel?” Gross wrote, apparently referring to others in his industry. “We shout an emphatic ‘NO!’ ”
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Tom Petruno can be reached at tom.petruno@latimes.com.
