"The king is dead, long live the king!"

Kings of Investing series - Is the golden age of Bond Kings over?

“To be a bond king or queen, you need a kingdom…Pimco had $2 trillion, ok? DoubleLine's got like $55 billion. Come on — that's no kingdom, that's like Latvia or Estonia," Bill Gross about Jeff Gundlach on Bloomberg

Go and read books by Peter Lynch about investing was one of the first things I was told when I joined an investment bank in the late nineties. Peter Lynch was the famous Fidelity fund manager of the eighties who had written best-selling books like One Up on Wall Street and Beating the Street. It was the golden age of active investing in stocks and everyone I knew wanted to be in stocks. Sure, there were legendary macro investors like George Soros and Stanley Druckenmiller who took on sovereign nations and won but bottom-up credit research on individual companies was almost as bad as getting a job in the back office. But times change!

The BlueBay IPO and rise of active bond managers

Fast forward to late 2006 and I was a sell-side stock research analyst covering financial stocks including listed asset managers. One day I was sent by our investment bankers to meet an asset manager who wanted to go public on the UK stock market: its name was BlueBay. The firm wanted to be the PIMCO of Europe, the first great active European bond manager.

The bull market was on. Hedge funds were hot. Credit was hot. Everyone was moving up the risk curve. I had been involved in several IPOs in the space over the prior year including sub-prime permanent capital vehicles backed by fixed-income hedge funds. I wrote about it recently in Remembering Queen's Walk - The IPO series - by Rupak Ghose.

BlueBay was founded in 2001 by CEO Hugh Willis and CIO Mark Poole and had $8bn of assets under management in long-only and long/short credit funds by the time of the IPO. An emerging markets debt-focused competitor Ashmore had been listed on the UK stock market a few months before. With the Ashmore deal well oversubscribed, the momentum was with BlueBay. UBS the bank which led the Ashmore IPO was super bullish on the space. The BlueBay IPO was priced at the top end of the range which was a valuation of $1.1bn.

BlueBay had a great story, but they had a problem. The sole lead bank on the BlueBay IPO was Credit Suisse and the analyst there wasn’t pushing the stock hard enough. Initiating coverage with a Neutral rating on a house deal almost 20 years ago was like a sell rating.

Who was this bah humbug analyst – alas it was me! The BlueBay founder and I became frenemies. We made up eventually and even went fondly down memory lane a decade later over coffee but just after an IPO he felt like I was attacking his newly born baby. He complained to my investment bankers and our senior management. I was bullish on the growth story of active bond managers, but BlueBay was valued at over 20x earnings which included low multiple performance fees that were volatile. The majority of BlueBay’s earnings came from its long/short hedge funds in particular its distressed debt fund investing in illiquid positions.

My bigger concern had been that the BlueBay funds had only seen a bull market since launch. I think I told them that Bill Gross had a longer track record and Mark Coombs at Ashmore had been tested through an emerging markets cycle while we had not seen a credit cycle in the few years before 2007. That wound them up even more - I was young, and I guess you live, and you learn!

BlueBay had a rough ride as a public company and the share price collapsed and then recovered. When RBC acquired BlueBay 4 years later after the takeover premium the valuation was around $1.5bn. Assets under management had grown to $40bn but the hedge funds had blown up and much of the new money was lower margin. In August 2022 the current CEO of BlueBay said it had assets under management of $67bn.

Why do I tell this story? It is really hard to become a Bond King!

From Gross to Ivascyn at PIMCO

On the day that Bill Gross left PIMCO and joined Janus in September 2014, the share price of the giant insurer Allianz that owned PIMCO fell by 6.2% while the share price of Janus rose by 43% illustrating the cult of the Bond King.

Bill Gross’ legendary Total Return Fund grew its assets under management from around $25bn in the late nineties to $100bn just before the Global Financial Crisis and peaked at around $300bn just over a year before his departure. By the time Gross departed PIMCO, he had seen 3 years of poor investment performance and investors were already heading for the exit. PIMCO Total Return Fund assets under management were down to $200bn. They fell further to $100bn within the next year and are around $50bn today.

Dan Ivascyn who replaced Gross as the PIMCO chief investment officer recently told the FT that the current environment for active bond managers is extremely attractive. The assets under management of his PIMCO Income Fund rose from $38bn at the time of Gross’ departure to around $150bn today. Ivascyn benefited from a churn between the two funds and put up stellar returns in the decade following the 2008 financial crisis. But much of this was owing to a big bet on US non-agency mortgage bonds, which are now shrinking in supply.

2024 fund flows have been strong at PIMCO with a run-rate of $25bn per quarter of inflows and there have been decent inflows into active bond managers given the anticipation of significant cuts in (short-term) interest rates by the Federal Reserve and other central banks.

PIMCO remains known as the king of aggressive active bond management. PIMCO’s overall assets under management had huge growth from $0.5 trillion in 2005 to $1 trillion in 2010 and around $2 trillion when Gross left. After declining to a trough of $1.4 trillion in 2015 it is back to around $2 trillion with Ivascyn’s funds leading the way.

Decline of Total Return Bond Funds

In the decade since he left Bill Gross has repeatedly said that there can never be another Bond King like he was. For all his competitive spirit Gross is the first to credit much of his success to a long bond bull market of declining interest rates. But author Mary Childs who wrote a book about the Bond King once described the Total Return Fund under Gross as a hedge fund in a mutual fund wrapper. Gross had a reputation for not only trading aggressively across duration, yield curves, and credit but also using derivatives and leverage.

In the last 5 years, Bill Gross has been particularly critical of this class of Total Return Funds and their inability to protect capital in downturns. He wrote in his newsletter that funds like his previous PIMCO Total Return Fund and the one run by his frenemy Jeff Gundlach – who had been named by the media as the new Bond King in 2014 – had become index trackers.

After starting DoubleLine in 2010 the former TCW Chief Investment Officer Gundlach had seen funds in his Total Return Fund rise to around $60bn in 6 years but they have declined in the 8 years since reflecting its weak performance. DoubleLine’s assets under management had increased from $50bn at the start of 2013 to $140bn by 2019 but in September 2024 this stood at only $95bn.

Stars come and go

The second largest active bond fund today at half the size of the PIMCO Income Fund is run by Capital Group, a firm more famous for its equity mutual funds. It has expanded its fixed-income team significantly in recent years. By contrast, Western asset management (commonly known as WAMCO) a storied name in long-only bond asset management that was founded in the same year as PIMCO has been in freefall in recent years. WAMCO had managed around $400bn of assets under management and joined Franklin Templeton as part of its 2020 Legg Mason acquisition.

But WAMCO’s co-Chief Investment Officer Ken Leech recently left the firm following investigations by US regulators into cherry-picking where he had favored some client accounts over others in terms of the allocation of more profitable trades. Leech’s funds had already seen tens of billions of dollars of client redemptions over recent years following a bad bet on the speed of Federal Reserve interest rate rises. Outflows across WAMCO bonds funds in the two and a half months since the announcement of regulatory probes into Leech have been more than $50bn.

Franklin Templeton shareholders must be wondering about their luck with Bond Kings. Just like Leech was more under the radar than Gross and Gundlach, the manager of the Templeton Global Bond Fund Michael Hasenstab wasn’t a CNBC sort of Bond King. But he was known among investors for his large and aggressive bets on emerging markets. Hasenstab’s put up some big returns in the years following the financial crisis, but performance has been weak for the last decade with periodic blow-ups whether it be a wrong way bet on Argentina or even US Treasuries. The Templeton Global Bond Fund run by Hasenstab grew from $10bn around the Great Financial Crisis to a peak of $70bn in 2014 ($110bn when including other funds tracking it) and is now only around $5bn of client assets.

Another Bond King known for large and aggressive bets on emerging markets debt over the last two decades is Mark Coombs of Ashmore. The firm’s assets under management grew from $20bn at the time of its IPO in late 2006 to $100bn by late 2019. Coombs was a wizard of the sovereign wealth fund investors just like Ray Dalio. Net inflows for Ashmore were extremely strong in the 2016 to 2019 period. But performance started to unwind. The Ukraine and Argentina crises and bad bets in corporate credits like Evergrande led to a sustained deterioration. Ashmore was not only struggling because of macro themes but also a significant underperformance versus peers. Net outflows have continued in 2024 with assets under management around $50bn.

The share price of Ashmore is down 70% from its peak and is 10% below its 2006 IPO price. Of course, in US dollar terms this is even worse. The firm’s founder Mark Coombs remains by far its largest shareholder with 30% of its £1.3bn equity value.

A shrinking pie

Being a Bond King is difficult in a bull market. But if tax cuts and tariffs mean the market expectations of huge interest rate cuts don’t come through quickly the current bull market flows into active bond managers could reverse quickly. As Gross said he was the right guy at the right time and enjoyed decades of those conditions.

There is increased competition for the best trades from hedge funds given the considerable growth of large, fixed-income, and multi-strategy hedge funds. There has been much written about the increased presence of leveraged bets by hedge funds in the US Treasury market.

The potential pie for active long-only bond managers is also shrinking. The likes of PIMCO will take on the private equity firms in private credit but the competitive dynamics and the skillset required are different. The private credit boom will shrink the public markets just as private equity did with stock markets.

Finally, there is an onslaught of passive investing and ETFs. The size of the bond ETF market increased fivefold to over $2 trillion. Net inflows into bond ETFs have paced over $200bn per annum for the last 6 years and the liquidity in the secondary markets keeps growing. Of course, there are both passive and active ETFs.

Bill Gross may never stop his public food fight with PIMCO or Jeff Gundlach, but it is hard to see a new era of Bond Kings!