New York and Boston are the centers of the U.S. asset management universe except when it comes to bonds. For that, a reporter has to travel to California, a state whose balmy climate and Hollywood glamour stand in stark contrast to the stereotypical bond manager: a pessimist with a math degree who looks after the most conservative of investments. But bond managers have been anything but boring the past few years.
In late September, I flew from Newark, New Jersey, to Los Angeles to check in on Trust Co. of the West, the asset manager founded in 1971 by blue blood Robert Day, grandson of the founder of Superior Oil Co., and later sold to French bank Société Générale. I went to see what had become of the firm that had fired its rock star manager, Jeffrey Gundlach, five years earlier, nearly destroying itself in the process. With the asset manager up for sale at the time, SocGen and TCW executives fought Gundlach a brilliant investor with a divisive personality who ran 70 percent of the firms money for control of the firm. TCW had only recently recouped the money that fled after Gundlach launched his own firm, DoubleLine Capital.
It seems I have good timing when it comes to bond brouhahas. The Friday before my flight, Pacific Investment Management Co. CIO Bill Gross, who had become a household name by divining the direction of interest rates and the Federal Reserves moves for decades, surprised everybody when he said he was leaving the firm hed co-founded the same year that Day started TCW; Gross would be joining Janus Capital Group, an unknown player in the fixed-income firmament. While the rest of the financial media were hotly debating whether the bond king would be better remembered for referring to himself as Secretariat than as one of the greatest investors ever, I was going to talk to the guys whod had their own Bill Gross moment in 2009.
I spent my first full day in California at a governance conference, talking with public pension officials angry that they were under pressure from their boards because the people who manage their most boring investments were in the news every day. The next morning I was scheduled to meet TCW CEO David Lippman. When I arrived at the firms headquarters in downtown LA at 9:00 a.m., everybody there was busy fielding calls from nervous PIMCO investors asking how much money TCW thought it could handle.
During the past year, as Grosss battles with Mohamed El-Erian, his designated successor; Grosss underperformance; and stories about the dysfunctional culture at PIMCO unfolded in real time in the press, TCWs philosophy of using a quiet team of managers to run bond strategies became the perfect antidote. TCW, which now has $163.4 billion in assets, has become the antistar managers manager. But in its heyday the firm was a magnet for star equity managers and had a legendary institutional brand. The team approach came from Metropolitan West Asset Management, a small but well-respected bond manager headed by Lippman, which TCW bought the same day it sacked Gundlach. Even though the MetWest acquisition was an audacious move by TCW to save its business, it didnt stop investors from ultimately pulling more than $30 billion from the firm. After all, Gundlach managed most of its assets, and not only were provisions in client contracts triggered when TCWs key man was ousted, but everyone knew it would be a tumultuous transition at best.
Lippman was late for our interview, caught in traffic after meeting with a big Japanese institutional investor. His office in the TCW Tower has a view of the Hollywood sign, soon to be obstructed by the rising Metropolis a megacomplex of hotels, condominiums and offices, and a testament to the long-awaited resurgence of the citys financial district. The Long Islandraised Lippman apologized for being late and after some small talk placed a clear glass paperweight on the table, saying it was half a crystal ball.
I bring it out in the following way, explained Lippman, 56, who practiced law for six months before becoming a bond trader at Paine Webber and Co. in 1983. You cant tell where youre going unless you know where youre coming from.
Clearly, I thought, Gundlachs shadow still inhabits this place. Lippman went on: The funny thing is, the side of the crystal ball that is missing is the one that your side of the business the press loves to talk about. They love the asset managers who are the Shell Answer Man. Here are the answers to all your questions. Again, Gundlach came to mind, beloved for his willingness to go on TV and tell the audience exactly what he thought would happen.
Lippman insisted, though, that everybody was missing the other half of the crystal ball. No one can predict the future, he said, and few people have a lock on brilliance: When people say, Im the smartest person youve ever met which seems to me a commonly uttered phrase in some corners of asset management I can say thats probably not true.
After almost being run into the ground after it kicked out its star portfolio manager five years ago, TCW has built a thriving asset management business using teams of anonymous investment professionals. Its a sharp reversal for a firm that founder Day called a confederation of boutiques, with incentives for managers to build empires. TCW, which was founded before asset management was a multitrillion-dollar industry, had become known for its larger-than-life investors, including not only Gundlach but Oaktree Capital Managements Howard Marks. However, with Grosss departure from PIMCO in September and that firms massive loss of $150 billion in client assets last year, asset managers now face critical questions about the dependence of their business strategies on a few famous names. Lippman is making the opposite bet: that his fixed-income team Bryan Whalen and MetWest co-founders Tad Rivelle, Laird Landmann and Stephen Kane can create a more enduring and stable model for TCW by providing a built-in backup plan.
Although TCWs team DNA came from MetWest, it was the Carlyle transaction that gave TCW an ownership culture and incentives for individuals to stay and continue building the firm. The Washington-based private equity firm bought a majority stake in TCW in 2013. As part of the deal, TCW management increased its ownership to 40 percent from 17 percent. Olivier Sarkozy, the Carlyle partner who led the buyout; Lippman; and TCWs then-CEO, Marc Stern, structured the transaction so that TCWs portfolio managers would have significant stakes in the entire business for the first time.
With his half a crystal ball, Lippman is carefully laying out his rationale for the strategy he helped put in place at MetWest and the philosophy he is championing at the new TCW: putting investment decisions in the collective hands of a group rather than a single person. Teamwork will always win in the long run because there is debate, heat and friction, he explains. From that friction you get the best ideas. Do you get that in an autocracy? No.
This is TCWs moment. So far, the firm has been the biggest winner among active managers as the industry undergoes its biggest-ever upheaval. TCW gained almost $20 billion in the last quarter of 2014.
But the price tag for the firms restructuring has been huge, and lessons abound for other asset managers. TCW has more than $160 billion in assets, including $22.3 billion in U.S. equities and $7.3 billion in alternative investments, but only about $20 billion more than it had before Gundlach was pushed out. The firm which sued its former star manager for allegedly stealing secrets and planning to launch his own, competing operation became embroiled in ugly litigation and missed out on much of the great bond rally from 2009 to 2013, when the asset totals of fixed-income managers ballooned. PIMCO doubled in size, to $2 trillion, and Prudential Financials fixed-income assets jumped from $354 billion to $628 billion.
At the same time, SocGen destroyed shareholder value. The bank sold TCW for $730 million ($430 million after accounting for the $300 million it paid for MetWest), far less than the $1.9 billion the firm was valued at in 2001. Jacques Ripoll, SocGens head of global investment operations and part of the French banks inner circle, was sent packing. Stern, who had been president of TCW since 1990, lost his position; TCWs sterling credit rating was downgraded and has yet to recover. Stern, who declined to comment on the lawsuit against Gundlach, says, While it was difficult, MetWest allowed us to change and go from a star system to a team and ownership culture.
But now TCWs recipe is in high demand, and the firm has a second chance. A team can create good performance despite stars dominance of the airwaves. The Metropolitan West Total Return Bond Fund is in the top 1 percent for performance in its category over the past ten years. The TCW Total Return Bond Fund, which focuses on mortgage-backed securities and includes Gundlachs track record, is also in the top 1 percent over the past decade. Over three years, while solely managed by MetWest, the team has put it in the top 2 percent.
Well-constructed teams can help create stable money management organizations while ensuring that the size of a fund doesnt impede good investment results. No doubt, people get excited about heroes, says Charles Ellis, author of 16 books, including Winning the Losers Game. Ellis knows something about stars. He wrote the foreword to Yale University endowment chief David Swensens book on portfolio management, which among other things discusses the traits of the most successful active investors. Ellis has also written extensively about Capital Group Cos. system of using multiple managers to oversee its funds. Teams produce better results than one person can on their own, he adds. For one thing, Capitals teams are organized around individuals who each do what they do best, and then the results are aggregated to produce more consistent and higher returns.
Teams are hot these days. Just look at PIMCOs massive new advertising campaign, which declares, We are PIMCO. Clearly distinguishing between teams and a star, however, can be difficult. There will always be certain people, even on a team, who are leaders and who will be critically important to a firms success, says John Casey, co-founder and chairman of investment management strategy consulting firm Casey Quirk & Associates, based in Darien, Connecticut, and New York. Look at the movies. There are big stars, but they didnt just appear; they are a product of the producers, directors and writers.
When I go to talk to Gundlach, the quintessential star manager, its hard not to think about just how different a leading man in finance is from the stars found closer to the iconic Hollywood sign, which can also be seen from DoubleLines offices. No one I interview, even at TCW, disputes how smart Gundlach is, but he can be difficult to talk to and so focused that he doesnt even notice people as they pass him in the hallways. He must have some magic, though. He was fired on a Friday, and the next day 15 TCW staffers from the mortgage-backed securities group met at his house to draw up plans to follow him and launch a new firm.
Sunlight streams through huge windows at DoubleLines downtown LA offices, highlighting pieces of Gundlachs famed art collection. Two lighted double red lines are carved into the curved wooden reception desk, a tribute to artist Piet Mondrian. Thieves stole Mondrians Composition (A) en Rouge et Blanc from Gundlachs house in 2012, but it was later recovered.
Gundlach says Gross approached him a few weeks before he left PIMCO to discuss the possibility of joining DoubleLine. When Gross first called the DoubleLine general office number asking for him, Gundlach thought it was a joke. But the two later talked seriously about working together, with Gross comparing himself to basketball legend Kobe Bryant and Gundlach to the younger LeBron James. Gundlach says the PIMCO imbroglio had one thing in common with his forced departure from TCW: Both money managers were owned by European financial institutions that did not understand the asset management business or how firing their leaders could destroy it. Though Gundlach says he enjoyed meeting Gross and thinking about how the two of them could work together, he emphasizes that my team loves me, his team hated him. See the difference?
For Gundlach, TCW was a case of selfish executives and an absentee-landlord bank that tried to destroy the person who had built an incredibly profitable business. It wasnt about his personality, which he asserts is only an urban legend. If I was such an autocrat, why did dozens of people follow me out the door? he asked me. In a follow-up interview on the phone a few weeks later, I asked Gundlach about the risks of stars and the value of teams. Why is it so hard to understand that some people have skills that others dont? he replied. No one questions that there arent a thousand Michael Jordans out there.
Tad Rivelle was stuck in Chicago last fall when he was supposed to be meeting with me during my trip to Los Angeles. Hundreds of flights had been grounded by a fire, allegedly set by a contract worker, that destroyed radar equipment at the Chicago Air Route Traffic Control Center. Its unbelievable that an airports systems can be so vulnerable to the actions of one person, Rivelle, 53, told me when he finally got back to LA. Responding to my questions about the history of MetWest and the development of its team, he gave me an organized tour through time, warning when he was about to return to an earlier point or go off on a tangent that appeared unrelated but, he assured me, would shed light on something critical to the discussion.
The story of any successful business, he said, often springs from the myth of two guys in a garage who had a plan and then fulfilled that plan. But the reality is that you couldnt see 100 miles into the distance, he added. Im reminded of Lippman and his half crystal ball. Rivelle attended Yale at 16 and earned a BS in physics in 1981; he went to work as a software engineer in the defense industry, getting an MS in applied mathematics from the University of Southern California along the way. After tiring of the lack of creativity in engineering, he decided to go to business school. He joined PIMCO after earning an MBA from UCLA Anderson School of Business in 1990, the same year as Laird Landmann, who had just gotten his degree from the University of Chicagos Booth School of Business.
After a two-year detour into investment banking, Stephen Kane, whod met Landmann when he was getting his own MBA from the University of Chicago, also joined PIMCO. Founded by Gross and two partners a couple of decades earlier, the firm was the place to work for would-be bond managers. Gross almost single-handedly invented active bond management, taking a value approach to buying securities and making his famous macro calls. Gross employed smart people, promoted intense and divisive rivalry among them, and used a generalist/specialist system. But for all that, he alone made the final decisions. You always knew whose kitchen you were working in, Rivelle says.
Chafing against the short leash they were on at PIMCO, Landmann and Rivelle in 1992 joined Hotchkis & Wiley, an LA firm that managed mostly equities, to build its bond group. Kane whose Connecticut family moved to Southern California when he was in high school and who has an undergraduate degree in business from the University of California, Berkeley followed two years later. The three formalized what they learned from Gross about picking undervalued securities. But we werent going to out-PIMCO PIMCO, says Kane, 52. We focused instead on finding cheap bonds, which we thought was a much more repeatable process than getting things like duration calls right time after time. The team developed a bottom-up investment philosophy whereby they could analyze the inherent complexity in bonds and use better information to their advantage, growing Hotchkis & Wileys fixed-income assets to $2 billion.
Across town in 1995, TCW lost a big battle. Howard Marks, who ran the U.S. bond operation, including high yield, and Bruce Karsh left to start their own firm, Oaktree, after a nasty fight with Day and Stern, then TCWs president. At the time, Day wrote to employees that no one person is so talented as to be irreplaceable.
Merrill Lynch & Co. bought Hotchkis & Wiley in 1996, but Rivelle, Landmann and Kane didnt like Merrills heavy-handed ownership and wanted to continue managing money in the team style they had been developing. The three founded MetWest that same year. Hotchkis & Wiley sued them, claiming they had taken confidential information when they left. After settling out of court for an undisclosed amount, the three MetWest founders started growing the new firm steadily, if slowly creating a collegial environment. To ensure that no single individual could hijack the firm, MetWest employed a system of generalists who set overall strategy and specialists underneath them with true autonomy. Asset management operates like a cottage industry with its cult of personality, says Landmann, 50, who studied economics at Dartmouth College and is a Greek and Roman history buff.
Bryan Whalen, who met Lippman when the two worked together in Donaldson, Lufkin & Jenrettes fixed-income department in the late 90s, joined MetWest in 2004. He says bond investing requires constant upgrading of models, systems and analytics. When there is an arms race going on, you need to be driven by a process, not an individual, says Whalen, 39, a former Yale football player who became a MetWest generalist portfolio manager in 2013.
But MetWest, whose name was either unknown or confused with MetLife Insurance Co., struggled. A handful of firms dominated fixed income in the late 90s, including PIMCO, BlackRock, Western Asset Management Co. and specialized managers like Fischer Francis Trees & Watts (now owned by BNP Paribas). Recognizing they didnt have all the skills to grow their firm, the three MetWest co-founders recruited Lippman in 2001. Lippman, who worked for junk bond king Michael Milken at Drexel Burnham Lambert from 1985 to 1990, had been managing director of structured-product sales at Credit Suisse First Boston.
In 2001, European banks, hit hard by the bear market, were beginning to buy asset managers to hedge their investment banking businesses. SocGen acquired a 51 percent stake in TCW a move that diluted the equity ownership of its portfolio managers and contributed to later battles with Gundlach, who had been at TCW since 1985. Gundlach was emerging as a great and unlikely diversifier for the firm: As TCWs equity strategies got hammered, his mortgage-focused and other bond investments started making up for the losses.
TCW, MetWest and other small bond managers faced challenges in raising assets in an industry dominated by an oligopoly. It was accepted wisdom that advisers to retail investors, trustees on the boards of institutions and big companies choosing options for their defined contribution plans werent going to get fired for hiring BlackRock or PIMCO, even if the firms underperformed their less-well-known competitors.
The financial crisis changed the status quo in bond management. Western Asset Management badly stumbled, exposing weak credit research and ineffective risk controls. OppenheimerFunds core bond offerings blew up because of bad bets on mortgages, among other things, leading to a settlement with the Securities and Exchange Commission. Gundlachs flagship TCW Total Return Bond Fund was among the few in positive territory in 2008 because he had been systematically scaling back his credit holdings. In 2009, when the markets were at lows, he put money back to work, and his fund gained 19.9 percent, easily outperforming its shell-shocked rivals. Though its performance wasnt as strong as Gundlachs, MetWests flagship bond fund was in the top 26 percent of its category in 2009.
Still, Gross continued to dominate fixed income. In many ways, investors needed a star more than ever. The narrative of the hero who hunts down the beast of risk and slays it and delivers alpha through his skill and genius and effort is powerful, says Landmann, who began his career working on the fixed-income trading floor at Morgan Stanley in the 1980s.
Though MetWests team approach was generating good investment results and had added $14 billion in three years, Lippman started to seriously consider a deal with a larger firm to help MetWest grow faster. He says he and his partners didnt want their firm which clients referred to as the best-kept secret to be a half-full restaurant with a three-star Michelin rating.
Meanwhile, SocGen was suffering from losses caused by rogue trader Jérôme Kerviel as well as from the credit crisis. By the end of January 2009, it had exited all of its asset management operations except TCW, which the bank said it would spin off in an initial public offering but which it really wanted to sell. SocGen planned to bring Stern on as CEO; the American had been working as chairman of the French banks North America investment management operations. In May 2009, Gundlach and several other portfolio managers sent a letter to SocGen proposing that TCWs key players instead form a management committee to govern the firm. They argued against rehiring Stern. Gundlach was unhappy and made it known that he was considering leaving. In September he offered to buy majority control of TCW for $700 million.
By then Stern had been named CEO, and on the recommendation of investment bank Morgan Stanley he called Lippman about a potential deal. If MetWest joined TCW, he said, it would infuse the larger firm with a team mind-set and broaden its fixed-income capabilities. Lippman proposed meeting later in the week, but Stern insisted on getting together right away. After hearing Sterns convoluted plan to save TCW, Lippman thought the whole thing might be a hoax and even Googled him to make sure he really was CEO. Though Lippman initially was troubled by the idea of getting rid of Gundlach and replacing him with another asset manager and didnt want to be a part of it Stern eventually convinced him that the move made sense and that the firm would be able to keep most of Gundlachs staff.
Lippman and his partners at MetWest agreed to being acquired. They wanted economies of scale and a well-respected global brand, even if it was somewhat tarnished. TCWs $300 million offer, $100 million more than MetWests valuation, helped seal the deal.
On December 4, 2009, TCWs chief counsel and another lawyer gave Gundlach a document that alleged he had been stealing secrets and conspiring with staff in an effort to launch his own firm. Meanwhile, Stern told Gundlachs staff the story and informed them that TCW had purchased MetWest to replace their boss. MetWest employees started moving in that evening.
The next morning a group of Gundlachs MBS staff met at his Santa Monica home and decided to join with him to launch DoubleLine. With an investment from Oaktrees Marks, the firm opened in mid-December, ultimately nabbing 45 members of Gundlachs 65-person team. The departures were a shock to TCW, which sued Gundlach in January 2010. Gundlach countersued, accusing TCW of wanting to steal his fees for managing money. DoubleLines business came to a halt. TCW quickly lost assets as well. In April 2010, DoubleLine went after mainstream investors less conservative than institutions and opened a mutual fund. The strategy worked; DoubleLine started growing.
Still, the trial was grueling. TCWs and Gundlachs dirty laundry was on parade in Los Angeles. The details of Project G, TCWs code name for the plan to terminate Gundlach, were revealed through e-mails and testimony. Amid the feud, R. Blair Thomas, head of EIG Global Energy Partners, an energy and infrastructure group within TCW that now has $15.7 billion in assets, fought to become independent, and alternative credit group Crescent Capital Group started discussions to spin out of the larger firm. On September 16, 2011, after a six-week trial, the jury reached a split verdict and awarded Gundlach $66.7 million in unpaid compensation, even though he was found liable for breaching fiduciary duty and misusing company secrets. TCW wasnt awarded any damages. By early the next year, SocGen had put the firm up for sale.
Olivier Sarkozy was busy kissing women on both cheeks and taking cell phone pictures of the ornate grand ballroom at New Yorks Metropolitan Club. Peering into his phone, Sarkozy told me he wanted his partner, former Full House star and fashion designer Mary-Kate Olsen, co-founder of luxury brands that include Elizabeth and James, to have a show there. But on that day in November, the room was being used for far less glamorous purposes. TCW was hosting a client seminar called Its No Time to Be a Hero: Investment Risks & Opportunities in Todays Market. Sarkozys boss, Carlyle co-founder and co-CEO David Rubenstein, opened the TCW gathering. An engaging speaker who never uses notes, Rubenstein told funny stories about Washington. No investment nuggets.
It must be intimidating to follow Rubenstein. But TCW fixed-income CIO Rivelle dutifully stood behind the podium and, with PowerPoint slides projected above him, talked about business and economic cycles and central bank policy. No funny stories. My mind drifted to the irony of how the boring bond world has ended up dominated by star managers, whose outperformance typically amounts to no more than 100 basis points. Of course, much of the drama has been fueled by the approaching end of a 30-year bond bull market.
Sarkozy oozes charisma. I had met him a few weeks earlier at Carlyles Midtown Manhattan offices. During a two-hour interview in which he made me feel he had little else to think about but me, we talked about everything from why financial services can be such a bad fit with private equity to how his black Labrador puppy needed emergency surgery after swallowing a corncob. It was jarring when Sarkozy, who looks uncannily like his half-brother, former French president Nicolas Sarkozy, told me that what the industry knows is Carlyle, not him. We deliberately focus on the brand, not on the individuals, he explained.
After a longer discussion about business value, I got it: The most-successful companies are known for their marquee brands, not the individuals on the marquee. An asset manager wont be as valuable if theres a rock star at its center. BlackRock, the largest money manager in the world, with more than $4 trillion in assets, has barely any recognizable fund managers. When no single person is responsible for a business success, the firm sells for a higher multiple of its earnings and has higher profit margins. If you can swap Jacques Doe for Sarkozy, then the business itself is less vulnerable and volatile. On the day Gross left PIMCO, parent company Allianzs stock dropped 6 percent, wiping out $4 billion from the German insurers market capitalization. But star power can work the other way: Shares of Denver-based Janus rose nearly 40 percent the day Gross told the world it was his new home.
The names Laird and Tad are deliberately subordinated to the concept of a team producing investment products with superior results, says Sarkozy. Its not that were Pollyanna-ish or think were on moral higher ground. We think that will create the most valuable company.
Like everything in TCWs recent history, getting the Carlyle acquisition done wasnt easy. Not everybody was happy with how equity was distributed. R. Brendt Stallings and Husam Nazer, managers of small- and midcap equities, left to join DoubleLine. EIG, the energy group that become independent in 2011, asserted that it needed to approve the Carlyle deal. Things again ended up in court when EIG challenged the deal on the grounds that Carlyle directly competed with it. (The two organizations settled, with EIG becoming fully independent and TCW losing a share of fees on new EIG funds.)
Sarkozy, a former investment banker at UBS, beat out rivals like Warburg Pincus to buy the stake in TCW. Carlyle financed the deal with $355 million in debt and a $50 million revolving credit facility. It used a modest amount of borrowing 2.9 times leverage, significantly less than the 4 or 5 times that other private equity firms said they would use, which would have made it harder for TCW to meet growth objectives.
To create stability and a healthy workplace, Sarkozy and TCW wanted to break the culture of individuals cutting private deals, creating an environment where people lived on their own islands and viewed their colleagues with no more warmth than the competitors up the street. Though Sarkozy admired Stern for what he calls the ballsiest move hes seen in his 25-year career, the firm needed a new chief. Everybody agreed that Lippman was the guy for the job.
TCW now has 550 employees, down from 615 at the time of Gundlachs departure (730 including MetWest staffers). While TCW has plans to expand into alternative investments and is thinking through how to grow its active equities business in the face of massive competition from index funds, its greatest strength is in bonds. Though Sarkozy stresses that he didnt have a crystal ball when evaluating TCWs prospects a year and a half ago, it was not lost on us that PIMCO was the 500-pound gorilla, that it was a cult of personality and that the personality in question wouldnt be there forever.
TCW is headed to success with its team philosophy, but star managers can hardly be written off. In any case, behind every star is some kind of team. While the We Are PIMCO tagline is easy to laugh at in the wake of Grosss departure, the firm has a point: Bill Gross wasnt managing hundreds of billions of assets without an army of people around him. He just didnt give them credit.
Even after a messy lawsuit, the firm Gundlach started after 24 years at TCW went from zero to $64 billion and 132 employees as of the end of last year, claiming the title of fastest-growing mutual fund firm in history. That was the result of Gundlachs starring role in the bond world. DoubleLine is 80 percent owned by more than 40 partners, including young trading assistants, most of whom left TCW for no pay to help Gundlach start the firm. Now that he has his name on the door, Gundlach truly needs the people around him. LeBron James cant win a game by himself.
When I meet Lippman at TCWs New York offices on a cold, rainy day in late December, I press him on whether weve really entered the era of the team. After all, MetWest merged with TCW because not enough people wanted to eat at Lippmans three-star restaurant. Yes, theres been a dramatic change as weve come through this crisis, he says. But at the same time, he acknowledges that everybody is always fighting the last war, looking backward. There was a superstar; now were concerned about redundancy, he explains. You have to maintain the right balance.