Asset Manager Talent and Pension Client Departures

As a trained appraiser, I have long considered the importance of key person risk when assessing the viability of an organization. A related critical issue is whether a succession plan exists and can be implemented with ease. This in turn depends on the existence and quality of talented professionals who understand how to grow a business, navigate complex regulations and focus on customer satisfaction. When a firm has too few successors who can assume a leadership role as needed, there is a risk of poor future performance and a worst-case scenario of not being able to maintain itself as an ongoing concern. On the other hand, installing new executives with a fresh perspective could lower business risks, especially if institutional investor clients have made it clear that they are unhappy with the status quo. A review of investment strategy alone seldom tells the complete story about an asset manager or advisory firm's acumen. An assessment of how the business is run and who is in charge is likewise important.

Consider the recent news about Pacific Investment Management Company, LLC ("PIMCO"). Established in 1971, this Allianz entity has grown into what many would describe as a bond market behemoth. According to a current press release, PIMCO had $1.876 trillion in assets under management as of September 30, 2014. A few weeks earlier, on September 26, 2014, it was announced that co-founder and Chief Investment Officer ("CIO") William H. Gross had resigned, adding that "The firm has a succession plan in place."

Since that announcement, some institutions have decided to terminate PIMCO or put the firm (or some of its funds) on watch, pending further analysis. According to "Arkansas Exits Post-Gross PIMCO as Pensions Review Money Manager" by Brian Chappatta (Bloomberg, October 13, 2014), the exit of Mr. Gross "caused $23.5 billion in redemptions in September from the $201.6 billion Total Return Fund." Skittish clients include the Arkansas Teacher Retirement System ($472 million), California's 529 college-savings program ScholarShare ($262 million) and Florida's State Board of Administration (withdrawing "more than $1 billion that the company manages for the 401(k)-style program that the state offers workers"). It is said that the Texas Municipal Retirement System and Indiana, North Dakota, Michigan and Illinois retirement plan decision-makers are mulling over how best to react to this staff change.

Although cited reasons vary as to redemption requests, at least some appear to be related to uncertainty about trading personalities. Reuters journalists Simon Jessop and Nishant Kumar warn that "With much of a mutual or hedge fund firm's value tied up in the brain power of its employees, as opposed to bricks, mortar and other hard assets, the loss of an important employee - known in the trade as 'key man risk' - exposes the firm to asset flight which can even force it to sell holdings at a loss." See "As PIMCO bleeds assets, Gross shows risk of star culture" (October 2, 2014).

Some companies have gone the route of having marquee employees sign non-compete contracts as a way to mitigate key person risk although they are not fail-safe protective mechanisms. Enforcement of a particular non-compete agreement can by legal venue. Signers sometimes get cold feet. "[S]tar trader Chris Rokos" is seeking to overturn what he deems overly harsh restrictions on his ability to start a new enterprise. See "Brevan's Ex-Star Trader Contesting Non-Compete Restriction" by Laurence Fletcher (Wall Street Journal, August 26, 2014).

Governance is an issue. For an institutional investor that relies on a disciplined selection and review process, a premature exit from a particular fund or fund company could be costly. In "Too Early to Hit the PIMCO Panic Button," Plan Sponsor journalist Jill Cornfield (October 9, 2014) describes the advantages of communicating the duties of an investment committee to plan participants. Such a letter or memo could include an explanation about how committee members pick and review asset management firms. This way, an exit from a fund when a key person leaves will not necessarily come as a big surprise.

The exertion of influence of third parties should not be ignored. In its Morningstar Stewardship Grade report about PIMCO dated September 29, 2014, Eric Jacobson and Bridget B. Hughes wrote that "Continued disruption among PIMCO's independent trustees raises significant concern about the board's independence as well as its long-established setup."

There is no doubt that more news will follow with respect to PIMCO and other investment management organizations that promote the use of individuals with the power to attract headlines.

Public Pension Risk Management and Fiduciary Liability

A few weeks ago, Attorney Terren B. Magid and Dr. Susan Mangiero jointly presented on the topic of pension risk management and fiduciary liability with a particular emphasis on public plans. Attorney Magid's insights reflect a particularly unique perspective inasmuch as he served as executive director of the $17 billion Indiana Public Employees' Retirement Fund ("PERF"). Dr. Mangiero shares her views as an independent risk management and valuation consultant, author, trainer and expert witness.

Click to download the 25-page webinar transcript for public pension fiduciaries entitled "Are You Properly Mitigating Risk? Assess Your Fiduciary IQ" with Attorney Terren B. Magid (Bingham McHale LLP) and Dr. Susan Mangiero (Fiduciary Leadership, LLC). Comments about ERISA plans are provided when applicable.

Topics discussed include, but are not limited, to the following:

  • Public Pension Transparency Act
  • Discount Rate Choice
  • Dodd-Frank Wall Street Reform and Municipal Advisor Registration
  • Expanded Definition of ERISA Fiduciary
  • Fee Disclosure Under ERISA 408(b)(2)
  • Failure to Pay and Actuarially Required Contribution ("ARC")
  • Benefit Reductions
  • RFP Process
  • Fiduciary Audits
  • D&O Policy Review
  • Vendor Contract Examination
  • Qualitative and Quantitative "Investment Risk Alphabet Soup"
  • Interrelated Risk Factors
  • Key Person Risk
  • Hard to Value Investing
  • Model Risk
  • Stress Testing
  • Pension Litigation
  • Fiduciary Breach Vulnerability
  • Characteristics of a Good Model
  • Side Pockets and Investment Performance.

Comments are welcome.

Key Person Risk - Whom to Back

On March 1, 2010, Dr. Susan Mangiero, CEO of Investment Governance, Inc. sat down to talk to financial and strategy expert, Mr. Pascal Levensohn. In this third question of ten, read what this Investment Governance, Inc. Advisory Board member has to say about key person risk. Click here to read Mr. Levensohn's impressive bio.

SUSAN: Given recent instances of VC-backed company fraud and questions about the management team, how can institutional investors protect themselves from key person risk?

PASCAL: You are asking a fundamental question here about trust. I could restate your question by saying, how do I know that I’ve backed someone as a general partner ("GP") who is trustworthy?  The answer is, you have to do your homework on that person, which means that you have to make a full range of reference calls to people who are not on the person’s reference list.  This takes resources and time.  If you are not equipped with the resources to do the work, then you need to rely on someone else’s process—but again that has to be an independent third party whose due diligence credentials are also trustworthy.

Let me turn the table on you a little bit because I sit in your shoes all the time– as a venture capitalist who bets on entrepreneurs, my greatest challenge is to sit across the table from a very enthusiastic person and judge their credibility—Will they actually do what they say they are going to do?  Will they work 24/7 to get the job done?  How will they behave when unforeseen challenges occur—which they always do? 

Institutional investors have to do the same thing because they are betting on people, and they need to establish a considerable measure of trust if they are going to sign on to a 10 year commitment to invest in illiquid assets.  This is the toughest part of our jobs. As I look back over my the 14 years I have spent in venture capital, as part of my 29 year finance career, the biggest mistakes I have made have always been related to key person risk, as opposed to picking the “wrong” technology.