Pimco's outflow headaches only just beginning

By Luciana Lopez

NEW YORK (Reuters) - Outflows from Pimco may be far from over as many investors have yet to decide whether to stick with the Newport Beach, California-based asset manager.

Pimco hasn't said how much money has been withdrawn since fund manager Bill Gross quit on Sept. 26 to join Janus Capital. Pimco said its Total Return fund, which Gross had personally managed for 27 years, saw $23.5 billion in withdrawals in September. Morningstar, which analyzes mutual funds and other investments, estimated net outflow from Total Return at $17.9 billion in September, part of $25.5 billion of net outflows across all of Pimco's U.S. open-ended funds in September.

The withdrawals come as broker-dealers are holding fewer bonds, reducing the options for fund companies seeking to sell holdings to raise the money to meet redemption demands. That may cause the performance of some funds - including Pimco's - to lag, as spreads among less-liquid instruments creep higher and investors find themselves forced to choose between moving quickly or getting a fair price for debt they're selling.

Outflows "will tend to be elevated over the next few months" said Jeff Tjornehoj, head of Americas research at Lipper, a Thomson Reuters company, who said Gross's exit is "the last straw" for some institutional investors. Those "investors are going from the wait-and-see when Bill was there to 'let's accelerate this'" outflow, he said.

Morgan Stanley said that the 6 percent drop on Sept. 26 in the share price of Pimco's parent, Munich-based insurer Allianz SE, implied the loss of about $400 billion in assets under management in the wake of Gross' departure. Morgan Stanley didn't say when those withdrawals would occur, nor why investors would pull their assets. Pimco has almost $2 trillion in assets under management.

Pimco was already on watch at a number of institutional investors after Gross's surprise resignation, including the $46 billion Teachers' Retirement System of the State of Illinois, the $23.4 billion Texas Municipal Retirement System and the $9.4 billion North Dakota Retirement and Investment Office.

Those three pension systems alone have almost $5 billion invested with Pimco, and they're only a small sample of the institutional investors nationwide who've entrusted their money to the company - much of it public funds.

Retail investors, too, could move out. Charles Schwab's target-date funds, for example, booted the Pimco Total Return Fund from its approved list last week.

This weekend, the new managers of Total Return, which Gross built into the world's largest bond fund with a peak in April 2013 of almost $293 billion in assets, scrambled to soothe clients and analysts. Rivals including DoubleLine Capital and TCW have also been speaking with Pimco clients as some of those institutional investors look for other money managers.

Not all institutional clients are on the fence, of course. The Employees' Retirement System of the State of Hawaii, for example, has decided to stick with the California asset manager.

"After recent meetings with Pimco staff, we currently believe that the new team is fully capable of meeting our expectations," the system's executive director, Wesley Machida, wrote to Reuters.

Pimco declined to comment.

Total Return Fund has gained 3.3 percent this year through the end of September, trailing the performance of 79 percent of its peers, according to Morningstar. The fund is up about 6.6 percent since Jan. 1, 2009, better than 58 percent of its peers, according to Morningstar.

To be sure, investors who follow Gross out of Pimco could find themselves losing out in the long run. Dan Ivascyn, Pimco's new CIO, was named 2013 Fixed-Income Fund Manager of the Year by Morningstar for his work on the Pimco Income Fund.

SPREADS WIDER, BUT CHANGES NOT DONE YET

At many pension funds, investment committees meet every other month, or even quarterly. Decisions to shift investments could be months away.

In the week ended Oct. 1, for example, money market funds saw net inflows of $18.9 billion, according to Lipper - almost twice the $9.5 billion net inflows in the previous week as investors parked former Pimco money in short-term assets to consider future moves.

The effect of bond sales can be seen in rising yields. Carl Eichstaedt, a portfolio manager with Western Asset Management, said yields on some Verizon bonds were 10 to 12 basis points wider against U.S. Treasuries on the Friday of Gross's departure. Western funds scooped up some of those bonds, but with an eye on the uncertainty around Pimco, did not rush in. Bond prices fall as yields rise.

"It's clear that some hedge funds and long-only money managers have been front-running in anticipation of redemptions" from Pimco after Gross's departure, he said.

By last Monday, the average high-grade bond spread had widened about 2 basis points to 119 basis points greater than Treasury bonds – its widest since March, according to the Bank of America Merrill Lynch Master Index. Among high-yield debt, the average spread widened even more, by 11 basis points.

"The volatility created by news of Gross's exit from Pimco gave us all a small taste of how fragile this fixed-income market has become because of illiquidity in secondary markets," said Michael Chuang, founder and CEO of electronic trading platform iTBConnect.

BROKER-DEALERS MAY SUFFER

Broker-dealers could be forced to absorb excess inventory and search for ways to get those securities off their books at a time when banking regulations have driven dealers to hold as few bonds as possible.

"Without any doubt, short-term there may be broker-dealers that are suffering a little for this," said Xavier Urpi, director of fixed income at Cutler Investment Group.

Many broker-dealers have reduced the inventory they keep on hand. A paper from the U.S. Securities and Exchange Commission earlier this year pointed the finger at fewer proprietary trading desks at broker-dealers and changes in regulatory requirements for capital.

Nevertheless, given Pimco's size, the firm is unlikely to be turned away from anyone who wants to keep doing business with it in the future.

"When you have such a big player like Pimco come to your door and say they want to sell, you have to take it," Urpi added. "They (broker-dealers) may lose a little point here, but in the long run they have to have that kind of relationship."

Investors who wait until year-end to move could find an added squeeze as the holiday season dries up liquidity, said Michael Rosen, the chief investment officer of Angeles Investment Advisors.

"If you're going to shift a portfolio, it gets tougher to do in big size as you get closer to the end of year," he noted.

The Illinois Teachers' Retirement System has eight different strategies with Pimco, one previously placed on watch, said spokesman David Urbanek. Further additions to the watch list require approval from the board, which next meets on October 29.

The Illinois system hasn't decided what to do about the almost $2.5 billion it's invested with the bond market giant.

"The situation with Pimco is fluid," Urbanek said.

(Reporting by Luciana Lopez, Jennifer Ablan, Ross Kerber, Richard Leong, Shankar Ramakrishnan and Jessica Toonkel in New York; Editing by David Gaffen and John Pickering)