John Hague, who helped Bill Gross build Pacific Investment Management Co. into the manager of the biggest mutual fund, is recruiting former colleagues for a firm to pursue more aggressive strategies as the bond rally fizzles.
Hague, who spent 18 years at Pimco before leaving in 2005, is talking with at least five ex-colleagues, including John Brynjolfsson, about creating a smaller alternative to Gross’s firm, he said in an interview. One vehicle for that venture may be Massif Partners, a Greenwich, Connecticut, partnership Hague formed with Philip Duff, co-founder of hedge fund FrontPoint Partners LLC, according to a January regulatory filing.
Hague, 53, is among a number of high-ranking Pimco alumni who are forming private investment funds that can take on more risk and rely less on top-rated bonds than Gross, who last year forecast the end of the three-decade debt rally. Pimco’s Total Return Fund became the world’s biggest mutual fund in 2009, helped by the historic bond market surge and a strategy that combined capital appreciation with interest income.
“To be thinking about total return in a bond portfolio with rates at 3.5 percent is yesterday’s news,” said William Powers, who worked as a global portfolio manager and served on Pimco’s investment committee during almost two decades at the firm. “Unless you are China and need to invest $2 trillion, you are likely to find much better outlets for your money than Treasuries and other high-quality bonds,” said Powers, who left Pimco in January 2010 and helps run two real estate funds from Manhattan Beach, California.
Mark Porterfield, a spokesman for Newport Beach, California-based Pimco, declined to comment on his firm’s strategy or Hague’s venture.
Since Gross co-founded Pimco in 1971, more than 20 former partners have resigned, many of whom still live in southern California. The firm has 40 partners, now known as managing directors, Porterfield said. The sought-after position entitles executives to share in lucrative fund fees.
Several of those who have departed since 2000, including Brynjolfsson, Powers, Lee Thomas and Paul McCulley, began working at Pimco during the 1990s, when the fast-growing firm was smaller. Thomas, a former Pimco managing director who worked there from 1995 until 2004, said he left in part because Pimco got too big.
“Meetings of the partnership and senior professionals could be held in one small room,” said Thomas, who is opening a macro fund through his Austin, Texas-based firm, Flint Rock Global Investors LLC. “Now there is an auditorium that doesn’t begin to satisfy Pimco’s needs” when the firm holds quarterly investment forums for its professional staff, he said.
Hague, whose new fund will focus on fixed income, joined Pimco in 1987, when the firm had about $4 billion in assets and four portfolio managers: himself, Gross, David Edington and Chris Dialynas. He started the firm’s international fixed-income business and its Global Relative Value hedge fund, managed 125 separate accounts with about $30 billion in assets, and, as one of Pimco’s primary rainmakers, spent 500 hours a year flying to meet with potential and existing clients.
“Bill would say, ‘Hague, you get on the airplane,’” according to Hague, who said he spent so much time flying that he befriended Jack Weselis, the former chief pilot at West Coast Charters Inc., in Santa Ana, California. When a heart attack killed Weselis last year, Hague was host at the funeral.
Hague began holding quarterly round tables last year at Newport Beach’s Big Canyon Country Club so that Pimco alumni and other investment professionals could swap trading ideas. He said he hopes to form an investment alliance of former Pimco managing directors, with the possibility of them joining Massif Partners.
An unresolved issue, according to Hague, is how managers such as Brynjolfsson who run their own funds could also work with him. He declined to name any other prospective partners.
Brynjolfsson, 46, built Pimco’s real return strategies during a 19-year career at the firm. He left in 2008 to start Armored Wolf LLC, an absolute-return fund in Aliso Viejo, California, focusing on inflation and deflation.
Asked about the possibility of working with Hague, Brynjolfsson said in an e-mail that he speaks with his former colleague “regularly,” without elaborating. Powers said he had been invited to the round-table meetings and was unaware of Hague’s initiative.
“People are trying to figure out the best configuration to work with each other to compete with Pimco and Wamco,” Hague said, referring to Western Asset Management Co., a Pasadena, California, unit of Legg Mason Inc. with about $454 billion under management as of Dec. 31. “We can run some money in the same style we did at Newport Center with the ability to be more aggressive,” Hague said, alluding to Pimco’s address at 840 Newport Center Drive.
Total Return Fund
Under Gross’s strategy, Pimco sought to purchase bonds that would appreciate in value as interest rates declined. This strategy got a boost after 1980, when the prime rate banks charge their most credit-worthy customers peaked at 21.5 percent and then fell during the next three decades, according to data from the Federal Reserve Bank of St. Louis.
Gross’s Pimco Total Return, with assets of $239 billion, averaged annual gains of 8.5 percent from inception in 1987 through Dec. 31, outperforming the 7.3 percent yearly increase by its benchmark, the Barclays Capital U.S. Aggregate Index. Its net assets exceeded Ireland’s gross domestic product last year as estimated by the International Monetary Fund.
While the fund’s prospectus says its objective is to provide “maximum total return consistent with preservation of capital,” Powers and Thomas said in interviews that Gross’s unofficial goal is to generate returns 100 basis points, or 1 percentage point, above those of the Barclays index each year. Gross, 66, seeks to limit the risk the fund assumes because it’s widely held in 401(k) plans, said Eric Jacobson, director of fixed-income research at Chicago-based Morningstar Inc.
“Gross is very cognizant that it is the core holding in many people’s retirement portfolio, so he wants it to be very predictable and risk sensitive,” he said.
Pimco has “well over” $450 billion invested in total return strategies including separate accounts, Jacobson said. Pimco Total Return was the most popular fund in the retirement market last year with more than $50 billion from defined-contribution plans, according to San Diego-based BrightScope Inc.
The firm has done so well in recent years, particularly with the total return strategy, that many institutional investors now have their fixed income assets concentrated at Pimco, according to Jacobson. As a result, some pension funds and endowments may consider moving assets to smaller firms, he said.
“These are questions that have come up for BlackRock and for Western Asset and they have definitely come up for Pimco,” Jacobson said. “They have so much money with Pimco, it seems like a rational business governance decision to try and diversify.”
Cash-strapped state pension funds are increasingly concerned about whether they can generate the returns needed to cover future liabilities to retirees, Hague said. Pensions and other institutional investors may prefer managers that look to provide an absolute return, such as 10 percent or more each year, over strategies designed to beat a variable benchmark such as the Barclays index, he said.
“The target Pimco is trying to meet is to earn 100 basis points over an index,” said Thomas, whose macro fund will seek to generate annual returns of 10 percent regardless of market performance. “The clients I anticipate dealing with are looking for a leveraged product with a much higher rate of return with more risk as well.”
Macro funds seek to capitalize on macroeconomic trends by investing in currencies, debt, equities or commodities.
The renewal of bond purchases by the U.S. Federal Reserve probably would signify the end of the 30-year bull market in bonds, Gross said in an Oct. 27 commentary on Pimco’s website. A week later, the central bank said it would acquire as much as $600 billion in Treasuries through June to spur employment and avert deflation, marking its second round of purchases to help the economy.
Pimco has the “vast majority” of its assets in bonds, according to Morningstar’s Jacobson. The firm has been seeking to diversify through stock funds and an Unconstrained Bond Fund, run by Dialynas, that seeks to generate absolute returns by investing freely across fixed-income markets rather than trying to beat a specific benchmark index.
“What they are doing is steering a lot of their strategies towards less-Treasury-linked markets, less interest-rate sensitivity, less exposure to the dollar,” Jacobson said.
Powers is a general partner at Los Angeles-based JRK Multifamily Platform LP, a $250 million fund formed in September that plans to invest in apartment buildings nationwide with the goal of generating an internal rate of return exceeding 20 percent, including a 9 percent annual dividend.
He is also a partner at Miami-based Encore Housing Opportunity Fund, which is raising as much as $200 million to buy undeveloped residential land, finished lots and housing projects in the works, mainly in California and Florida. The fund is targeting an internal rate of return of 30 percent annually.
Hague is Massif’s chief investment officer and Duff is the managing member, according to a Jan. 18 filing with the U.S. Securities and Exchange Commission. Massif will invest in assets globally, according to Hague, who said the fund’s trading strategy is still being developed.
“The interesting areas of the market are credit, currencies and emerging markets,” Hague said. “When it comes to Treasuries, I’m not interested.”
Duff, 53, co-founded FrontPoint Partners in 2000 after stints as the chief financial officer for the investment bank Morgan Stanley and chief operating officer at Tiger Management LLC, the hedge fund set up by billionaire Julian Robertson. Duff sold FrontPoint to Morgan Stanley for $400 million in 2006 and then sought to start a hedge fund under the name Duff Capital Advisors LP, only to shutter the Greenwich firm when he had trouble raising money during the 2008 stock-market collapse.
Steve Bruce, a spokesman for Duff, declined to comment.