The recent drama at Newport Beach, Calif.-based Pacific Investment Co. (PIMCO) serves as a stark reminder that asset management firms should not underestimate the risk of a star manager’s departure, says Fitch Ratings.
In a new report, the rating agency says that “key man” risk is common in the investment management space. Typically, it arises when a company is heavily reliant on a single person, or a few key individuals, often the founders, Fitch says. And, it notes that it also sees many alternative managers that are exposed to this sort of risk. “A key individual’s exit can cause a material outflows, disrupt the organization’s future business prospects, damage its franchise and potentially support a competitor,” it says.
In PIMCO’s case, despite its size, product diversity, and solid ownership, the firm “was still heavily influenced by a single person”, Fitch says — its founder and most visible chief investment officer, Bill Gross. “While PIMCO has evolved to a point where its operating and governance infrastructures served to alleviate key man risk, Gross’ stature as a driver of the firm’s success also drove the magnitude of the risk of negative response to his exit,” it says.
Indeed, its Total Return Fund reported US$23.5 billion in net outflows for September, with the largest single-day outflow coming on the day of Gross’ departure. “For PIMCO, outflows thus far have not been material enough to raise serious concerns for the financial health of the company, given its continued AUM scale and diversity, and the background and expertise of the remaining management team. That said, the suddenness of Gross’ departure has placed the firm in a more challenging position than might be otherwise seen through a well-telegraphed, tightly orchestrated turnover,” it says.
Fitch suggests that succession planning and contingency plans are important to mitigating these kinds of risks, particularly for firms with open-ended fund products. “A firm’s size, staffing, ownership, maturity and perhaps most importantly, its overall governance structure, can collectively serve to substantially mitigate key man risks,” it says, adding that these sorts of risks should not be underestimated as a critical assessment factor in investment manager and fund ratings.
Additionally, it notes that key man clauses, and redemption mechanisms such as manager replacement clauses, manager insurance policies and manager-related redemption gates that may be explicitly outlined within fund agreements may also be important in controlling key man risks. Managing closed-end fund structures can also mitigate outflow risk, it says.