NEW YORK--(BUSINESS WIRE)--Active asset management firms that rise to prominence on the strengths and reputation of powerful investment managers invariably face the risk of these managers' departures. Bill Gross' exit from Pacific Investment Management Company, LLC (PIMCO) one week ago has made for one of the starkest case studies of why key man risk should not be underestimated as a critical assessment factor in investment manager and fund ratings, according to Fitch Ratings.
Key man risk is not uncommon in the investment management space, typically arising when an investment management company becomes heavily reliant on a single person or a few key individuals, often the founders. We also see many alternative managers as exposed to the risk.
PIMCO, in spite of its large size, diverse number of products, established processes and solid ownership backing, was still heavily influenced by a single person, who was also its founder and most visible chief investment officer. 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.
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. 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. This point is evidenced by the $23.5 billion of outflows in September experienced in the firm's Total Return Fund, where the largest daily outflow occurred on the day of Gross' departure.
In Fitch's view, a firm's size, staffing, ownership, maturity and perhaps most importantly, its overall governance structure, can collectively serve to substantially mitigate key man risks. Effectiveness of executive committees, succession planning and contingency plans, are important elements of both Fitch's fund and investment manager rating evaluations. In PIMCO's case, given the firm's largely open-ended fund products, these elements are especially important.
For some managers, especially alternative managers that utilize more general partner and limited partnership agreements, Fitch evaluates 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. Some of these factors may be important in controlling key man risks.
Similarly, managing closed-end fund structures can mitigate outflow risk, given that redemptions are conducted at an open market price rather than through liquidation of fund assets.
On Oct. 1, 2014, Fitch commented that the preferred shares issued by four PIMCO-managed closed-end funds rated 'AAA' were unaffected by Gross' departure, given the redemption structure of the funds, the maintenance of the prior investment strategies and the background experience of the successor managers.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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