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The following interview with Neel Kashkari, Charles Lahr and Anne Gudefin of PIMCO appeared in the January 31, 2012 issue of Value Investor Insight, a monthly newsletter for investment professionals that spotlights through in-depth interviews the strategies and current ideas of the most-successful investors in the business – which in past issues have included Seth Klarman, Bill Ackman, Mason Hawkins, Jeremy Grantham, Marty Whitman and many, many others. To receive the entire January 31 issue and one other as part of a no-obligation free trial subscription, please visit http://www.valueinvestorinsight.com/freetrial.
Bond titan PIMCO has been methodically building its equity-investing expertise. Here the architect of that effort and his first major hires describe their strategy and where it’s uncovering value in today’s market.
Known for its global prowess as a fixed-income investor, giant money manager PIMCO decided three years ago to build an active equity management business from scratch. To head the effort it hired former Goldman Sachs investment banker Neel Kashkari, who also ran the U.S. Treasury’s Troubled Assets Relief Program (TARP). The firm next lured Anne Gudefin and Charles Lahr from FranklinTempleton’s highly successful Mutual Global Discovery Fund to create a deep-value equity strategy for PIMCO, which has thus far attracted more than $3.5 billion in assets. We spoke recently with Kashkari, Gudefin and Lahr about the strategy behind the firm’s foray into equities, how they’re executing it, and where they are – and aren’t – finding opportunity in today’s market.
Why after all these years did PIMCO decide it wanted to be an active-equity money manager?
Neel Kashkari: There were three main reasons. The first was that coming out of the financial crisis, it became clear to us and to our clients that traditional narrow-style-box investing wasn’t enough, and that in order for us to be a full solutions provider to our clients we couldn’t just be in fixed income alone. Number two, we believed there were certain active strategies using bottom-up research as a base that could perform even better when combined with the global economic, currency, hedging and cash management expertise that already existed at PIMCO. Finally, post-crisis we were in a strong position to recruit the best equity talent in the industry, and if we were careful about ensuring a cultural fit, they would bring additional expertise to the firm’s overall investment process. One pleasant surprise has been how easy it’s been to get the best talent on the phone to talk about the opportunity to work here.
You decided to grow organically rather than by acquisition. Why?
NK: We thought that was the best way to maintain quality and to protect PIMCO’s very strong investment culture. There’s an acute focus on performance, a deep intellectual curiosity for investing and a collaborative team-based orientation. Making a large acquisition could make us big in equities overnight, but along with all the people who fit perfectly into the culture would be a lot of people who didn’t. We’d rather cherry-pick the right ones and build from there.
It plays to your strengths, but are there other reasons for pursuing only equity strategies that are global?
NK: It does play to our strengths, but we also believe the world is moving away from narrow style boxes and that the best way to serve clients is by giving the very best investment talent the flexibility to invest across capitalisation sizes, geographies and security types – forget about benchmarks, just build the best portfolio you possibly can. The fact that the style boxes of yesterday performed so poorly during the financial crisis is further justification for this strategy.
Charles and Anne, how tangibly has being a part of PIMCO been of benefit?
Charles Lahr: Probably most important, given the way Anne and I invest, is tapping into the expertise here to help us avoid false positives that come out of our bottom-up approach. The best example of that was 12 months ago when a number of banks in countries like Spain, Italy, Ireland, Portugal and even Greece were flashing all of the traditional bottom-up, deep-value signals. As we all know now, of course, there was something much more sinister at play, a sovereign debt crisis which PIMCO had already been digging into for more than two years.
I don’t know if we’d have taken the plunge had we not been here, but it certainly helped us avoid the sector entirely. I would add to that by saying we have no exposure today to any large-cap continental-European banks, or to any peripheral-country European equities at all, in any industry.
More generally, the ability to tap into the depth and quality of the credit research in-house has been quite beneficial. Many successful equity investors take a relatively human-capital-lite approach, with small teams covering the world and looking for the best ideas. It’s inevitable that opportunities will slip by you. At PIMCO there are more than 70 different credit analysts covering just about every credit on the planet and producing research that very often has a valuable read across to the equity. That includes being on top of specific financing events that may be debt-negative, equity-positive, or vice versa. All of that is a very rich source of ideas and fundamental insight into companies.
NK: All of our strategies at some level are anchored in value, so our fixed-income managers also benefit from the analysis Anne and Chuck produce, which is fundamentally rigorous and heavily valuation oriented. It’s not a coincidence Anne and Chuck were the first people we hired – they think a lot like bond people.
Has your core investing strategy evolved at all since joining PIMCO?
Anne Gudefin: The basic strategy of investing in equities with a long-term, deep-value bias and supplementing returns with merger arbitrage and distressed debt has not changed at all. It’s a flexible approach, using different methods to value companies. Chuck may focus on returns on equity in the case of financial companies, while I may focus more on high free cash flow yields to help identify value in consumer-oriented stocks.
We have always taken a global approach, but have historically found more value in European markets than elsewhere. You can argue for hours and hours why that tends to happen – the markets are less liquid, investors are less sophisticated, investors are more momentum-oriented – but our largest portfolio share is typically European. We have about 45% of the portfolio there today, with roughly one-third in the U.S. The next biggest exposure is in cash, at about 10% of the portfolio.
This post originally appeared on Advisor Perspectives.
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