“Cautionary tale” is not the way most fund managers would choose to be remembered.
GAM Holding AG, a Swiss money manager, announced on July 31 that it was suspending one of its top bond fund managers, prompting panic among many of its investors. When investors tried to pull their assets from that manager’s funds, GAM froze redemptions, leaving clients even more unsettled.
Given the state of current events, it was almost a relief to hear that the fund manager in question was not subject to allegations of sexual wrongdoing or of lining his own pockets at clients’ expense. Instead Tim Haywood, who is based in London, is mainly accused of cutting corners. In a letter to clients, GAM explained that an internal investigation had found evidence that Haywood may have failed to conduct sufficient due diligence on some investments and signed some documents by himself that required two signatures. GAM also says Haywood may have used his personal email for business purposes.
All of these are serious matters, though whether they merited such an abrupt and high-profile suspension is debatable. GAM has insisted “no material client detriment” occurred due to Haywood’s conduct and that no investment strategies for products outside Haywood’s supervision were affected at all. Haywood has not spoken to the public of this writing, so we cannot usefully speculate on his motives. But GAM CEO Alexander Friedman and its head of sales and distribution, Tim Rainsford, said in the letter to clients that “the investigation found no evidence that Mr. Haywood was motivated by an improper rationale in making investment decisions or that there was any conflict of interest between him and clients.”
That letter, however, arrived after GAM blocked redemption requests for the funds Haywood oversaw. The money manager suspended all redemptions for its unconstrained/absolute return bond funds, citing “high levels of redemptions.” According to The Wall Street Journal, GAM said that the funds had the liquidity necessary to meet all withdrawal demands, but that if it sold the most liquid bonds in order to pay them, remaining investors would face a disadvantage, since the process would dramatically change the funds’ makeup. The affected funds represent about 7.3 billion Swiss francs ($7.34 billion); Haywood supervised about 11 billion francs ($11.1 billion) in the firm’s absolute return strategy and 14.6 billion francs ($14.67 billion) overall.
This story serves as a reminder of two important points. First, the era of celebrity mutual fund managers is over. In addition to Haywood, consider Bill Gross, “once the undisputed king of bonds,” as The New York Times recently put it. Gross helped found Pacific Investment Management Company, and the company’s main bond fund was once the largest of its kind. However, Gross was forced out in 2014 amid allegations that he mismanaged the business and abused his staff. He joined Janus, a competing firm, but has struggled to replicate his performance record since then. In May, his bond fund experienced a 3 percent drop in one day – highly unusual for a bond fund. Any investors still convinced that Gross has a Midas touch have had a disappointing few years.
Gross’s story, like Haywood’s, is a reminder of why it is unwise to pin your hopes on a single fund manager’s ability to outperform the market indefinitely. If you invest 10 percent of your portfolio in a given fund, and you expect the manager to outperform the benchmark by 1 percent annually – in a good scenario – is the extra 0.1 percent of reward really worth the extra risk? People are only human. When you pin all your hopes on a celebrity money manager, you have no cushion if that manager suffers from bad judgment or bad luck.
This is not to say actively managed funds are never appropriate. We often use them in client portfolios at Palisades Hudson. But we focus on funds run by experienced teams, backed by deep benches of analysts. Yes, all funds are required to list at least one individual manager in their disclosure documents. But in a properly administered fund, if that person leaves, someone else on the team will be ready to step in for a smooth transition. No fund should rely solely on a single individual’s perceived genius.
The second moral of the GAM story is that investors should understand the liquidity of funds they invest in. GAM management decided to freeze the funds in question because they judged that honoring at least 10 percent of redemption requests would damage all remaining investors’ fund positions. This strikes me as odd, although assuming this evaluation is right, it suggests to me that the bond funds’ underlying investments skewed far too heavily toward illiquid assets.
Illiquid investments can generate higher returns, an ongoing concern for bond funds as we gradually emerge from an era of low interest rates. Yet as GAM’s dilemma demonstrates, you can easily overdo illiquid investing. A fund could face up to 10 percent redemption requests for much more common reasons than a fund manager’s scandal. Honoring such withdrawal requests should not throw a fund horribly out of balance. Cautionary tales like the Third Avenue Focused Credit Fund have already illustrated the hazards of chasing yield too aggressively in a bond fund.
GAM has not yet said whether it will liquidate the funds, though it has acknowledged that the option is under consideration. It has pledged not to prioritize any investors over one another, whatever happens next. But regardless of the way forward for this particular firm, the story serves as a useful reminder for investors to be mindful of liquidity and not to pin too many hopes on any fund manager, no matter how talented.