In the week since Bill Gross left PIMCO the company has already faced tens of billions in outflows and it probably has more in its future as institutional investors reconsider where to keep their fixed income investments. The question is whether to follow Gross to Janus Capital Group Inc (NYSE:JNS) or simply look for a new manager. According to Claude Erb, a manager at TR, Gross could have as much as 10% alpha now that he’ll be managing a significantly smaller fund.

“Historically, a doubling in assets under management led to a 10-20% reduction in ‘alpha’,” he writes. “Naive extrapolation of the historical relationship between fund size and one year “alpha” suggests Bill Gross’ new ‘unconstrained’ bond fund could have an ‘alpha’ of about 10%.”

bill gross expected alpha 1014

Higher AUM hurts performance

Erb looks back at the returns of PIMCO’s Total Return Bond Fund and Jeffrey Gundlach’s Doubleline Total Return Bond Fund from April 2010 to the end of this August and compares assets under management to outperformance. Both funds outperform the US bond market over that time frame, and according to Erb when AUM drops performance tends to go up, and vice versa.

 

Bill Gross doubleline v market 1014

Bill Gross pimco v market 1014

Based on this, he determines that PIMCO’s Total Return fund should have about 90 basis points of alpha going forward without Bill Gross, Gundlach should have about 3% alpha, and Gross himself could have as much as 10% in the early days of the Janus Total Return Fund while AUM is still low and Gross is able to be more selective in making trades.

Bill Gross may have to compete with his own strategies

Erb’s conclusion is in line with what most of us already assume. As AUM increases a fund manager has to both restrict himself to larger investments and move further down the list of ideas instead of only taking the very best. But there are two big reasons why you might want to pause before blindly following Bill Gross to Janus Capital Group Inc (NYSE:JNS). First, some people have started to doubt whether Gross is as talented as he used to be when he earned the Bond King nickname. Remember that withdrawals from the PIMCO Total Return fund started long before Gross left because investors were losing confidence.

But PIMCO is also going to be competing against a group of bond traders who, by all accounts, are smart and hardworking – and who are familiar with the strategies he’s likely to use at Janus. Even if we all agree that rising assets tends to moderate a fund’s performance, that doesn’t mean a drop in assets will necessarily lead to outperformance.

The full study can be found here – here