(Bloomberg) -- When Fortress Investment Group hired Dave Shell two years ago to start an equities business at its Logan Circle Partners, a traditional bond fund manager, Chief Executive Officer Randy Nardone called it a “natural extension” for the firm.
Last week, Nardone told analysts and investors that he decided to shutter the stocks division because it became a “distraction” that made Logan Circle, with $32 billion in assets, unprofitable. Shell, a former co-chief investment officer at Goldman Sachs Group’s money management unit, left the firm along with five colleagues.
“We thought the strategy had promise as a good first step to build out a broader traditional capability at Logan,” Nardone said on a call while discussing 2014 earnings. “Turned out to be a bit of a distraction. The strategy didn’t meet our targets for performance or growth or timing.”
Fortress isn’t alone in struggling to diversify a bond shop into equities. Pimco, best known for its bond funds, has tried three times to expand into equities and has less than 1% of its assets in funds that pick stocks. Bill Gross, Pimco’s co-founder, left the firm last year in part after disagreements over whether and how to diversify. Jeffrey Gundlach’s DoubleLine Capital has also struggled to grow traditional stock mutual funds in its lineup.
MORE COMPETITIVE
“There are a lot more players there, in the equity world,” Robert Callagy, an analyst at Moody’s Investors Service, said. “It’s more competitive and it takes time for firms that have brands that are synonymous with fixed income to get institutional and retail investors to understand that their brand doesn’t just speak to fixed income.”
For many bond managers, equities seemed like a great idea after the 2008 financial crisis. The Federal Reserve had pushed interest rates to near-zero, potentially leaving little room for bonds to appreciate and fueling a rally in stock markets that’s about to enter its seventh year.
Pimco, which first experimented with stocks in the mid-1980s and again in 1999 through its parent company, started a third attempt to build an equities business in 2009, hiring former Goldman Sachs banker Neel Kashkari to oversee it. DoubleLine in 2013 hired Husam Nazer and Brendt Stallings from TCW Group to expand into stock funds.
GOLDMAN HIRES
Fortress started the growth-equities strategy in 2013, the year Gross said the bond bull market had ended. Shell brought with him from Goldman Sachs three money managers -- Joe Hudepohl, Scott Kolar and Warren Fisher -- as well as a research analyst, Greg Frasca, and a trader, Matt Milazzo, according to two people with knowledge of the matter.
The team left Logan Circle last month and the firm closed the Tampa, Florida, office where they worked, said the people, who asked for anonymity because the details weren’t made public. Gordon Runte, a spokesman at New York-based Fortress, declined to comment.
DoubleLine has only one active stock-picking fund, the $8 million DoubleLine Equities Growth Fund, despite its founder’s outspoken views on the market and individual securities. Gundlach said in September 2012 that equities are a superior investment to bonds as an inflation hedge and that he was seeking to diversify and broaden the firm. It liquidated a small-cap growth fund run by Nazer last year, who left the firm.
MORE SUCCESS
The firm has had more success with a fund that uses derivatives and fixed-income investments rather than individual stocks to try to beat the Standard & Poor’s 500 Index. The DoubleLine Shiller Enhanced CAPE Fund, started in October 2013, has $316 million in assets after beating 99 % of rivals over the past year.
BlackRock, the world’s largest money manager, has made the transition from debt to equities. Co-founded by Laurence D. Fink in 1988, the New York-based firm was known mainly as a fixed-income manager until the mid-2000s, when it acquired State Street Research & Management and Merrill Lynch & Co.’s investment unit to add stocks and other assets. BlackRock’s 2009 purchase of Barclays's investment division gave it $829 billion in stock assets, most of which were tied to indexes.
Even as markets have rallied, BlackRock, with $4.65 trillion, hasn’t grown its presence in stock picking. Assets in its active equity strategies have slid to $304.9 million from $334.5 million in the fourth quarter of 2010. The S&P 500 has rallied almost 80% in that time. BlackRock’s assets in equity strategies based on indexes have grown to $1.37 trillion from $911.8 billion in 2010.
BROADER MISTRUST
The firms’ recent struggles in active equity funds reflect a broader mistrust among investors of stock pickers. Investors pulled $98.4 billion from actively managed U.S. stock funds last year, while they added $166.6 billion for passive strategies, according to Morningstar. Taxable bond funds tied to indexes received $104.8 billion last year, and active strategies had redemptions of $17.2 billion, the data show.
At least for some bond managers, the obstacles run deeper. Pimco’s first effort to add stocks faltered in the 1980s after the firm’s bond traders overwhelmed a handful of equity managers at strategy meetings, eventually prompting them to quit. Gross had vowed not to repeat those mistakes when he pushed into stocks again in 2010, predicting that stock-market returns would beat bonds.
OPPOSED PUSH
Four years later, he opposed the push into equities and other non-core assets in an internal meeting. Gross in September left the firm after losing a power struggle with management. Today, the $1.68 trillion firm has about $5 billion in funds that pick stocks.
“I personally think we’ve done a lot of grunt work, a lot of hard work, and for Pimco it’s actually quite recent,” Virginie Maisonneuve, chief investment officer for equities at Pimco, said in a telephone interview. “Rome wasn’t built in a day but I think we’ve made some very good progress,” said Maisonneuve, who joined last year from Schroders.
Like DoubleLine, Pimco has had more success with funds that try to beat the stock market using derivatives, such as futures. Its StocksPlus strategy, which Pimco started in 1986, has about $19 billion in its strategies.
Pimco also has about $27 billion in its Fundamental Index Plus strategies, which are in partnership with Robert Arnott’s Research Affiliates. The company says these funds should be included in their equity products, even though they don’t invest primarily in individual stocks. By that measure, Pimco has about $52 billion in equities, about 3% of assets.
REFOCUS LOGAN
Fortress is also scaling back equities outside of its traditional asset-management division. Michael Novogratz, who runs the firm’s $3.25 billion macro hedge fund strategies, said last week that he’s reducing the stock-picking strategy within the firm’s macro fund, which is down 4.5% this year through February.
Fortress acquired Philadelphia-based Logan Circle in 2010 from Guggenheim Partners for about $21 million in cash. The firm has invested the majority of its assets in long-duration, intermediate and short-term fixed income.
It hasn’t been profitable se at least 2011, dragged down each year by operating expenses. Closing the stocks group gives Fortress a profit stream from Logan Circle for the first time, Nardone said.
As a result of the change, “I’m pleased to say that today Logan is all-in, run-rate profitable,” Nardone said. “We’ve strongly believed in the opportunity in the institutional fixed-income space. We’ve decided to refocus Logan 100 % on its core fixed-income business.”
