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Bloomberg Markets Magazine

SURFIN’ THE YIELD CURVE

THE DRIVE INTO NEWPORT BEACH can feel like getting lost inside an endless summer of money—especially along the Pacific Coast Highway, winding past billion-dollar hills that plunge to white sand beaches and the sparkling blue ocean.

It’s easy to forget this was once the California of John Wayne, who moved here in the 1960s (when he could still afford it, as he later joked). Back then oranges actually grew in Orange County. These days it sometimes seems it’s money that grows on trees. That spread next to the Duke’s old place? Nicolas Cage bought it and then sold it in 2008 for $35 million.

Even so, on a foggy morning on the Balboa Peninsula, watching surfers shred the Wedge, you can still sense the Brian Wilson, SoCal strains that sang to a young man from steel-town Ohio. His name: William H. Gross.

It was the 1970s. The Summer of Love was long gone, and young Bill, with shaggy hair and a $90 suit, had a job in the fixed-income department of Pacific Mutual Life Insurance Co., where his first duties included clipping bond coupons. The company had recently moved from a gray building in downtown Los Angeles to south of Disneyland. Gross had a new assignment he believed would lead to something big. He told his parents he was going to be the world’s best bond manager.

“They looked at me like I was loony,” he recalls.

You know the rest.

Gross went on to become the Bond King of Pacific Investment Management Co. He lasted 43 years, until 2014 when Pimco pushed him out. Like many dreamers, Gross found a place in the West to reinvent himself. And yet Pimco is just one part of a bigger saga of companies around Greater Los Angeles that today manage $3 trillion in fixed-income assets.

What you probably don’t know is why and how it happened here, in Southern California, to Gross and to others who became towering figures in the fixed-income world.

THE STORY BEGINS in 1971, when Pimco and two other future bond giants, Trust Co. of the West and Western Asset Management Co., sprang up in the City of Angels. Others followed. In 1978, Pimco was still a unit of Pac Mutual when a Wall Street banker, originally from the San Fernando Valley, returned from New York to set up an outpost for Drexel Burnham Lambert. His name: Michael Milken. Before long, Milken’s new junk-bond-fueled era was rocking to the strains of Ghostbusters with custom lyrics, answering “Who ya gonna call?” from the original with “Call Drexel!”

Jeffrey Gundlach, future bond master of DoubleLine Capital LP, arrived in L.A. with dreams of becoming a rock star. Scott Minerd, later of Guggenheim Partners, moved West for the bodybuilding scene on Muscle Beach.

Let New York have its state of mind, its snow-bomb winters, its stock exchange. Balmy Southern California, with its palm tree-silhouetted twilights, would make its mark in fixed income. Those who surfed the yield curve around L.A. will tell you that the move West granted perspective and independence from the groupthink of New York. “Maybe distance from Wall Street is key,” says Gross, who turns 74 in April.

DISTANCE: 2,797 MILES, give or take. That’s about a 41-hour ride in a ’67 Ford Mustang, the sort of horse Gross rode in 1971, after Duke University, a Vietnam War-era hitch in the U.S. Navy, and an MBA from the University of California at Los Angeles, where he financed tuition with winnings from the blackjack tables of Las Vegas. Gross taught himself to count cards after reading Beat the Dealer by Edward O. Thorp, and it was during a four-month gambling binge that he first practiced a version of portfolio risk management that would underpin his bond funds.

When Gross applied for his job at Pac Mutual, Los Angeles was stuck in the grim aura of the Doors’ L.A. Woman, the Manson Family murders, and Stage 3 smog alerts. The next year, the company bolted for a new suburban frontier: Newport Beach’s Fashion Island, a luxury mall where they commissioned a spaceage, mushroom-shaped office pavilion designed to lure talent from Southern California’s aerospace industry.

“Newport Beach was a revelation,” Gross says. “Fresh. New.’’ Pac Mutual also experimented with new ways to diversify, one of which was expanding into a signature Wall Street business—managing other people’s bond portfolios. And, unlike most insurance companies, the unit that grew into Pimco wouldn’t only clip bond coupons until the debt matured; it would also be an active trader.

“That idea from Wall Street is something that we grabbed hold of,’’ says Ben Ehlert, Pac Mutual’s former head of fixed income and Gross’s first boss. Gross, then 27, seemed sharp and, in the words of another executive, Mike Fisher, “was a kind of cool-lookin’ dude.” Ehlert gave the dude $5 million of “play money” and told him to get going.

Pimco took years to gain traction. East Coast pension executives were happy to visit, maybe take a boat ride to Catalina Island. Putting money down, however, was another matter. President Gerald Ford helped by signing the Employee Retirement Income Security Act of 1974, which cracked open the club of big bank money managers. Pimco’s breakthrough didn’t come until 1977, when AT&T’s retirement plan became a client. “It was the pension fund seal of approval,” Gross says.

From that modest beginning, Pimco, with Gross at the helm, grew into one of the world’s biggest and most powerful bond shops, amassing $2 trillion at its 2013 peak. Gross’s thoughts were courted by Federal Reserve governors and financial-TV networks. Yet he could toss off colorful riffs like a guy propping up the 19th-hole bar at Newport Beach’s Big Canyon Country Club: “AAA?” Gross wrote about the U.S. credit rating industry’s grades for subprime mortgage-related securities in 2007. “You were wooed, Mr. Moody’s and Mr. Poor’s, by the makeup, those 6-inch hooker heels, and a ‘tramp stamp.’”

MAY BEGINS EACH year at the Beverly Hilton with a parade of black Cadillac Escalades disgorging heads of state, cabinet secretaries, and Wall Street billionaires. They come for “Davos with palm trees,” as Milken’s annual conclave is known. This is the same Milken whose junk bonds fueled the 1980s buyout boom, who was slapped with a lifetime trading industry ban, who served 22 months in prison for securities and tax law violations, and who surfaced thinly veiled last year in the Broadway play Junk, in which the protagonist’s catchphrase is “Debt is an asset.”

Unlike other West Coast bond princelings, Milken started out in Southern California. At Birmingham High School, a public school in the San Fernando Valley, he was a cheerleader and prom king. At the University of California at Berkeley he became the radical antiradical, choosing Wall Street as his battleground to change the world. After seeing the flames of the 1965 Watts riots, he decided that creative financing should become a tool for social justice. “I concluded that the American dream required access to capital,” Milken says. “We were denying a large percentage of our population access.”

He went off to business school at Wharton and then to Wall Street and Drexel, before returning to California, where he tipped the credit world’s balance toward L.A. From his X-shaped desk, Milken, along with Drexel, underwrote leveraged buyouts for Carl Icahn and John Malone, among others. “An explosion of money managers was created out here, many of them because they wanted to be close to us,” says Milken, now 71. “Let’s just say many of them got their Ph.D.s in capital structure and finance when we worked together.”

David Lippman moved from New York to L.A. in 1985 to escape the strictures of Wall Street and work for Milken. “The East Coast was color inside the lines,” he says. “Out here it was the cutting edge.” When Drexel collapsed after Milken’s 1990 guilty plea, his minions spread across the financial world. Lippman now runs TCW Group. Leon Black and Antony Ressler co-founded Apollo Global Management before Ressler left to start Ares Management.

Howard Marks was dispatched in 1978 from the fixed-income desk at Citicorp. He recalled his boss’s instructions in a 2016 speech upon his induction into the Fixed Income Analysts Society Inc.’s Hall of Fame in New York: “There’s some guy in California named Milken, and he deals in something called high-yield bonds. Do you think you could figure out what that means?”

Marks met Milken and stayed. He eventually quit Citi to join TCW, which he left in 1995 to co-found Oaktree Capital Group LLC, which now oversees $100 billion.

Gundlach, child of snowy Buffalo, originally moved to L.A. as the drummer for a band called Radical Flat (later rechristened Thinking Out Loud). One day he saw an episode of Lifestyles of the Rich and Famous that said the best-paid jobs were in investment banking. Gundlach found TCW in the Yellow Pages, unaware that the asset manager wasn’t an investment bank. A math and philosophy major at Dartmouth College and former doctoral candidate at Yale, Gundlach got a job.

He worked his way up to chief investment officer at TCW by 2005, only to be fired four years later during a power struggle, sparking a two-year court battle. Three dozen employees and billions of dollars followed Gundlach out the door to his new company, DoubleLine. Oaktree provided office space and $20 million for a 20 percent stake in the company. “It wasn’t a decision we had to agonize over,” Oaktree’s Marks says in an email. “And it’s the highest-returning investment any of us have ever made.”

The East-West divide is not only about geography. Put roughly, New York was dominated by the faster, more transactional sell side, crowding out the slower, analytical buy side, which could then flourish in Southern California. “The patience the buy side takes relative to the sell side is meaningfully different,” says Ken Leech, CIO of Western Asset Management, who joined the Pasadena-based company in 1991 after stints on the East Coast with Greenwich Capital Markets and Credit Suisse First Boston.

IN MAY 2014, Pimco moved to a new 20-floor tower that soars above Fashion Island and the old mushroom pavilion. By then, Gross was deemed by some to have lost his investing edge, and his underlings rose up in revolt, forcing his ouster four months later. Pimco’s post-Gross assets plunged to $1.43 trillion, but by the end of last year they rebounded to $1.75 trillion.

Gross now runs the $2.2 billion Janus Henderson Global Unconstrained Bond Fund out of a small 14th-floor corner office above Fashion Island, where he can watch the sunset if he stays late enough. At his desk, Gross has a long view up the Pacific coast that fades into blue haze behind Pimco’s headquarters, the white tower Gross did so much to build. From the outside he now sees his old company losing ground to other industry pioneers: managers of low-fee, passive funds. “Pimco,” he says, “will never reach $2 trillion again.”

Gittelsohn covers investing for Bloomberg News in Los Angeles.

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