Pimco’s shadow equity replaces with more stable cash incentive

Bloomberg/New YorkPacific Investment Management Co, beset by fund outflows and management turmoil, swapped out the part of its compensation plan that hinged on earnings growth in favour of a more stable cash incentive.The company, which manages about $1.5tn in assets, stopped giving top managers new options to buy M shares, equity in the firm that fluctuates with profitability, according to a US Securities and Exchange Commission filing last month. The shares, also known as shadow equity, had been a key component of pay since 2008. In their place, high-ranking executives will get long-term compensation in cash paid over three years.The change comes as Pimco, fattened by years of rapid growth, seeks to retain employees in leaner times. The value of the M shares, which can be exchanged only in internal auctions, fell over the past two years as revenue growth sputtered and earnings declined, according to two holders of the options. Some of the units, which convert to shares only if profit hit a specified target, are worthless.“The firm would have to do significantly better for the M shares to be worth a lot,” said Michael Sarnoff, a principal at Highland Road in Los Angeles, an executive-recruiting firm for money managers, including some who have worked at Pimco.Michael Reid, a spokesman for Newport Beach, California- based Pimco, a unit of Allianz, declined to comment on the company’s compensation plan or reasons for the change.The value of M shares has fallen by about half amid record fund outflows and the departures of former Chief Executive Officer Mohamed El-Erian and Bill Gross, the firm’s co-founder and public face. Shares are now worth about $13,000 each, down from almost $25,000 in 2013, and provide a quarterly distribution of about $384, according to the two holders, who asked not to be identified because the matter is private. That’s off from a peak of about $950 in 2013, one said.Pimco’s assets under management doubled from 2010 to 2013, reaching a peak of $2.04tn on March 31 of that year. They have fallen almost 25% since then, through the end of June, according to the firm’s website.When the plan was adopted in 2008, top managers received about 10% to 20% of their compensation in M units, according to Sarnoff, the executive recruiter. That portion rose to as much as 30% of annual pay, he estimated. The units convert to shares over a three-year period, starting three years after they’re granted, assuming growth targets are met. They allow holders a slice of Pimco’s profits.In addition to receiving M shares, managing directors also participate in a profit-sharing plan that gives them the right to split a portion of the firm’s earnings. As part of the transaction in which Munich-based Allianz acquired Pimco in 2000, the portion was set at 30%. The profit-sharing helped make pay at the firm legendary: Gross took home $290mn in 2013, including earnings from the pool.The fund outflows began in May of that year as investors concerned that the Federal Reserve would soon boost rates fled traditional fixed-income strategies. They continued after El-Erian abruptly quit in January 2014, sparking reports of management discord. Then, in September, Gross left without warning for comparatively tiny money manager Janus Capital Group. Assets in the Pimco Total Return Fund, which was managed by Gross and was once the world’s biggest mutual fund, plunged to $101bn at the end of July from a high of $293bn in April 2013. Pimco’s first-quarter revenue dropped 3.1% to €1.14bn ($1.3bn), Allianz reported.Pimco is trying to right itself in the wake of the turmoil. It renegotiated client fees, bargaining to keep business at the expense of profitability. And Allianz added a 225mn-euro award programme to boost compensation for the rank-and-file, whose jobs became more challenging after Gross left. The “special performance award,” adding to bonus and salary policies already in place, consists of a cash grant in the fourth quarter paid over 12 to 30 months, Allianz said in November. The new long-term incentive plan replacing the M shares tilts compensation for top managers away from growth and toward guaranteed payouts. While the possibility of huge payouts is diminished, executives are protected from watching their options go to zero. The plan also binds them more tightly to the company because the payments, which fluctuate based on Pimco’s operating earnings over three years, are contingent on staying at the firm. That wasn’t the case with options for M shares.Pimco can afford these moves. It’s still one of the most profitable asset managers, and it pays better than peers, according to Sumit Desai, an analyst at Chicago-based data provider Morningstar.