MONEY stocks

Gordon Gekko Is Back—by Another Name

WALL STREET, Michael Douglas (standing), Saul Rubinek (head, right) 1987.
Today's Gordon Gekkos may call themselves activist investors instead of corporate raiders—but they're just as greedy. 20th Century Fox—Courtesy Everett Collection

You've been hearing a lot about "activist investors" lately, a fresh bit of Wall Street jargon that may leave you scratching your head. Here's what you need to know about this not-really-new breed of financial power players.

Investors have been pushing for—and often winning—big changes at companies. This week, Ebay EBAY INC. EBAY -2.066% split off its PayPal division, a move long urged by Carl Icahn, who controls 30 million shares of the company. The value of each of those shares has jumped $3 since the news. Meanwhile, the hedge fund Starboard Value has been calling for another big tech deal: a merger of Yahoo YAHOO! INC. YHOO -1.0552% and AOL AOL INC AOL -3.2925% .

Icahn and Starboard are usually described as activist investors, a fresh bit of Wall Street jargon that may leave you scratching your head. Here’s what you need to know about this not-really-new breed of financial power players. They may be shaking up a company you invest in—or work for—next.

What is an “activist investor”?

Ownership of a company’s shares usually comes with voting rights of one vote per share. Whereas most investors simply hold a stock and seek no direct role in management decisions, activists use their voting rights—and those of other investors they can rally to their side—to push for changes in how companies are run.

Activist shareholders can include big pension funds and mutual funds. But the most prominent activists these days are hedge funds, including Bill Ackman’s Pershing Square, Starboard Value, and funds run by Icahn.

The label “activist” itself is a bit of a public relations coup. Back in the 1980s, investors like Icahn used to be better known as “corporate raiders.” Gordon Gekko, the charismatic villain in Oliver Stone’s film Wall Street, is someone who today might be described as an activist. (He was also an illegal insider trader, but that’s different from being an activist or raider.) In his iconic “greed is good” speech, Gekko is at a shareholder meeting berating “Teldar Paper” managers for their fat salaries and poor performance. He wants control of the company. If there’s a distinction between then and now—that is, between corporate raiders and activist investors—it’s that activists today seem less inclined to mount a full-fledged hostile takeover and instead use their stakes and public pronouncements to exert pressure on the existing management and boards.

“Activism” calls to mind the image of idealistic political activists, but only a tiny slice of activist investors have political or social goals, like trying to get companies to reduce their carbon footprint. Most activists just want a higher share price, and tend to cash out once the price pops up.

What do activists want companies to do?

Sometimes activist investors are interested in changing day-to-day operations. In one notorious example, Ackman pushed JC Penney J.C. PENNEY JCP -7.2709% to appoint Ron Johnson of Apple as its CEO. Johnson tried to transform Penney’s into something more Apple-like, remodeling the stores and promising always-fair prices instead of constant discount sales. Bargain-hunting customers hated it. Revenues tanked, and Ackman later admitted he made a mistake.

More recently, Starboard Value drew a lot of (amused) attention with a 294-slide presentation on Darden DARDEN RESTAURANTS INC. DRI -0.9911% , owner of the Olive Garden restaurant chain, criticizing, among other things, the generous breadstick servings and decision not to salt the pasta-cooking water.

But activists are often focused on one-time financial restructuring moves. As David Dayen at Salon pointed out, most people missed another thing Starboard wants Darden to do: sell or spin off the real estate its restaurants sit on. That generates cash for shareholders now, or creates a new real-estate stock that might be worth more outside of Darden. It may not be so great for Darden, though, if the restaurant side of the business later hits a slump.

Some other things activist investors like companies to do: get acquired by another firm for a higher price. Buy up other companies the activist happens to also own. Take on debt, which can amp up near-term profits. Or pull cash out of the company and give it to shareholders via dividends or stock buybacks. For example, Apple APPLE INC. AAPL -1.5583% has lately been paying investors more from its enormous stockpile of cash, thanks in part to pressure from the likes of Icahn and the fund Greenlight Capital.

Why are activist investors getting so much attention these days?

This may be an echo effect of the 2008 crisis. Activists looking for opportunities will often look for stocks that are cheap, so they can scoop up lots of shares and (they hope) engineer a large price gain. The crash created lots of opportunities. And as companies recovered, Time‘s Rana Foroohar says, many were still nervous about the economy, so they built up big reserves of cash. That cash is a fat target for activists.

The recent rise of hedge funds has something to do with it, too. Mutual funds and pensions have to be highly diversified, so they have limited ability to build up big share blocks, and less incentive to get involved in specific fights. But in a recent paper UCLA law professors Iman Anabtawi and Lynn Stout observe that lightly regulated hedge funds, which are only available to institutions and wealthy investors, can focus their assets on just a handful of stocks.

So what’s the verdict: Are activists good guys or bad guys?

Economist and blogger James Kwak puts it this way: “In finance, there are rarely battles between good and evil. Instead, you have battles of, say, greedy and corrupt versus greedy and ruthless.” CEOs in these battles want to keep their jobs and control, and shareholders want a better return for themselves.

Critics of activists say they are too focused on short-term goals. The cash a company pays out as special dividend today can’t be plowed into R&D; the debt that finances a restructuring could later drive the firm into bankruptcy. Some companies, like Google GOOGLE INC. GOOG -1.5744% , have set up multiple share classes, some without voting rights, to insulate management from investor demands. The wild success of Google both as a stock and as a business shows that a company can do just fine without nagging from hedgies.

One influential study looks at what happened to 2,000 companies targeted by activists over a number of years. It concluded that activism worked out fine for investors, even over a period as long as five years. And “operating performance relative to peers improves consistently,” writes co-author Lucian Bebchuk, an economist at Harvard. This was true even for companies that took on debt or cut capital spending. But another recent study is less upbeat, finding little impact on growth and profit margins.

Even if share prices do rise, this doesn’t mean activists are good for the flesh-and-blood people who work for the corporation, or for that company’s customers, or for society or the economy as a whole, UCLA’s Stout has argued. By forcing top managers to be relentlessly focused on share price, activists make it even less likely that companies will take into account, say, their impact on the environment, or the interests of their workers. Think companies based in America shouldn’t move headquarters abroad just to save money on U.S. taxes? Talk to the hand, say the activists.

In the 1980s, the early heyday of corporate raiding, after Icahn’s takeover of TWA led to significant pay cuts and layoffs, economists Adrei Shleifer and (future Treasury secretary) Lawrence Summers described the gains from Icahn’s activism this way: “essentially a transfer of wealth from existing flight attendants… to Icahn.”

One thing a real-life Gordon Gekko probably wouldn’t have done: cut the salary of the next CEO of Teldar Paper. Although activists are supposed to be tough disciplinarians for managers, their focus on “shareholder value” helped push more companies to pay the C-suite largely in stock incentives instead of fixed salaries. CEO pay exploded.

MONEY Airline Stocks

Airline Stocks Are Sinking—and Ebola Is Only Partly to Blame

Dr. Tom Frieden, director of the Centers for Disease Control (CDC)
Assurances about Ebola safety from CDC Director Tom Frieden apparently fell on deaf ears on Wall Street. Tami Chappell—Reuters

Airline stocks got hammered this morning after the first official case of Ebola was confirmed in a Texas patient. But calm down: Investors have a long history of overreacting to deadly diseases.

Shares of major U.S. airlines descended about 4% Wednesday morning, and investors are blaming Ebola.

The CDC and Texas Health Department confirmed the first official diagnosis of Ebola in the U.S., in a man who had traveled to Dallas from Liberia.

CDC Director Tom Frieden was quick to point out that “there’s all the difference in the world between the U.S. and parts of Africa where Ebola is spreading. The United States has a strong health care system and public health professionals who will make sure this case does not threaten our communities.”

Those assurances apparently fell on deaf ears on Wall Street, where investors pushed the stocks of major carriers such as United Airlines UNITED CONTINENTAL HLDG. UAL -2.8211% , American Airlines AMERICAN AIRLINES GROUP INC AAL -3.0722% , and Delta DELTA AIR LINES INC. DAL -3.4578% lower in early morning trading.

UAL Price Chart

UAL Price data by YCharts

Anytime diseases arise that could restrict air travel — in this case, to and from various parts of West Africa — airline shares are among the first to see a reaction.

Last year, for instance, global airline stocks took a tumble on worries of the spread of bird flu. Before that, in early 2009, the outbreak of swine flu pushed airline stocks to double-digit losses amid concern that the disease might curtail travel at a time when the economy was already faltering due to the global financial crisis. And before that, in 2003, the first signs of SARS drove airline stocks lower on fears that international travel — in particular to and from Asia — would be hurt.

In this case, though, even airlines that do not travel in West Africa — for instance, Southwest Airlines SOUTHWEST AIRLINES CO. LUV -3.6127% — have been hit.

LUV Price Chart

LUV Price data by YCharts

To be sure, Southwest is headquartered in Dallas, which is where the first U.S. Ebola case was reported. But the fact that an airline like Southwest is being affected makes Morningstar analyst Neal Dihora think that “this might be about something else.”

That something might have to do with oil prices. Oil prices have fallen recently to below $100 a barrel. This is generally good news for airline stocks, since that means a major input cost is headed lower, Dihora says.

But there comes a time in every oil cycle, he points out, where investors wonder if oil prices are headed lower for a reason — as in, is this a sign of further troubles for the global economy?

It’s too soon to say if that’s the case. Many observers are currently chalking up falling oil prices to the strengthening dollar.

But for the moment, it seems that this worry about the global economy is what’s really driving the sector — and the emotional reaction to Ebola only compounded the situation.

MONEY 401(k)s

What Bill Gross’s Pimco Departure Means for Your 401(k)

The people who tell companies what retirement-plan investments to offer employees are questioning the value of the giant Pimco Total Return bond fund.

Bill Gross’s sudden departure from Pimco and the Total Return Fund he ran for 27 years was the last straw for Jim Phillips, president of Retirement Resources, a Peabody, Mass. firm that advises 401(k) plans with $50 million to $100 million in assets. He’s advising clients to head for the exits.

After 16 straight months of outflows and a 3.5% return over the past year, worse than 75% of its peers, the $222 billion Total Return Fund is failing Phillip’s standards when it comes to meeting the retirement needs of his customers.

“We do not have ongoing confidence in the way the fund is being managed,” Phillips said. “We are recommending to clients that we replace this fund with another one.”

Philips said he joined a conference call Monday with Pimco chief executive Doug Hodge and some of the company’s portfolio managers, but said the conversation “doesn’t change any actions that we have planned.”

About 27,000 of the largest corporate 401(k) plans in the country had money in the Total Return Fund as of the end of 2012, according to the most recent data from BrightScope, which ranks retirement plans. The roster includes Walmart’s $18 billion plan, the largest in the country by assets, as well as Raytheon’s and Verizon’s.

Total Return holds $88.3 billion of the $3 trillion in 401(k) assets listed in BrightScope’s database of more than 50,000 of the largest plans, the biggest mutual fund in the database.

Walmart didn’t return calls, and Raytheon and Verizon declined to comment for this article.

Phillips isn’t alone in his dissatisfaction with the fund — investors have pulled $25 billion from Total Return Fund so far this year. But a bad year that began with a public falling out between Gross and top deputy Mohamed El-Erian in January and has now seen the Pimco co-founder quit is causing many 401(k) plan consultants and advisers to put the Total Return Fund on their watch lists, and in some cases start replacing it.

Though companies usually make decisions about where to invest their retirement funds during investment committee meetings, which typically occur quarterly, Gross’ exit could prompt companies to have meetings or calls sooner than scheduled, said Martin Schmidt of H2Solutions, a Wheaton, Ill. consultant for 401(k) plans with assets from $150 million to $4 billion.

“I have sent out emails to clients telling them that we need to start looking at alternatives,” Schmidt said. He said he hasn’t heard from anyone at Pimco.

Once an employer decides to switch a fund out of its plan, it can take three to five months to make the change and give employees the required 30-days’ notice.

Jump Ship

Gross’s new fund, the $13 million Unconstrained Bond Fund from Janus Capital, is unlikely to be the destination for any funds that decide to jump ship on Total Return, given that it’s only been in operation since May and has produced a negative 0.95% return since inception, according to Morningstar.

“We have to see at least a three-year track record and we actually prefer five,” said Troy Hammond, president and chief executive officer of Pensionmark Retirement Group, a Santa Barbara, Calif. adviser that serves over 2,000 small 401(k) plans across the country.

There is also the question of whether Gross will have the same level of support and resources at Janus as he did at Pimco.

“If Bill were leaving with the top 10 people from Pimco, like Jeffrey Gundlach did when he left TCW, that would be different,” said Mendel Melzer, chief investment officer for the Newport Group, a Heathrow, Fla. consultant to institutional investors, including 401(k) plans with assets between $20 million and $1.5 billion. “But this is just Bill Gross leaving on his own, and it is hard to say that the track record he accumulated at Pimco should translate into the Janus fund.”

Melzer is advising clients to see how the new Pimco team does with the Total Return Fund, which has been on Newport’s watch list since earlier this year.

“We will keep it on a very short leash,” Melzer said. “If it does not improve in the next two quarters we will look at alternatives.”

MONEY Markets

Why You Should Start Preparing for the Next Market Crash

End of the railroad tracks
Pete Ryan—Getty Images/National Geographic

Today’s valuations aren’t to be taken lightly – here’s what you can do.

Several phrases call to mind the dot-com boom and bust, but one of the most recognized started with a 70-year-old man in a bathtub. That man was writing a speech, and he came up with the term “irrational exuberance.” The speech was broadcast on C-SPAN, and stock markets around the world dropped a few percentage points the next day.

That suds-soaked soothsayer was Alan Greenspan. On Dec. 5, 1996, he delivered a speech he called “The Challenge of Central Banking in a Democratic Society.” He said, “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

Greenspan didn’t say those famous two words (of the 4,322 he uttered) until he was more than three-quarters through his speech. But they’re the only words people remember.

The phrase gained further fame after Yale professor Robert Shiller wrote Irrational Exuberance, a book that explained how stocks were significantly overvalued. The book was published in 2000 in the same month that the bubble began to deflate. Shiller published a second edition in 2005, this time arguing that the housing market was historically off-the-charts overvalued. We all know how that turned out.

But I’m not talking about the history of “irrational exuberance” just for the joy of making you think about Greenspan taking a bath. I’m bringing it up now because Shiller is once again saying that stocks are overvalued.

What’s Next In This Series?: 1929, 2000, 2007…

Beyond his books and the Case-Shiller housing index that he co-created, Shiller is known for the cyclically adjusted price-to-earnings ratio, also known as the CAPE or the Shiller P/E. Rather than relying on just one year’s worth of earnings to measure a P/E, the CAPE uses an average of the past 10 years’ worth of earnings, adjusted for inflation.

So what does the CAPE say now? It’s at 26.3, according to an interview published Sept. 5 by British website This Is Money. “There’s only three major occasions in U.S. history back to 1881 when it was higher than that,” Shiller said. “One is 1929, the year of the crash. The other is 2000, which I call the peak of the millennium bubble, and it was also followed by a crash. And then 2007, which was also followed by a crash.”

Before You Hit the “Sell” Button…

That sounds ominous, but know that Shiller’s research indicates that the CAPE is highly correlated to the stock market’s return over the next 20 years — not the next year. The ratio was very close to today’s figure when Greenspan mentioned “irrational exuberance” in 1996, and the market kept rising for more than three years. Plus, as Shiller pointed out in the interview with This Is Money, although the market eventually crashed after the three times the CAPE reached these levels, that’s not a large sample size, statistically speaking.

Still, today’s valuations are not to be taken lightly. At The Motley Fool we are known for our “buy and hold” investing approach — even sometimes saying that we plan to hold on to great companies “forever.” But we know that “forever and ever” isn’t realistic for everyone.

You’re probably investing today to pay for something in the future, whether it’s retirement, a vacation home, or a family legacy. That means you have to sell sometime. And if that sometime is soon — as in, the next few years if a significant market decline would imperil some important plans you have — now may be a good time. Rebalancing your portfolio and playing it safer is a reasonable strategy when the market is overvalued.

Shiller and I aren’t saying that the market can’t keep rising from here. After all, a historically high P/E could fall to a more normal level if profits rise (i.e., the E in P/E) rather than prices crash (a lower P). But the smart assumption is that returns will be be modest.

How Bad Will It Be For You?

When I create a financial plan, I assume an annual return of 6%. But even that may be too high, according to some experts who argue that today’s CAPE implies a future return of 1% to 5%. Returns will certainly be on the lower end of that scale after you throw some cash and bonds into the investment mix. At that point you’re looking at a portfolio that will struggle to simply keep up with inflation.

But it doesn’t have to be that bad for you. Remember, the CAPE estimates of implied return is for the overall market, which is dominated by large-cap stocks. A few smart tweaks to your portfolio can make all the difference. Throw in some small caps, international stocks (Shiller thinks the U.K. market could be a bargain because it’s below its long-term average CAPE), and prescient stock picks, and I think you can do a lot better. Then keep your spending in check and your savings high. And when you start to feel anxious, take a long, soothing bath. Just make sure Greenspan has hopped out beforehand.

MONEY facebook

Why You’ll Never Leave Facebook for Ello

Berger & Föhr is a graphic design studio in Boulder, Colorado. Its partners, Todd Berger & Lucian Föhr are Co-founders of Ello. Ello

It’s hard to build a large network using a freemium strategy.

By no means was Facebook FACEBOOK INC. FB -3.1503% the first major social network, nor will it be the last. MySpace and Friendster predated Facebook, and Twitter came after it. There’s a new social network in town now positioning itself as the “anti-Facebook,” and its primary pitch is the notable absence of any ads. Should Facebook be afraid?

Say hello to Ello.

Why now?

Over the past few days, Ello’s popularity has soared, even though the service launched in private beta in March. One reason why some users are now flocking to Ello is that Facebook has recently begun to crack down more on enforcing its longtime “real name” policy. That’s created tension within specific communities, such as the LGBT community, that prefer not to use their real names for personal privacy and protection.

The service is currently invite-only, but requests for invites have skyrocketed in recent days, particularly as media attention escalates. The site was created by artists and designers, and offers a minimalist interface. The company’s “manifesto” outlines Ello’s philosophy quite clearly:

Your social network is owned by advertisers.

Every post you share, every friend you make and every link you follow is tracked, recorded and converted into data. Advertisers buy your data so they can show you more ads. You are the product that’s bought and sold.

We believe there is a better way. We believe in audacity. We believe in beauty, simplicity and transparency. We believe that the people who make things and the people who use them should be in partnership.

We believe a social network can be a tool for empowerment. Not a tool to deceive, coerce and manipulate — but a place to connect, create and celebrate life.

You are not a product.

Interestingly enough, the language is very similar to Apple CEO Tim Cook’s recent letter on privacy, which was a clear shot at Google: “A few years ago, users of Internet services began to realize that when an online service is free, you’re not the customer. You’re the product.”

An ad-free social network sounds differentiated and idealistic, but should Mark Zuckerberg be losing sleep over Ello’s entry? Nope.

Ello’s monetization strategy is questionable

Fact: every company needs a viable monetization strategy. Most social networks and free Internet services to date have all relied on ad-based revenue. If Ello hopes to expand its service and grow its user base, the required funding will have to come from somewhere. Data centers and software engineers aren’t cheap.

Ello has raised $435,000 in venture capital funding from Vermont-based FreshTracks Capital. Ello’s founders still own over 80% of the company, so FreshTracks can’t quite call the shots yet. FreshTracks isn’t looking to make a quick buck, and has bought in to the value proposition that Ello is pitching to users. Namely, that Ello will not sell user data or insert ads.

Inevitably, Ello will need to make money somehow, in part to satisfy the return requirements of its venture capitalists, even if FreshTracks has a long time horizon and is willing to wait it out. It turns out that Ello hopes to use a strategy that’s been taking over mobile gaming: freemium.

Ello’s strategy will be to offer higher-value services and features that users will have to pay for. The basic service will be free, but the company will try to upsell and generate its revenue directly from users. This strategy is questionable at best, but it can theoretically succeed with a niche audience. Mainstream users are likely not willing to open up their wallets to use a social network.

Seemingly every year, speculation arises that Facebook is preparing to charge monthly fees, and every year these hoaxes get shot down. Facebook then added, “It’s free and always will be.” to its homepage back in 2011 just to put the matter to rest.

There’s even one that originated from The National Report circulating right now, claiming that Facebook is preparing to implement a $3 per month fee. The National Report may not have the same brand cachet of The Onion, but it’s similarly a satirical news site. The report quotes a likely fictional Facebook spokesman as saying, “There’s so many pictures of cats, and all of those costs add up, we just can’t foot the bill any longer.” That sounds legitimate.

It’s also worth noting that Facebook itself effectively has a freemium business in the form of its payments segment. This segment is mostly comprised of Facebook’s cut when developers sell digital goods, but also includes revenue from user paid services such as promoting personal posts, among others. Guess which business is doing better.

Source: SEC filings

While Ello is unlikely to begin selling virtual tractors, it’s debatable whether or not it can build a large-scale social network using a freemium monetization strategy. It could work on a niche scale though.

Hating ads is not enough

Having a philosophical disdain for ads is misplaced and perhaps naive. Hating ads assumes that users derive absolutely no value from them, which couldn’t be farther from the truth. A small percentage of people do end up clicking relevant ads that appeal to them, and they end up purchasing something that they value. For the rest of us, the ads are a more viable way to fund the underlying free service.

Facebook expects to spend $2 billion to $2.5 billion on capital expenditures this year to build network infrastructure, construct data centers, and purchase servers. Without the backend infrastructure, the service would suffer terribly. If Ello’s user base begins to explode, and it lacks the funds to beef up its infrastructure, the service will suffer and users will return to the familiar Facebook.

Then there’s the basic tenet that social networks derive all of their value from network effects. Let’s say you loathe Facebook’s ads, which can admittedly be obnoxious at times, and are looking for an alternative place to post about what you ate for lunch.

If you choose a network where none of your friends or family have joined, no one will ever know what you ate for lunch. Your contacts have to hate ads just as much as you do, and that’s a tall order to fill in this day and age where netizens have developed a practiced apathy for ads in exchange for free services.

Facebook has nothing to worry about.

MONEY mutual funds

Here’s What You Need to Know About the Pimco Stampede

The headquarters of investment firm PIMCO is shown in Newport Beach, California.
The headquarters of PIMCO, in Newport Beach, California. Lori Shepler—Reuters/Corbis

$10 billion left mutual fund giant Pimco in one day after "bond king" Bill Gross announced his departure. Should you head for the exits too?

The Wall Street Journal has reported that investors on Friday pulled out $10 billion from funds run by Pacific Investment Management Co., or Pimco. The redemptions came after news of the departure of Bill Gross, the company’s chief investment officer and manager of the $220 billion Pimco Total Return bond mutual fund.

For a sense of scale: Pimco is a huge, $2 trillion money manager, so that’s 0.5% of its assets. Even so, it’s a lot of money to go out the door in one day, and the company has been struggling to hang on to investors for some time, largely as a result of Total Returns’ recent mediocre performance.

Pimco’s funds are widely held in many 401(k) retirement plans. If you don’t watch Wall Street regularly, but are tuning in now because there’s a Pimco fund in your plan, don’t be too alarmed. Mutual funds don’t necessarily decline in value just because a lot of people sell.

A fund is designed to allow investors to redeem shares each day for the value of underlying assets, and its shares don’t rise and fall based on investors’ demand for the fund. You shouldn’t worry about getting out of Pimco “too late,” and nor is there any opportunity to be had in buying “on the dip.” (A nerdish caveat: A wave of redemptions can impact performance if it forces a fund to sell investments at a bad time in order to raise cash, but managers generally design their portfolios to handle the possibility of redemptions.)

Analysts expect even more money to leave Pimco. Thomas Seidl, who follows Pimco’s parent company Allianz for Bernstein Research, predicts that between 10% and 30% of the money Pimco runs for outside clients (that is, not related to Allianz) may eventually leave the company. That adds up to $170 billion to $530 billion.

Why is the departure of one man, even a star once known as the “bond king,” triggering so many to get out Pimco?

One reason for people to go is quite rational. As Money’s Penelope Wang argued on Friday, there isn’t a great case for buying an actively managed bond fund such as Pimco Total Return, as opposed to a low cost index fund that simply tracks the wider market.

The returns on bonds don’t vary as widely as they do on stocks, which gives even the best funds less room to outperform the market average. That means a fund that keeps annual expenses low, as index funds do, starts with a big built-in advantage. Gross’s departure from Pimco is a good time for current Total Return shareholders to reassess whether they want to spend the extra money for a manager who tries to outwit the rest of the market.

But not everyone running from Pimco is going the index route. DoubleLine funds, run by Jeff Gundlach, is reporting big inflows. Gundlach is the bond world’s new hot manager. The institutional share class of his DoubleLine Total Return Bond fund earned over 5% in the past 12 months, vs. 3.5% for the comparable Pimco Total Return fund. Other investors may go to Janus, Gross’s new employer.

Bernstein’s Seidl thinks most of the outflows he anticipates will come from retail investors concerned about performance. Although Pimco has a deep management bench and impressive research capabilities, most investors picking a bond fund are making a bet on a manager’s judgement and feel for the markets. With Gross leaving Pimco, investors may not feel they have much to go on in deciding whether to hold Pimco Total Return. “Performance builds up over time — it takes a number of years,” says Seidl.

Of course, that’s assuming even performance is a helpful guide. Gross built up a brilliant record, and then misjudged the bond market in 2011, and then again in 2013. Bad luck for him, but even more so for the typical Pimco Total Return investor. As the Journal‘s Jason Zweig observes, much of the money in Gross’s fund came in after his best years, and just in time for his mediocre ones.

In short, it may make sense to go now, if you want to get costs down and taxes aren’t an issue. (Your trade won’t trigger taxes if the fund is inside a 401(k) or IRA). But think twice about trying to find the next new bond star.

MONEY bonds

Video: Bill Gross Leaves Pimco for Janus

In the wake of weakening performance and bad press, the bond guru is leaving the company he co-founded in 1971.

MONEY mutual funds

What Investors in Pimco’s Giant Bond Fund Should Do Now

One-time star manager Bill Gross is leaving. The case for choosing an index fund for your bonds has never looked better.

For many bond fund investors, star fixed-income manager Bill Gross’s sudden leap from Pimco to Janus is a moment to rethink. Gross’s flagship mutual fund, Pimco Total Return long seemed like the no-brainer fixed-income choice. Over the past 15 years, Gross had steered Total Return to a 6.2% average annual return, which placed it in the top 12% of its peers. And based on that track record it became the nation’s largest fixed income fund.

But much of that performance was the result of past glory. Over the past five years, Pimco has fallen to the middle of its category, as Gross’s fabled ability to outguess interest rates faded. It ranks in the bottom 20% of its peers over the past year, and its return of 3.9% lags its largest index rival, $100 billion Vanguard Total Bond Market, by 0.5%.

Nervous bond investors have yanked nearly $70 billion out of the fund since May 2013. Those outflows are driven not only because of performance but also because of news stories about Gross’s behavior and personal management style. Still, Pimco Total Return holds a massive $222 billion in assets, down from a peak of $293 billion, and it continues to dominate many 401(k)s and other retirement plans as the core bond holding.

If you’re one of the investors hanging on to Pimco Total Return, you’re probably wondering, should I sell? Look, there’s no rush. Your portfolio isn’t in any immediate trouble: Pimco has a lot of other smart fixed-income managers who will step in. And even if you can’t expect above-average gains in the future, the fund will likely do okay. The bigger issue is whether you should hold any actively managed bond fund as your core holding.

The simple truth is most actively managed funds fail to beat their benchmarks over long periods. Gross’s impressive record was an outlier, which is precisely why he got so much attention. That’s why MONEY believes you are best off choosing low-cost index funds for your core portfolio. With bond funds, the case for indexing is especially compelling, since your potential returns are lower than for stocks, and the higher fees you pay to have a human guiding your fund can easily erode your gains.

Our MONEY 50 list of recommended funds and ETFs includes Harbor Bond, which mimics Pimco Total Return, as an option for those who want to customize their core portfolio with an actively managed fund. When issues about Pimco Total Return first began to surface, we recommended hanging on. But with Gross now out of the picture, we are looking for the right replacement.

If you do choose to sell, be sure to weigh the potential tax implications of the trade. Here are three bond index funds to consider:

*Vanguard Total Bond Market Index, with a 0.20% expense ratio, which is our Money 50 recommendation for your core portfolio.

*Fidelity Spartan U.S. Bond, which charges 0.22%

*Schwab Total Bond Market, which charges 0.29%

All three funds hold well-diversified portfolios that track large swaths of the bond market, including government and high-quality corporate issues. Which one you pick will probably depend on what’s available in your 401(k) plan or your brokerage platform. In the long-run, you’re likely to get returns that beat most actively managed bond funds—and without any star manager drama.

MONEY Environment

Why “Green” Cars Are Still Destroying the Earth

Tesla Model S.
Tesla's battery makes it cleaner than gas-guzzling alternatives—but think about what else it's made of. Tesla

In 2013 Tesla‘s TESLA MOTORS, INC. TSLA -1.0054% Model S won the prestigious Motor Trend Car of the Year award. Motor Trend called it “one of the quickest American four-doors ever built.” It went on to say that the electric vehicle “drives like a sports car, eager and agile and instantly responsive.”

What is remarkable about the car’s speed and agility is that it’s powered by a battery and not an internal combustion engine. Because of that it produces absolutely no tailpipe emissions, making it both better performing and cleaner than its gas-guzzling peers. That said, the company does have one dirty little secret: It’s not as clean as you might think.

The secret behind Tesla’s success

While the power driving Tesla’s success might be its battery, that’s not the real secret to its success. Instead, Tesla has aluminum to thank for its superior outperformance, as the metal is up to 40% lighter than steel, according to a report from the University of Aachen, Germany. That lighter weight enables Tesla to fit enough battery power into the car to extend the range of the Model S without hurting its performance. Vehicles made with aluminum accelerate faster, brake in shorter distances, and simply handle better than cars loaded down with heavier steel.

Even better, pound-for-pound aluminum can absorb twice as much crash energy as steel. This strength is one of the reasons Tesla’s Model S also achieved the highest safety rating of any car ever tested by the National Highway Traffic Safety Administration.

But it’s not all good news when it comes to aluminum and cars.

Aluminum’s dirty side

Aluminum is the third-most abundant element in the world, behind oxygen and silicon. In fact, it makes up 8% of the Earth’s crust by weight. However, despite aluminum’s abundance, it’s not found in its pure form because it’s so reactive; instead, it is found in combination with more than 270 different minerals. Aluminum wasn’t even isolated until the 1800s when the predecessor company to Alcoa ALCOA INC. AA -2.4239% discovered how to transform a raw form called alumina into the metal.

Before alumina can be converted into aluminum its source needs to be mined. That source is an ore called bauxite, which is typically extracted in open-pit mines that aren’t exactly environmentally friendly. Bauxite is then processed into the fine white powder known as alumina, and from there alumina is exposed to intense heat and electricity through a process known as smelting, which transforms the material into aluminum.

Aluminum smelting is extremely energy-intense. It takes 211 gigajoules of energy to make one tonne of aluminum, while just 22.7 gigajoules of energy is required to produce one tonne of steel. In an oversimplification of the process, aluminum smelting requires temperatures above 1,000 degrees Celsius to melt alumina, while an electric current must also pass through the molten material so that electrolysis can reduce the aluminum ions to aluminum metals. This process requires so much energy that aluminum production is responsible for about 1% of global greenhouse gas emissions, according to the Carbon Trust.

There is, however, some good news: Aluminum is 100% recyclable. Moreover, recycled aluminum, or secondary production, requires far less energy to produce than primary production, as the following chart shows.

Source: U.S. Energy Information Administration

Recycled aluminum, which in the U.S. primarily comes from beverage cans and automotive parts, doesn’t require as much energy because the aluminum is simply melted down in a furnace that is usually fired by natural gas. As illustrated in the chart, this segment’s energy consumption is just a fraction of that of the aluminum sector as a whole.

Still, Tesla, which doesn’t specify whether its aluminum is from primary or secondary production, is using a very carbon-intensive metal for its Model S. Moreover, even if it did use purely recycled aluminum, Tesla is still creating demand for aluminum by taking supply from the metals marketplace to make its cars. One way or another, new primary aluminum production will be required to increase overall supply, which will only create more emissions. This means Tesla’s success will require more aluminum to be produced in the years ahead.

Investor takeaway

While green technologies might be better for the environment, none is completely clean yet. Somewhere down the line a dirty material is being used to make green technology. Aluminum production could be a lot greener given how much less energy is required for recycled aluminum. That’s why Tesla and other automakers looking to the material to reduce weight and increase performance need to make an effort to push for increased aluminum recycling. Otherwise, we could be replacing one dirty technology with another.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool recommends Tesla Motors. The Motley Fool owns shares of Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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