Yet the remuneration of traditional portfolio managers has taken centre-stage this year, with European politicians debating proposals to change the ways in which bonuses are accrued, paid and reported to end investors.
The most eye-catching element of the reforms, championed by European Parliament member Sven Giegold, sought to cap the variable pay of retail fund managers at 100% of their fixed remuneration. Such a restriction would have brought asset management into line with the banking industry, where similar rules will limit the bonuses of high-earning employees from 2014.
However, after much wrangling – and lobbying by fund managers, according to Giegold – the proposals were amended in July, and the pay cap thrown out.
Banks got a lot of money from the state, but not everything in the financial community is as bad as people want to make out. You can’t compare investment banks with asset managers
Fund of funds manager, Erste Sparinvest
Christopher Traulsen, Morningstar’s director of fund research for Europe and Asia, says the cap was a “blunt instrument” which failed to tackle the core issue – the potentially negative effects of incentive schemes on fund manager behaviour.
“If you’re paid on a 12-month basis, for example, you might be encouraged to take on lots of risk because you just start over again the next year,” he says. “Or if you are paid on growth in assets under management and running a small-cap fund that’s already large, that might not work in investors’ favour.”
Fund selectors were similarly unimpressed with the cap. Indeed, Markus Jandrisevits, a fund of funds manager at Erste Sparinvest in Vienna, and Carolus Reincke, an investment manager at Finnish insurer Mandatum Life, both dismiss the proposal as an extension of populist “banker-bashing” since the recent financial crisis.
“Banks got a lot of money from the state, but not everything in the financial community is as bad as people want to make out,” says Jandrisevits. “You can’t compare investment banks with asset managers.”
Reincke additionally notes that such restrictions would affect fund companies’ ability to reduce employee remuneration in tougher times, thereby enabling them to keep down costs for end clients and protect jobs.
“If you look at Sweden for instance, where they have a lot of flexibility [in labour markets], industry and the financial sector have fared quite well,” he adds. “So flexibility, to my mind, is good. And, of course, a cap hinders that.”
What was kept in
But while the bonus cap, and its rejection, grabbed the headlines, Giegold’s amended proposals could yet have a profound impact on manager behaviour and transparency.
Requirements include: greater oversight of remuneration by fund houses; the calculation and payment of performance bonuses over time-horizons appropriate to the fund; and the reduction of variable pay during periods of “subdued or negative financial performance of the management company or of the Ucits concerned”.
In addition, the proposals call for at least half of variable pay to be dispensed in fund units, and for companies to disclose their remuneration policies annually. Traulsen says moves to improve transparency are “a step in the right direction”, and an effective way of protecting less-sophisticated investors from the undesirable consequences of incentive schemes.
Flexibility, to my mind, is good. And, of course, a cap hinders that
Investment manager, Mandatum Life
“If the information is transparent and readily obtainable, people can make decisions about which incentive structures are the best for the situation they are in, the types of funds they want to invest in,” he adds. “To me, that kind of market-based solution is generally better than regulators saying: ‘You must have a maximum of one-times fixed salary’.”
Professional fund selectors, meanwhile, do not share Traulsen’s concerns about the impact of variable pay on risk-taking – in the long-only world, at least.
For example, Antti Vesa, the head of research at Aktia Invest in Helsinki, welcomes bonus payments – on the condition they are clearly linked to fund outperformance, and not on harder-to-quantify factors such as a manager’s contribution to the investment team. Vesa relies on his own qualitative analysis to avoid funds where financial incentives could encourage undue risk.
“If the structure of the fund is such that the risk management [team] are doing their job, then this should not be a big issue,” Vesa explains.
“We understand that a manager can have that situation, where he is incentivised to put more risk on the portfolio than he would otherwise like to have. But when we interview managers, we [do not] choose managers who would act in that way. It’s more of a problem if you use multiple star managers – most of our funds have more than one person making the decisions.”
While fund selectors are broadly relaxed about the impact of bonuses on fund manager behaviour, remuneration can be a deciding factor when choosing between similar products.
Manuela Thies, head of Allianz Global Investors’ multi-manager group in Frankfurt, and responsible for 18 funds of funds with combined assets of more than €12bn, says pay structures have tipped the balance in the past. However, remuneration – in particular, the ratio of variable to fixed pay – is just one of many incentives her team considers. Thies looks at a broad set of elements, primarily to gauge how likely a manager is to switch employers.
She says: “The remuneration of the fund manager is one small piece of this big puzzle. What we try to find out is if the manager has enough incentive to stay with the firm. It is not just bonus and remuneration – it is also other aspects which lead to employee satisfaction: working environment, the responsibility and freedom that managers have, for example.
“Some of these details you don’t discuss in your first interview – these are things you learn only if you have long-term relationships [with fund managers].”
Taste test recommended
Where fund selectors applaud Giegold is in the area of better-aligning manager and client interests, including the requirement for bonuses to be paid in fund units. Indeed, they place a high value on managers who “eat their own cooking” – a common practice in the hedge fund world, Reincke notes – but say such data is hard to obtain.
“[Fund groups] do not necessarily share information on whether managers are co-investors – it is information we rarely get,” Vesa adds. “If they are co-investors, that’s an added bonus for us.”
The remuneration of the fund manager is one small piece of this big puzzle. It is not just bonus and remuneration – it is also other aspects which lead to employee satisfaction
Head of Frankfurt multi-manager group, Allianz Global Investors
Traulsen is similarly upbeat on this aspect of the reforms, as well as the proposal to pay 40% of variable remuneration over a time-frame appropriate to the fund – a period of “at least three to five years”. He says fund groups currently have a poor record of employing such policies.
“It’s something as a company we believe strongly in,” he explains. “We’re not here to dictate how much fund managers make – their employers need to figure out what the market rate for a good fund manager is. All we’re saying is that the structure of that pay should be designed to ensure that the interests truly are aligned with those investors.
“Any fund company has two masters to serve – the stakeholders in the company, who want profits from that company, and the stakeholders in the fund. Much of the time, those two line-up okay. But in the areas of fees charged and capacity, they don’t. So just making sure that everyone has some skin in the game goes a long way towards addressing those conflict-of-interest issues.
“There’s also specifically the kind of risk the manager is incentivised to take on. And again, I feel these [reforms] address that.”
Looking at the proposals in their entirety, Traulsen cautions that some of the language is vague, and that similar efforts to improve disclosure – around performance fees, for example – have so far failed to produce the desired effects. However, he supports the thrust of the amended reforms, and says the initiative could ultimately prove beneficial for investors and fund managers alike.
“It is a positive step for investors in European funds, and by extension for the European fund industry,” he says. “[Fund groups] may not all see it that way – because it is change, and change causes cost and concern.
“But in the long-run, the industry needs to work hard to keep the trust of the investors it serves. Otherwise it is going to be hard for anyone to gain scale or build meaningful asset management brands over time. Anything that promotes transparency and helps investors understand how the fund manager’s interests are aligned with theirs – and imposes certain safeguards to ensure that there is a degree of alignment – does a huge amount to promote trust in the industry.
“So it’s good for investors and, although it may be tough medicine to swallow at first, good for the industry as well.”