Should we ban fund managers from being paid based on the scale of assets in their portfolios?
Specifically, should we prevent fund house investment staff being paid based on fund size or inflows and outflows – i.e. sales?
Should pay be based solely on performance?
The manager pay issue is back thanks to reports M&G Investments paid bond manager Richard Woolnough a whopping £17.5m in the last financial year, in spite of recent poor performance.
His longer-term returns have been good and no doubt his incentivisation is based partly on those, so there may be sensible reasons for this gigantic payout. But other managers underperform time and time again and yet walk away with consistently high bonuses – often because their funds remain large, regardless of the lacklustre returns.
This is a classic consumer protection issue.
If a fund manager is paid based solely on assets, they are incentivised to maintain their fund’s size, even at the expense of the performance they deliver to their clients.
They may do this by selling high-conviction stocks and hugging the index when they reach a certain size, cutting the risk of underperformance that might lead to an asset slump – and therefore a bonus cut.
Or they may spend too much time on the sales and marketing trail, focusing on keeping clients invested even when they could do better elsewhere.
An IMF economic stability report last week warned of the now well-documented risk that a ‘run’ on funds – bond funds in particular – could lead to an almighty illiquidity mess.
Interestingly, it also raised the pay issue. The IMF said fund managers being incentivised based on relative performance, versus rival funds or market indices, gives rise to systemic problems.
Pay based on relative performance can heighten risk-taking, market contagion, herding, return chasing, incentives to join in a market run and churning, among other issues, the IMF said.
The report essentially said the same systemic problems are present even if fund managers are paid based on assets under management, because a fall in assets often follows underperformance and so the effects are similar.
A high-level industry executive recently told me that perhaps the industry needs to be more transparent about fund manager pay and list bonus scheme details across the board.
Given the fact this is now clearly both a consumer protection and systemic risk issue, transparency would seem to be a good place to start.
If we knew the proportion of bonuses paid due to asset size versus performance, how long term performance had to be to generate a better bonus and the details of bonus-deferral programmes, we’d be better placed to assess the problem.
The fact is, if the industry fails to take the lead on all this, it’s only a matter of time before the regulators step in.
