Has fund manager pay gone too far?

The huge salaries awarded in the asset management industry could have a damaging effect on investor returns.

The Financial Conduct Authority’s asset management market study, published last November, highlighted the deleterious effect of fund charges on investment returns. With staff remuneration accounting for 56% of asset managers’ total costs, could fund manager salaries be put under pressure?

“This is an enormously profitable sector with enormously, some might say excessively, paid people,” said Shareaction chief executive Catherine Howarth at a London Business School asset management conference in April. “And it is delivering relatively little added value for clients, especially clients with little negotiating power.”

Obtaining figures on individual pay packages is difficult but in 2016, Prudential made headlines when it introduced a cap on fund manager pay after M&G bond manager Richard Woolnough was revealed to have raked in £32m over two years. Average staff pay at boutique firm Lindsell Train jumped from £629,412 to £1.1m in the latest financial year, according to Companies House filings published in May.

Research by the High Pay Centre suggests senior staff at fund manager firms are paid an average of more than £200,000, but Howarth has noted that the majority of fund managers are delivering underperformance for their large pay packets.

In their defence…

“There is a reckoning coming in relation to the pressure on fee levels and the move into passive management. I think it is going to create a big crunch for the industry,” says PWC partner Tom Gosling, who leads the firm’s UK reward practice.

Gosling concedes fund managers are “very well paid”, noting they surpassed investment bankers in 2015 for remuneration. Asset managers’ defence would be that they’re paying themselves out of the profits their organisation makes, he says.

“The industry has been carried along on the tide of rising markets and positive fund flows.”

The FCA highlighted the wide profit margins enjoyed by asset managers in its study, questioning whether figures of up to 70% indicated a lack of competition in the industry.

“Remuneration is in the mix of things we consider [when assessing fund managers], but it’s rarely a deciding factor,” says AJ Bell’s head of active portfolios Ryan Hughes. “We want to get a sense the manager is motivated. One element of that is pay, but it’s also about the organisation, long-term prospects of the business and how autonomous they are.”

Long/short mismatch

There is a mismatch between fund selectors’ three-year investment horizons and the fact many fund managers are remunerated on a calendar-year basis, according to Hughes.

He explains: “We tell our investors to think long term and then we reward short-term performance.”

Gosling reckons shorter-term remuneration structures feature among retail fund managers, whose clients are focused on one or three-year performance, compared with institutional investors, who focus on five years of performance.

However, Gosling believes that change is afoot. “There is a much stronger focus on multi-year fund performance and we are also seeing most portfolio managers investing, or having a proportion of their bonus deferred, into the funds they are running.”

Star managers

In contrast, Miton stated in 2017 it would establish a more attractive remuneration policy after George Godber and Georgina Hamilton defected to rival Polar Capital, leading to their former UK Opportunities Fund leaking assets.

Gosling suspects in a decade’s time good fund managers will be paid as much, if not more, than they are paid today.

“But I suspect there will be fewer of them and it will be much harder for the mediocre to earn a comfortable living.”

Peel Hunt analyst Stuart Duncan agrees, pointing to Terry Smith as an example. “He charges 1%. But if you look at his performance even after that 1% he will have outperformed the benchmark quite materially,” Duncan says.

Smith, who runs £13.4bn in his flagship Fundsmith Equity Fund, took home £8m in the last financial year, according to Companies House in January.

Innovate to remunerate

Fidelity International has most notably led the charge when it comes to innovation on fund fees, with its introduction of the variable management charge in November 2017. Its base annual management charge is 0.65% with a fee floor and ceiling of 0.45% to 0.85% that shifts in response to performance.

This year, Allianz Global Investors launched an outperformance fee model on five UK funds, which charges a basis fee of 0.20% combined with a performance fee up to 20%.

However, both asset managers say the new charging structures will have no impact on fund manager remuneration.

Adam Gent, head of wholesale for Northern Europe at Allianz GI, says: “What you will not see is one of our fund managers taking more risk to create more outperformance in a particular year. They will continue to run their funds in accordance with objectives stated in the prospectus.”

Portfolio managers are compensated with base salaries in addition to bonuses, which have a performance and a discretionary element, Gent says.

Orbis Investments, in contrast, applies the principle of its variable fee to fund managers’ pay packages, says UK director Dan Brocklebank.

“Your biggest outlay is employment costs so the pay of your fund managers should naturally fluctuate with how well they are doing. I do not think that is a radical idea,” Brocklebank says.

However, variable performance pay is a red flag for Quilter multi-asset portfolio manager Stuart Clark, who runs around £5bn in Quilter’s managed portfolio service.

“Fund houses that have a reward structure which is heavily weighted towards performance- linked pay will need to be able to demonstrate they mitigate the risk of disproportionately incentivising short-term performance,” says Clark.

Change is coming

Mandatory transparency on pay will ultimately change the industry for the better, according to Howarth. “Gender pay gap figures have been so illuminating and would never have been revealed without this law requiring disclosure.”

The FCA did not comment but Portfolio Adviser understands the UK regulator considers overall pay levels a commercial decision for firms.

However, Gosling argues economics will ultimately drive fund manager pay, even though momentum is moving further in favour of transparency.

“I do not think that regulation will drive pay. The banking sector is the most regulated industry by far, to the point where the regulators are determining how you pay people. This has had very little impact on pay levels.”

 

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