Much ado has been made recently over the issue of bonus caps for fund managers. This discussion stems directly from a proposal from Sven Giegold, German MEP and UCITS V rapporteur, to cap fund managers’ bonuses at 1x their fixed pay.
According to the Financial Times, Giegold has since indicated a willingness to loosen the proposed cap to allow for bonuses up to 2x fixed pay. However, the cap is by its nature arbitrary and does nothing by itself to address the core issues: (1) the need for manager incentives to align the interests of fund managers with those of fund investors and (2) the need for sufficient information to be available about incentives for investors to make informed decisions.
In this respect, the larger UCITS V proposal that Giegold is shepherding through the European Parliament has far more laudable components than the headline-grabbing bonus-cap. In particular, it would require that:
- performance-based incentives be spread over a long-term period in keeping with the risks and redemption policy of the fund in question;
- performance measures used to determine a bonus be risk-adjusted;
- at least 50% of bonuses be paid in the form of shares of the fund managed or an equivalent; and
- at least 40% of the bonus be deferred over a period in keeping with the risks and redemption policy of the fund in question, at least three to five years except when the life-cycle of the fund is shorter.
Taken collectively, the proposals represent a material recognition of the need to deal with potential conflicts of interest between variable pay and the interests of fund investors. In a general sense, they agree with much of our thinking on the matter.
At Morningstar, we prefer to see manager bonuses clearly linked to fund performance with a majority of the emphasis on long-term performance in keeping with holding periods for which funds are best used. We also frown on direct links to AUM growth, as this ties manager pay to a factor that helps drive revenue to the fund house, but may have no link or be detrimental to the interests of fund investors (particularly if a strategy is capacity constrained or emphasises a less liquid area of the market).
Our favourite remuneration programmes invest manager bonuses in fund shares (not shares of the fund house) and defer a portion of the compensation over time--this feature, in tandem with the use of long-term periods when evaluating performance, helps prevent managers from being incentivised to take large near-term risks in an effort to win a big one-year payout.
However, the proposals are silent on one of the most important factors: transparency. Setting minimum standards is a good step, but if one wishes to promote better manager incentives and allow investors to compare key differences in manager incentives, any proposal should include a requirement that the incentive programme design be disclosed in clear terms. There is precedent for this--the US regulator, for example, requires such disclosure in every fund’s publicly available documentation. We humbly submit the following table as a starting point, being sure the regulators could devise something better should they pursue it:
(Click table to enlarge)
This omission is not a new problem. Indeed, we still don’t have a rule that requires disclosure of basic pieces of information such as the name, tenure and relevant background of the manager running a fund. Let’s hope Brussels doesn’t miss the same trick here.
This article first appeared in Investment Adviser.
