It’s that time of year again, when some portfolio managers dare to dream and others fear the worst, when business heads fret over reconciling the resources available with the aspirations of portfolio managers. Yes, it’s bonus time.
HR departments across the industry will be sitting down with CEOs and line managers, cutting and dicing, reworking numbers, trying to arbitrage the needs and demands from up and down the line.
The annual pay round pantomime is my least favourite event of the asset management calendar. It absorbs resources for weeks, if not months, and invariably creates HR issues, regardless of the endowment of the company or how well the process has been planned and managed. To exacerbate the seemingly irreconcilable expectations, the 2008 financial crisis led to public hysterics about pay in financial services, which regulators seemed unable to ignore.
These forces have already had a major impact on banking, especially pay in investment banking. Here, compensation caps and capital withdrawal have seen sharp reductions in overall pay. According to one estimate, compensation costs per employee in leading global investment banks fell by 25% between 2006 and 2014.
At the same time, pay rose by 22% for leading global asset managers, whose remuneration could overtake that of investment bankers next year. The industry has certainly had a fair wind. Explosive quantitative easing has seen asset prices rise to record levels in the past five years, inflating assets under management and therefore boosting ad valorem revenues.
With the mantra catching on that the average manager underperforms their benchmark, these trends could turn asset management into the next target for regulatory attention.
The EU has already started: various restrictions are imposed on ‘alternative’ asset managers through the AIFMD, the main impact of which is felt through the deferment of large portions of variable pay. However, the take-up by member countries has been slow since it came into force in 2011, while asset management companies have had little trouble finding workarounds that prevent the key provisions from applying to their core, front-office employees. But this may be a temporary relief if AIFMD-like compensation provisions find their way into the final version of MIFID II, which is due to be implemented in 2017.
HR departments are trying to anticipate a closer focus on pay. One trend has been the greater reliance on pay-for-performance. Aligning manager and client interests is the main justifier. However, at its worst, it does the opposite.
This has been most observable in hedge funds and on the prop desks of investment banks. Here, performance pay can encourage a kind of roll-the-dice mentality. The fact that the embedded risk/reward optionality allows risk takers – using others’ capital – to hit the jackpot if things go their way has always seemed perverse to me, and ultimately not in the client’s interest. Where I have introduced performance pay, I have strongly favoured schemes that acknowledge performance but manage conflicts of interest, for example through long-term deferrals and forms of pay that, in effect, create a stake in the business and therefore an interest in the longevity of the client.
But do asset managers need to be paid what can be eye-watering sums? In most active management groups, the highest-paid people sit in the front office. Given the popular perception of a failing industry when it comes to active performance, this seems incongruous at best.
Ultimately, asset management is a people business. As a CEO, if I was run over by a bus on the way to work, the company’s share price would barely budge. But if one of my star fund managers suffered the same fate, value would be wiped off the next day.
Bosses and owners know where the primary store of value lies in their business. Look at the fate of Gartmore when Roger Guy decided to step down. The resulting redemptions forced the company into the hands of Henderson within six months. Similarly, witness the asset flight that followed Woodford’s departure from Invesco or what followed Bill Gross’s exit from PIMCO.
Admittedly, these are big names who will have a big impact. But it reflects the general problem that the industry faces at this time of year – how to manage within a finite resource the compensation expectations of valuable human capital. This problem will only grow as asset managers replace investment bankers as the big compensation hitters and regulators turn up the heat on fair pay and conflicts of interest.
But pay is not the only criteria for portfolio manager satisfaction. In my 30-plus years in the industry, I never lost a key fund manager purely for money. In my experience, there are three key determinants of job satisfaction. One is pay, although it is more to do with fairness – am I being paid what I deserve given what I see in my peers?
However, this is not a sufficient condition for staff retention. A second factor is personal growth. I have paid managers very well but lost them because they saw more potential for growth at another house, whether a startup or a global giant.
The third criteria is freedom of expression. Is a manager’s investment process implementable or is it subordinated to some outside constraint or interference? Is the individual’s part in an investment process properly recognised or drowned by other elements?
As plan sponsors continue to put the heat on performance and regulators look to manage conflicts and eliminate excesses, the active industry will need to refine its HR management. If continuity and longevity of performance are key, plan sponsors will take an even greater interest in the way employees are nurtured and protected by their managers.
Pay philosophy and implementation will be one part of this – key people will be properly incentivised and conflicts of interest will be clearly mitigated. But we should also expect greater scrutiny of the environment in which key staff operate – can they grow and express themselves appropriately?