Bankers’ bonuses have been under intense scrutiny from politicians, regulators and citizens since the 2008 crisis and the pressure is having an effect — investment banking pay has fallen by 40 per cent since 2007 in real terms. But those who worry about inflated rewards within the financial services industry may be looking in the wrong direction.
While investment bankers’ bonuses have been squeezed as the industry adjusts to higher capital requirements and reduced leverage, those working in asset management have quietly been doing better. One study suggests that average pay of asset managers could surpass that of investment bankers by 2016, having risen from just over half that level a decade ago.
Pay in asset management has floated upward on a rising tide of assets under management, according to the think-tank New Financial. It is less a function of the exceptional skills of employees than the fact that, as their industry gets bigger, it draws in more fees.
This coincides with growing interest among regulators in whether large asset management groups present systemic risks to the financial system. It also raises questions about why fund managers are benefiting so handsomely from sheer size, rather than passing on more of the economies of scale to their clients in the form of lower investment charges.
More bankers are switching from the sell side to the buy side, spying superior career and pay prospects in hedge funds and fund management. While hedge funds make most money from performance-related fees, the rest of the industry is allocated fees according to assets under management. The larger a fund, the more it gets.
Actively managed funds have been under pressure from index funds, which charge less. So it would be logical to expect the industry’s pool of fees to shrink as a proportion of assets under management, and more of the returns to be allocated to fund investors rather than fund managers.
Instead, pay rose roughly in line with assets under management and revenues between 2007 and 2014 at firms for which there was comparable data, according to New Financial. The proceeds were captured by shareholders and employees. Pay would be 15 per cent lower if a third of the gains in efficiency and scale in the past decade had been shared with clients.
This raises thorny issues for the industry and regulators. One is that, if asset managers take over from investment bankers as the highest paid people on Wall Street and in the City, they will have less incentive to restrain executive pay at companies in which they invest. Even if they attempt it, they will have less credibility.
Second, if competition among asset managers does not curb employees’ pay and it keeps on rising in line with assets, their reputations as the prudent custodians of other people’s money will suffer. The entire industry could end up mimicking the pay and lifestyle of hedge fund managers.
Third, firms that depend on management fees alone tend to focus on size rather than performance, a tendency that intensifies as the level of financial rewards rises. Even if the industry is not too big to fail, it could become too big to concentrate effectively on higher investment returns.
That should worry the industry, which is unaccustomed to being in the public spotlight and prefers to avoid it. It should equally worry financial regulators who are responsible for ensuring that fund managers invest money efficiently and responsibly. Neither should want investment managers to become the next investment bankers.
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