John Kay, a professor at the London School of Economics, caused quite a stir in July when, as part of a UK government-commissioned report into the workings of the UK equity market, he called for an overhaul of fund manager pay.
The Kay Review – as it has become known – called on asset management firms to align the pay of their fund managers with the interests and timescales of their clients, with Mr Kay warning that the asset management industry had become dominated by short-term thinking and a “misalignment of incentives”.
Although Mr Kay’s findings were specifically aimed at the UK, his criticisms have long been levied at fund managers around the world and flag up the much-debated dichotomy between the short-term nature of asset managers and the long-term needs of institutional investors.
“It’s true that investment managers get drawn into ‘quarterly capitalism’, which is the tendency to focus on short-term numbers,” says Aled Jones, head of responsible investment for Emea at Mercer, the investment consultancy.
“The outcome of this short termism is a series of leakages, which creates a drag on the returns to long-term investors. These leakages include manager fees, executive remuneration that is tilted to short-term performance, and excessive portfolio turnover.”
According to Mr Kay, who writes a column for the Financial Times, the result of this short termism is that fund managers become more inclined to act on the views of other market participants, rather than fundamentals, in order to outperform.
Mr Kay also believes the tendency towards short-term performance encourages benchmark-hugging by fund managers with the emphasis on monthly and quarterly results being the only way managers can be sure of avoiding lengthy periods of underperformance.
Shiv Taneja, managing director at fund consultancy firm Cerulli Associates, suggests there are three main problems: the amount fund managers are paid; the alignment of the long and short term; and the structure of how fund managers are remunerated.
“Being paid a percentage of the assets seems reasonably fair until you take into account there is no penalty for fund managers when they lose client assets, especially if they promise not to. Does this need to be addressed in a fair and equitably manner, protecting both manager and client? Yes, absolutely.”
The challenge is to reduce or remove the “leakages” so that end investors receive more, says Mr Jones.
“In practice, removing this is not straightforward because the costs and benefits of doing so are not symmetrical. The costs are borne by those willing to be proactive and the benefits accrue to everyone.
“Ultimately, it is down to all actors in the chain to take steps – company directors need to establish appropriate incentives for executives, investment managers need to act as owners rather than traders, and trustees need to ask more questions of their managers on fees and turnover,” he says.
In his 112-page report Mr Kay broaches the issue of pay on numerous occasions and says in no uncertain terms that pay should not be related to short-term performance of the investment fund or asset management firm.
“Rather a long-term performance incentive should be provided in the form of an interest in the fund, either directly or via the firm, to be held at least until the manager is no longer responsible for that fund,” he says.
Finding out the pay of most fund managers is no easy feat but, according to publicly available information, the chief executive of M&G Investments, Michael McLintock, was paid £7.3m last year, Martin Gilbert, the head of Aberdeen Asset Management, took home £4.5m, and an unnamed executive at Pimco Europe – the European arm of the world’s largest fixed-income manager – was paid almost £30m.
M&G and Pimco declined to comment on the figures but an Aberdeen spokesperson says: “The remuneration committee of Aberdeen’s board reviews the remuneration of our senior management every year and focuses on ensuring that executive pay is closely matched to the performance of the business.
“We strongly believe that executive bonuses should only be paid for high performance and failure should not be rewarded. We also believe that any bonuses should be paid largely in shares and deferred over a number of years, aligning the long term interests of senior executives with shareholders.”
Amin Rajan, chief executive of fund consultancy Create Research, believes there are reasons for optimism.
“In the last three years, merit-based pay has been introduced by 45 per cent of fund management firms with just as many likely to do so over the next three years,” he says, citing findings from his company’s own investigations. “And within a growing number of asset management firms, pay is no longer based on just seniority. Merit is now a big factor.”