The 'End of the Line' for Highly Leveraged Packages in Asset Management
On 26 March the BEIS Committee published its “Executive rewards: paying for success” that covered the committees’ views on the roles of asset managers, asset owners and proxy advisors on influencing executive pay. The report also provided recommendations for the new Audit, Reporting and Governance Authority on how to effectively regulate excessive executive remuneration.
The report identified that asset managers are often vocal where executive remuneration does not align with the interests of shareholders but will pay their own staff some considerably large bonuses based on short term performance. Potentially hypocritically, this reward does not necessarily align with the asset owners’ long term interests. Furthermore, given the ownership structure of most asset managers, most are not subject to regulations that require public disclosure of their remuneration structure or policy. It is therefore usual for asset owners to be unaware of how asset managers’ remuneration aligns to their interests.
Market Practice – what we see in the market
Mercer is increasingly being asked by asset owners to assist in reviewing remuneration structures for asset managers where they have placed mandates. We have consulted widely with asset managers of various sizes to understand their compensation structure. Our findings show that their structures are designed to retain talent and incentivise the workforce to satisfy client needs and generate profit. Most asset management companies do not apply caps to individual compensation elements (e.g. base salary, bonus) nor total remuneration.
The main retention tool stems from the mandatory deferral of bonuses and long-term incentives. Deferred incentives are typically invested into company funds to further incentivise profit generation. The size of bonus pools is usually based on company profitability as well. The pools are often split based on a combination of team and individual performance against the company’s KPIs and client experience.
Variable compensation for investment staff is largely discretionary although generally most will consider fund performance over 1 to 5 years. Whilst this may be in line with the mandate of the fund, it is unlikely to be fully aligned to the investors long term interests, e.g. where an institutional pension fund has an investment horizon of greater than 30 years. This could encourage maximisation of short-term profits, rather than long-term sustainable performance.
In rising markets, remuneration outcomes for asset managers are likely to face less scrutiny than when markets are falling. For example, if the benchmark for a fund has fallen 10% and the fund value has fallen by 5%, you could legitimately argue that the outperformance of the benchmark is due to the skill and talent of the investment manager.
Outperforming a benchmark by 5% is no mean feat and it would not be uncommon for the investment management team to be rewarded for this. However, what asset owners are beginning to question is how the reward of the investment manager aligns with their experience.
Asset owners are seeking greater transparency of how the investment managers are being rewarded and the message that the investment manager is being rewarded for only losing you 5% rather than 10% may be increasingly difficult to justify.
Impact of regulations
Due to the nature of their operations, asset management firms have not come under the same level of regulatory scrutiny as banking firms. However, as the regulatory purpose shifts from mainly systemic risk to include reputational and conduct risk elements, the remuneration of asset managers is likely to become subject to more regulation.
With the introduction of the Investment Firm Directive (IFD), all but the smallest firms will be subject to some additional degree of remuneration regulations, whilst the largest firms are likely to continue being classified as credit institutions under CRD IV. Whilst IFD does not propose a maximum cap to variable remuneration, firms will have to consider what ratio of fixed to variable is appropriate to its particular circumstances.
IFD takes a more structured view of proportionality and does not mention apportionment of remuneration that has been possible under AIFMD and UCITS V. However, proportionality will only permit disapplication of the requirements including payment in instruments and deferral of variable pay, and not those relating to performance adjustment.
As the landscape for compensation becomes more regulated and transparent in the public listed sphere, attention is turning to remuneration practices of asset managers who have recently become vocal in their opinions of remuneration for executives in the companies in which they invest.
Increased interest in asset management remuneration from asset owners and an increased regulatory focus may put growing pressure on asset managers to disclose, or even change, their remuneration practices.
This briefing is for general guidance and does not necessarily cover all areas of the topics included in this briefing. It is not designed to give legal or other professional advice.