The sample came from financial advisers and sophisticated investors. This is worrying indeed and means that as an industry, fund management has lost as much credibility as bankers, national journalists and – god forbid – politicians.
It shows that the customer is deeply unhappy with the way things are and it demonstrates a very clear call for reform.
This is the bandwagon that the European Parliament has jumped on with its recent missive to restrict "variable pay" of UCITS fund managers to 1x their salary, effectively ending the concept of incentive-based pay.
On 22 May this year, the European Parliament, in all its democratic glory, will vote to alter the way UCITS fees are charged.
The idea is to reduce risk through limiting performance-related pay of managers to a maximum of 1x (possibly 2x) base salary. These proposals could also cover all senior staff of a firm that manages UCITS funds.
These proposals then go into a process known as a trialogue – a tortuous-sounding activity that means the Commission, the Council of Ministers and the European Parliament all thrash out the exact legal wording of the directive.
The possible result? By next year your favourite fund manager will not be able to be paid for making you money.
Here are my reasons why we should reject these proposals – however emotionally satisfying they may appear to be.
- As an investor in our funds at Somerset Capital, I want to know that our managers are focused on one thing – the performance of that fund. If you remove incentives for performance – and dis-incentives for bad performance – you remove the performance variable itself. If you don’t pay for performance, you probably won’t get it.
- As active fund managers, you can be paid in one of two ways – for managing lots of money, or for managing that money well. As a buyer of funds, which one would you rather? These proposals favour the huge behemoth asset-gathering machines, not the specialists who stay small and consistent with their process. They also affect those multi-boutique models that are trying to re-create the alignment concept too. As a result, the larger firms trying to do the right thing are also at risk here.
- If you increase regulation yet further you make it even harder to establish a new business. This is a problem, since evidence suggests that newer, smaller businesses that are able to survive the initial start-up tend to perform very well. Performance bonus caps mean higher fixed salaries, and capital requirements which are near impossible to meet for small boutiques. Bonus caps therefore equal less choice and higher costs – paid for by, guess who?
- These measures are supposedly designed to reduce risk, the theory being that if you do not pay for good performance, you reduce the incentives for bad performance. The historic context is that during the financial crisis, bankers were paid if they won, and paid by the public if they lost. My view is that you need to align interests between customers and investors more urgently than you need to try to regulate out loss from financial products through arbitrary caps.
What we need is a revolution in culture – not regulation, where small, employee-owned fund management businesses can flourish. We need to get back to old fashioned partnerships where the link between principal and client is truly restored.
These models are far more effective at risk management since they enforce the penalty of failure, enforce collaboration between partners and align interests between client and manager.
The industry needs to insist upon longer-term measurement periods for performance, greater transparency of how remuneration is structured, and co-investment that rewards performance above asset-gathering.
However, the system must also punish poor performance through true alignment.
The fear of failure must be as real as the desire for rewards. Removing the rewards alone does not achieve any of our goals: consistent performance and sound risk management.
The age of a thriving boutique model financial services industry is starting to look like a thing of the past.
Fund management, the jewel in our crown, is under threat from crowd-pleasing limits to reduce pay, which actually will end up destroying the product-providers who individuals depend on to generate a return in this ever difficult world.
Financial advisers and investors – be careful what you wish for.
Dominic Johnson (pictured above) is founding partner of Somerset Capital Management. The views expressed here are his own.