Fund managers' pay remains cloudy
Until mutual funds are forced to disclose how their managers are paid, investors won't know if they're getting their money's worth.
By Larry Dignan
May 13, 2003
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Investors found out this week how much fund managers are making these days. But how they make it remains a mystery to anyone outside of their insular world.
Median annual fell to $325,000 for stock mutual fund managers, according to a survey released earlier this week by the Association for Investment Management & Research and Russell Reynolds Associates, who jointly conduct the poll every two years. The latest figure is down 26 percent from 2001, but that might not be much of a comfort to mutual fund shareholders, given that diversified funds, on average, are down 34 percent over the past three years.
The fact that managers' pay hasn't fallen as much as the value of their funds has some observers wondering how these folks earn their keep. The question is even more perplexing since it's easy to find out how much some of their bosses earn: A few clicks through the Security and Exchange Commission’s EDGAR site are all it takes to find details for board members, CEOs, presidents and usually some vice-presidents of many financial and investment firms. But if you wanted to find out how much is paid to fund managers -- in other words, the ones who actually invest clients' money -- you have nowhere to go. Portfolio managers' pay isn’t disclosed and neither are the incentives behind their compensation.
What exactly do they have to do to get a bonus? Do they get extra for keeping trading costs down? Do they get shares of the funds they manage?
Don't bother asking fund companies such as T. Rowe Price.
"Details of portfolio manager compensation is not generally something we discuss," a T. Rowe Price spokesman said, echoing the industry's typical response. "Certainly if the SEC required it we’d do it, but it’s not information we provide."
Generally speaking, mutual fund managers get fees based on a percentage of assets, and bonuses for beating benchmarks such as the S&P 500 and above-average performance compared to their peer group. But the mutual fund industry argues that manager compensation details simply aren't important to shareholders.
Industry observers say otherwise. "The actual salary figure doesn’t matter to me," said Russ Kinnel, director of fund analysis at research firm Morningstar. "But I do want to know what the bonus incentives are."
Kinnel believes that the most important disclosures are: the amounts that managers invest in their own funds; bonus incentives; and the rationale for those bonuses.
Mutual fund managers privately say they wouldn’t be opposed to additional disclosure, especially considering returns lately. "Compensation becomes more illuminated when things are bad," said a director at one major mutual fund company. "In many situations, people lost 50 percent and the fund manager is pulling down millions. And to make matters worse the mutual funds won’t report it."
Many experts say there's little likelihood of additional disclosure about portfolio manager compensation. For starters, the mutual fund industry and groups such as the Investment Company Institute often pooh-pooh additional disclosure by arguing it will increase costs.
Nevertheless, manager pay could become an issue since rising mutual fund fees -— including trading commissions -- are under the microscope. A report by the General Accounting Office found that mutual fund fees have been going up as investors have been watching returns decline. Studies by the SEC and the Investment Company Institute found fees rose from 1980 to 1990, and declined between 1990 and 1998. However, expense ratios increased from 1999 to 2001.
Since those expenses eat a big chunk of returns, the SEC has proposed additional fee disclosures in semiannual reports sent to investors. An alternative to that approach would be disclosure in quarterly statements, according to the GAO. A recent hearing on Capitol Hill brought mutual fund executives to talk about fees, and although the hearing didn’t specifically mention portfolio manager compensation as an item for disclosure, industry watchers say it is an expense shareholders should know about.
"I would like to see if there’s a relationship between salaries and performance," said Matthew Morey, an associate professor of finance at Pace University. "I would like to see a rough guide to the salary structure and what the incentives are."
Lawrence York, lead manager of the WWW Internet Fund, believes the industry's pay structures should be better aligned with returns. If his fund fails to beat the S&P 500, his 1 percent management fee is halved as it has been for the last three years. If the fund beats the S&P 500 by 3 points or more, the management fee can rise to 1.5 percent. The fees are also put in dollar terms in the prospectus.
“In today’s environment there should be as full disclosure as possible,” York said. “Disclosure can be made better. In this case a summary of the base management fee, a dollar amount and terms of bonuses would be good.”
Drawing up an ideal summary of portfolio manager pay is largely an academic exercise, given that the mutual fund industry, Congress and other parties will have to duke it out over compensation disclosure. But fund managers, analysts and academics seem to agree on what pay disclosure would be the most helpful to shareholders:
How much skin is in the game. Across the board, industry players agreed that there should be a disclosure of how much the portfolio manager has invested in his own fund. The amounts may vary, but shareholders should know if a portfolio manager eats his own cooking. The disclosure should run at the top of statements and resemble statements that sell-side analysts have to provide. Those statements note if the analysts hold shares to avoid any conflict of interest. Conversely, mutual fund managers should reveal how much they have in the fund.
It’s not hard to find anecdotes about portfolio managers that don't invest in their own mutual fund, and tell shareholders to do one thing while doing the opposite in a private account, Morey said. If more portfolio managers were invested in their own funds, they would be less likely to make reckless bets.
“I think it’s important that you put your money where your mouth is,” York said, noting actual percentages could vary. York has his own money invested in the WWW Internet Fund, but notes it wouldn’t be prudent to bet his whole net worth on a sector fund.
Criteria for a bonus. Typically, bonuses are pegged to how a fund manager stacks up against an index, but not all benchmarks are created equal. Fund managers note it’s difficult to outperform the S&P 500 because it’s a very efficient index; however, the Russell 2000 should be easier to beat, even for a mediocre fund manager.
“Why would you reward somebody for being mediocre?” said the mutual fund insider. “The manager has to beat a valid benchmark."
Bonuses should also be handed out for keeping expenses down, lowering trading costs, limiting taxes and portfolio turnover, analysts said. By pegging bonuses to lowering costs, investor returns would benefit, said analysts.
Incentives for long-term performance. Some analysts proposed what would be a radical thought in the mutual fund industry -- paying bonuses every three years. The argument behind that structure goes like this: Any manager can make some good bets that pay off for one year -- remember dot-com stocks? Compensation shouldn’t be based on a short-term return, analysts believe.
The overall goal: Stop rewarding the gunslinger that delivers big returns for one year, then loses investors' money. A portfolio manager that made big bets in 1999 pocketed enough to retire for life, but investors were left holding the losses in later years. With the correct compensation structure, a manager who tops the indexes for three years and keeps costs down would be rewarded.
“The key is to discourage excessive risks and tie incentives to long-term performance,” Kinnel said, noting there should be a balance between short-term and long-term goals. “The short-term benchmarks can’t be too high and the long-term benchmarks can’t be too low.”
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