Focusing this month on the high-profile issue of performance fees and guarantees, our survey found opinion divided on how best to incentivise staff. Some feel a decent salary should be enough, others are prepared to pay generous bonuses. When it comes to external managers and advisers, some also see performance fees as the way of the future
The issue of performance fees and guarantees has become singularly prominent in recent times, with the debate fuelled by such high-profile cases as the Unilever /Mercury affair and the recent announcement by the UK pension fund of the J Sainsbury supermarket chain that it is seeking indexed performance guarantees from indexed investment managers.
For this month’s Off The Record we asked what arrangements you already have in place to boost the competitive edge of pension fund investment. We also wanted to know how effective you think such incentives are and how you see the whole performance/bonus/risk conundrum going forward.
Opinion seems divided about the way to reward staff, with a quarter of respondents remunerating their staff on a salary-only basis and a marginally higher number – 30%, adding a bonus factor .
All the managers operating a bonus scheme relate this wholly or in part to investment performance with the extent of the package varying between 20% and 100% of basic salary. The average figure comes out at an impressive 86%.
However, payment is certainly not in the bag for investment staff. Performance rewards for last year span the spectrum from a lowly 1% from some funds (time to pull your socks up!) to a grandiose 100% maximum lining the pockets of some professionals after a good year (time to put your feet up?).
Such a range of payment is perhaps grist to the mill of the quarter of pension fund managers who note that they will not be offering such incentives in the future.
Furthermore, 35% of funds do not believe that bonus payments actually achieve the required result and only 15% come out unequivocally in their favour.
For some, the bottom line is that investment staff are paid a decent salary to perform – full stop. One manager notes: “If staff are paid well we expect them to do a good job.”
Others point out that waving the cash in front of the eyes of staff merely stymies their judgement adversely, with one respondent claiming: “It introduces too much buying and selling and thus volatility in to portfolios.” A case of losing sight of the target perhaps?
Another fund manager sums up today’s dilemma in a quasi paean to a ‘lost’ culture. “I don’t believe that bonuses work but we have to provide them – that’s the way of things today. The danger is that the individual award preoccupies them and they overlook the long-term picture.”
Another adds that incentives are counterproductive except for service aspects.
The comment is not all negative though. One eulogises the benefit of the bonus: “It is an incentive to staff to work in the right direction and do it to their best.”
Certainly, investment staff appear lucky in comparison with colleagues with more peripheral roles in the pension fund set-up. Only 15% of schemes say they pay any extra to other staff, a factor that sits incongruously with some of the service aspects flagged up in prior responses.
Significantly, only one respondent believed that performance sweeteners were always beneficial, qualifying this with the fact that staff should be paid over a rolling three-year period.
Once again a firm quarter of managers opine that they ‘never’ work, although a similar number are pragmatic in noting that they can under ‘certain circumstances’.
The comment though is generally critical: “In the long term you pay better fees in the better performing years but over five to six years you don’t see the outperformance,” states one fund.
One pension fund manager suggests what many investment managers might view as the unthinkable: “The manager should take part in the downside too and eventually pay for having the portfolio.” Radical thoughts indeed!
Another tells it like it is… maybe: “Payments should depend on results, if not I would use passive.”
Such vehemence may be the reason why only one fifth of schemes say they pay performance-related fees to external investment managers. Those that do, however, seem to have put in the necessary thought on encouraging performance without tipping the balance towards higher risk.
“For our total balanced mandates we have a three-year rolling outperformance target,” says one fund, seeking to quell any quick- buck behaviour.
Other schemes have selected bonus plans for certain mandates, placing the onus squarely on manager performance: “For our currency overlay mandates we have a flat fee of only five basis points plus 10% of any outperformance.”
Certainly, the riskier the asset class the more likely that a performance factor is involved.
And the requests here are coming from the pension funds themselves, with no replies stating that performance fees are at the investment manager’s behest.
Caution may be the watchword, as one manager states: “The performance bonus only kicks in for the index plus 2% and it is capped.”
Opinion is divided though on whether performance fees are the future. A third of funds believe they are, with some seeing their advent as inevitable: “There is pressure for maximum performance by all external parties.”
Some feel performance fees could shape the future investment terrain: “Specialist managers will increase their market share and there will be a better link between performance and fees.”
Conflicting views from 45% of respondents suggest a turn away from the bonus philosophy by pension funds with enough on their plates already: “I think trustees will be more concerned with risk and impose tighter constraints on how funds are to be managed,” says one. “There is a changing culture against the payment of large bonuses,” adds another.
Certainly, investment managers are not leading a performance charge. Only a single scheme says it receives any guarantee of return margin from its manager.
The complexity of such guarantee questions is highlighted by division over whether externally managed passive portfolios should come with a tracking error label on the wrapper. Forty per cent of funds feel a defined measure of tracking should be a staple ingredient of indexing: “That’s the whole point of indexing, tracking error performance should be contractual!” cries one manager.
However, a quarter of managers concede this may not realistically be possible. “It can’t be done except at great cost to performance,” notes another.
Funds seem more realistic in the realm of merger and acquisition – perhaps becoming inured to the daily occurrence rate – with only 10% of schemes expecting any performance guarantee should a manager be acquired or be acquiring themselves.
Those that do suggested periods of between one and three years or at least a statement that targets previously set would indeed be met.
For most funds the continuation of the service and process paid for is the one guarantee sought, although a number of funds state that no one can be sure of what will happen in an M&A situation. Recent events would certainly back that up!
As for the consultants, well, the debate that has reared up over payment for advice does not appear to be troubling schemes. Sixty per cent of replies say consultants should not be paid relative to the quality of their advice, with one manager summing up most comment by focusing on what a ‘consultant’ is. “They are consultants and are paid to advise. The trustees take the decisions. Bad advice results in lost business for the consultant.”
Certainly, this month’s replies point to interesting debates to come.