To bonus or not to bonus?

Towards the end of August there was great fanfare in the financial media regarding the decision of Woodford Investment Management to cease paying bonuses to their executives. Daniel Godfrey, the former chief executive of the Investment Association, announced similar intentions for his soon-to-be-launched investment trust. We considered remuneration in a 2015 TAI research piece, and floated the fixed-pay-only model as an option worthy of consideration. Having raised this subject within in the forum of the Thinking Ahead Institute, it is clear that the discussion around compensation is highly nuanced. Remuneration could be structured in any number of ways, with fixed pay at one extreme and (for illustrative purposes) a fully variable compensation package at the other. Arguments on the impact of pay structure on motivation, performance and alignment of interests are likely to run and run – it is difficult to move beyond subjective beliefs and to make categorical statements regarding outcomes. What seems fairly certain is that a differentiated pay structure, such as that adopted by Woodford and Godfrey, will attract certain professionals to these firm and put off others. Likewise, it may impact on investors’ manager selection decisions (although is unlikely to be the primary consideration). We applaud these moves for a number of reasons:

If nothing else, they will provide an interesting case study for the industry
The firms are setting a precedent for others to follow. It requires great courage to break with the compensation status quo – if things go badly a firm risks losing its valued staff and may struggle to attract the people it wants
We believe that the case for variable pay in asset management is weak, for a number of reasons (see our paper on compensation and incentives)

In truth, though, these are small, relatively new firms that can start with a blank slate – more established firms will be naturally reluctant to make sweeping changes to compensation practices that affect many employees. And the employees may be even more reluctant to see change. The industry may be at an ‘interesting’ juncture, where the inertia on compensation could be tested by the continued pressure on asset managers’ fee structures. Arguably, the practice of charging an ad valorem fee as a fixed percentage of AUM creates a clear incentive for asset managers to gather assets, and hence sales staff are remunerated according to how much new client money they are able to bring in. Similarly, the impact of past performance on product uptake encourages a natural link between relative performance and compensation for investment professionals. The consequences for unchecked asset growth on alpha decay are well-documented, and do not serve asset owner interests. So there is a clear alignment issue at stake. It is also an issue that is difficult for asset owners (other than the largest) to address in isolation, and the path to a solution seems to rely on greater cooperation between asset owners and the pooling of their collective buying power.

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