Mutual fund companies risk developing unstable cost structures as they may have to double fixed salaries to sidestep proposed European bonus caps, industry analysts say.
About three-quarters of mutual fund managers’ total compensation is from bonuses and long-term incentives, meaning salary increases of 50 percent to 100 percent would be needed to negate the cap, said Jon Axcell, head of asset management at London-based Morgan McKinley. A European Parliament committee last month proposed to limit fund managers’ bonuses to no more than base salaries.
“We will see many firms put up fixed pay by 50 percent and maybe they will put them up by 100 percent because they’re worried about losing people,” said Carl Sjostrom, director of executive reward for Europe at Hay Group, a Philadelphia-based management consulting firm. “The worry is that, systemically, this will make the firms less stable because they’re less able to adjust in bad times.”
European asset-management firms are concerned the proposal, which may affect two-thirds of senior fund managers, may cause a bidding war for their best-performing employees, increasing fixed costs and making the industry more vulnerable to market downturns. European Union lawmakers supporting the cap say their proposals will rein in risk-taking and better align the interests of fund managers with investors.
A U.K.-based fund manager running an actively managed equity fund with 300 million pounds ($460 million) of assets can expect to earn an annual base salary of 150,000 pounds to 200,000 pounds, according to Nigel Mills, a pay consultant at London-based MM&K Ltd. The U.K. is home to Europe’s largest asset-management industry.
That fund manager could receive as much as 300 percent of his salary as a bonus for top-quartile performance over one, three and five years, Mills said. The bonus ratio falls to 150 percent for second-quartile performance, 75 percent for the third quartile and zero in the bottom 25 percent, he said.
Fund managers may also receive a long-term incentive of about 100 percent of their salary, based on the fund’s performance. Pay can also depend on managers having specialist skills in certain asset classes such as emerging markets.
“As most fund managers don’t beat the market, at least not on a regular basis, those who do are extremely important,” Morgan McKinley’s Axcell said. “They drive performance and are vital to attracting new assets, and as such recognized names or those with strong track records can always command premium packages.”
Banks including UBS AG (UBSN), Credit Suisse Group AG (CSGN) and Nomura Holdings Inc. increased fixed salaries in 2009 in response to European rules requiring three-quarters of bankers’ bonuses to be deferred or held in shares for at least three years.
The European Parliament this week approved rules for banks that require shareholders to vote on bonuses larger than the recipient’s basic salary and that ban awards more than twice fixed pay. The proposal for fund managers would have to be approved by the European Parliament and the Council of Ministers, which represents national governments in the EU, before taking effect. The council has yet to take a position on the proposals.
The rules, as proposed, “wouldn’t affect profitability in total terms but it would skew the fixed-versus-variable pay and render some businesses less flexible in a downturn,” said Sarah Ing, a London-based analyst at Oriel Securities Ltd.
Ashmore Group Plc (ASHM) would be most affected by the rule among U.K. publicly traded firms due to its maximum 100,000-pound salary policy, she said. Meanwhile at Schroders Plc (SDR), Europe’s biggest publicly traded fund manager, “only a handful” of well-paid individuals would be affected, she said.
Invesco Perpetual, M&G Securities Ltd., Scottish Widows Investment Partnership, the biggest U.K. fund managers, declined to comment. Ashmore and Schroders also declined to comment.
Sven Giegold, the lawmaker leading work on the draft rules in the European Parliament, agreed that the bonus cap may push up fixed pay.
“One has to say that there might be an effect, but you would have to justify that in front of your investors,” he said in an interview, referring to higher salaries. “Total pay will certainly shrink.”
Giegold, 43, is a member of the Group of the Greens/European Free Alliance in the European Parliament. He founded the German branch of ATTAC, which was set up in France in 1998 and seeks to have financial markets and global trade regulated and tax havens closed.
The rules would affect so-called UCITS funds, or Undertakings for Collective Investment in Transferable Securities. The funds are regulated at the EU level and have the right to operate throughout the 27-nation bloc on condition they meet minimum standards of oversight and investor protection.
European lawmakers including Giegold in the economic and monetary affairs committee voted last month on imposing a 1-to-1 ratio between variable and fixed pay for managers of UCITS funds, which cover 5 trillion euros ($6.5 trillion) of assets in the region.
The measures are scheduled for a vote of the full Parliament between May 21 and 23. Representatives of the assembly’s political groups will meet before this to discuss the pay rule, Giegold said.
Giegold said he would be open to expanding the variable to fixed-pay ratio to 2 to 1 if investors voted to approve awards larger than fixed pay, mirroring the planned rules on banker bonuses. “So far, no one has suggested anything to me on how to align this effectively,” he said.
Political interest making asset-management pay better aligned with long-term client interests is “legitimate,” according to the London-based Investment Management Association, which represents U.K. fund managers.
“The objectives of Parliament and industry in wanting to have remuneration policies that align variable remuneration to long-term investor outcomes are absolutely shared,” Chief Executive Officer Daniel Godfrey said in an interview. “But you can make a very strong case that aligning those interests is not about introducing caps on bonuses. In fact, bonus caps inadvertently misalign interests by increasing the proportion of fixed to variable remuneration.”
“No evidence whatsoever of excessive risk-taking in UCITS funds has been provided, nor do we think there is any,” said Dan Waters, managing director of ICI Global, a worldwide lobby group for the fund-management industry.
Giegold said it is impossible to say some parts of the financial-services industry such as UCITS are inherently good and some are bad. There have been “excesses in the UCITS sector that go in the direction of gambling,” he said.
The effect of a 1-to-1 ratio for variable and fixed pay may not be as pronounced as initially thought due to the prevailing market conditions, according to Charles Morrison, head of discretionary fund management at London-based recruitment firm Altus Partners.
“The balance is in favor of the companies at the moment,” he said. “It’s a very candidate-heavy market due to all the layoffs from banks and hedge funds over recent years, combined with reduced hiring.”
That’s had an impact on how fund managers are being paid. “Before the crisis, it was possible for managers to receive 200 percent of their salary as a bonus for outperforming their benchmark by as little as 1 percent,” he said. “Now many would be happy getting 100 percent of their salary even for very good performance.”
Giegold said the proposals as they stand are “rather modest” and would help to change the culture of risk-taking in the financial-services industry as a whole. “The financial industry would be well advised to understand they are a part of a wider society.”
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