Commentary: You Should Know What Your Fund Manager Is MakingGeoffrey Smith
Investors pour millions of dollars a day into mutual funds, but they do so without one piece of critical information: How are fund managers paid? For decades, the Securities & Exchange Commission has required public companies to reveal CEO pay--but that doesn't extend to mutual funds. Now that the funds hold more than $2 trillion of the public's money, new questions are being raised about why fund companies should be exempt from disclosing how much they pay portfolio managers.
Regulators have long been concerned about rising fees levied on fund investors. But they have never focused on the small part of fees that goes toward compensating portfolio managers. Some fund experts and compensation specialists say that bonus incentives have become such an important tool to attract and motivate fund managers that compensation should be disclosed as a way for investors to evaluate fund managers--much as shareholders in public companies are told what the CEO makes. "Considering how much money is in mutual funds today, it's surprising no one knows how managers are paid," says Alan Johnson, president of compensation consultant Johnson Associates in New York.
EXTRA RISK? For sure, pay for performance is an excellent way to motivate managers. But some incentive programs may come into conflict with an investor's interests. For example, there are funds that place a heavy emphasis on short-term results-- with up to 80% of a manager's annual pay coming from one-year performance. A high-risk investor might go with such a fund, but it makes little sense for an investor with a long-term horizon.
At Fidelity Investments, most managers receive bonuses based on the rolling three-year performance of their fund, which encourages long-term results. But sources say at least six of Fidelity's top managers, including Jeffrey N. Vinik, who runs the $40 billion Magellan Fund, have bonus arrangements potentially worth millions if they meet certain performance goals and if the firm's profits are strong. Fidelity won't comment on the compensation of individual managers, but investors might ask: Which managers have the best deals, and might those bonus arrangements be structured in such a way that it could lead the manager to take extra risk as the plan comes up for renewal?
Bonus plans at other firms sometimes include equity in the firm--a favorable sign, say fund watchers, since the manager is likely to have a long-term outlook. Firms that don't have ownership arrangements "tend to pay up for portfolio talent and put on an enormous amount of pressure for a big hit," says James Berns, a recruiter for Korn/Ferry International. Other bonus plans encourage managers to market their funds by focusing on asset growth, which might prompt a manager to spend time on promotion that should be spent on investment.
Manager pay is such a closely guarded secret that most fund directors are not informed of how managers are paid, fund lawyers say. Directors oversee contracts that determine shareholder fees, but they rarely review specific compensation packages. Says Johnson: "If directors of mutual funds don't pay attention to how much people are paid, they're missing the point. They should know what the reward structure is and what kind of chances [managers] might take."
TOUGH FIGHT. The SEC has been gradually requiring more disclosure from the traditionally secretive fund industry. In recent years, it has required funds to actually name the individuals who manage funds and also to disclose directors' pay. But portfolio-manager compensation has not yet appeared on the agency's radar screen, says an SEC source.
Jon Fossel, CEO of Oppenheimer Management Corp. and chairman of the Investment Company Institute, the fund industry's main trade organization, admits that "it's hard to argue that investors shouldn't be able to know how managers are paid," particularly when a bonus plan includes significant short-term incentives. But he suggests that fund companies would fight any new disclosure rules on compensation. What really matters, he says, are fees and performance. A manager's pay, he argues, is a "highly sensitive" and competitive piece of information.
There was a time when public companies made much the same argument. But just as the regulators did before, they may again have to consider whether to put investors' concerns ahead of the managers'.
Mutual-fund companies use many methods to calculate bonuses:
SHORT-TERM Compensation may be based on one-year performance
RESULTS against a benchmark index such as the S&P 500.
LONG-TERM Similar to short-term, but uses rolling three- or five-
RESULTS year returns and compares them with a benchmark.
PERFORMANCE Large portion of managers' bonus comes from the
FEES performance-based fees collected from fund assets.
MARKETING Bonus may reflect the fund's asset growth. This may
induce managers to publicly promote their funds.
COMPANY Bonus is based on profits of the management company
PROFITS or those of a group of funds.
DISCRETIONARY Management company uses subjective criteria to evaluate
manager's contribution to firm.