Are UK Fund Managers Jeopardising Transparency?

Neil Woodford is used to making headlines, but his firm, Woodford Investment Management, is in the news for slightly different reasons right now. The UK’s best-known fund manager has announced he is to scrap bonuses at his firm – instead, all staff will be paid a flat-rate salary.

That flies in the face of conventional City wisdom – it’s usually thought that bonuses are essential for staff motivation. In fact, Woodford was a trailblazer on the issue of remuneration even before this latest announcement. His firm has been unusually transparent about its pay structures – indeed part of the marketing pitch for the company’s Patient Capital Trust is that Woodford Investment Management does not get paid unless it delivers compound annualised returns above a hurdle rate of 10 per cent a year.

Many other firms in the fund management are going to come under pressure on remuneration in the months and years ahead – not only on how much their fund managers are paid but also on what information is disclosed to investors and other stakeholders.

For one thing, there may soon be a regulatory imperative to improve disclosure standards. The Financial Conduct Authority’s market study of the asset management sector, due to report imminently, focuses specifically on the question of whether investors are getting value for money. Greater transparency may be among the remedies proposed by the FCA if it concludes that improvements are necessary.
Even without explicit regulatory action, however, fund managers are likely to face more calls to disclose remuneration data as part of their communications with investors. Since the retail distribution review of three years ago, fees have come down sharply in both the open-ended and closed-ended fund sectors, but investors and their intermediaries increasingly want greater detail of where those fees are going.
Are UK Fund Managers Jeopardising Transparency? 1

Recent research by Money Marketing magazine suggests many asset management companies are going to have to work hard to make the shift to greater transparency. It asked 28 leading UK fund managers to provide detailed information on how their pay structures operate – just seven provided comprehensive answers.

That may reflect cultural factors – fund managers simply aren’t used to the idea that they might or should have to disclose remuneration. While some areas of the financial services sector – banking in particular – have faced intense public scrutiny over pay and bonus structures, asset management firms have not been targeted in the same way.

Nevertheless, fund management firms should expect to be asked both how much their managers are being paid and how remuneration packages are calculated. That will force firms to think hard about their remuneration structures, but also about how they communicate this detail.

For example, it is standard practice to link fund manager pay to performance, but investors will expect those links to be very clearly defined and to be aligned with their own interests. If a manager is required to beat a particular benchmark, for example, how much must he or she beat it by and over what period? Why was that specific benchmark chosen? Does this mean the manager may still be paid more even if returns are negative?

There are likely to be many more difficult questions of this nature. For instance, while investors looking for strong performance over the long term might be satisfied with a pay structure that rewards managers who deliver a five-year return above the benchmark, in practice that might require just one very good year of outperformance; in which case, the structure may not reward consistent long-term performance at all. Similarly, benchmarks often make most sense in the context of a relevant peer group – this is likely to be narrower than, say, an entire industry sector, but choosing the peer group requires a subjective judgement.

The question of what form remuneration takes is also likely to be important. In banking, the practice has increasingly been to make deferred awards of shares in the parent company. This encourages employees to prioritise the interests of their shareholders while also ensuring that awards can be clawed back if subsequent events require it. Might fund management companies move to a similar model?

Money Marketing’s research suggests relatively few fund management firms are currently engaging with these questions – or, if they are, that they’re not engaging with investors on these issues. Don’t expect that to be allowed to continue.

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