(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
March 1 If you want to understand an industry
you have to understand how employees get paid, and for what.
In the mutual fund industry the one thing fund managers are
not paid for, as a general rule, is performance.
A new study using the publicly available tax returns of
mutual fund managers in Sweden portrays a mutual fund industry
in which the interests of fund company owners and their managers
are aligned, but those of fund managers and investors only kind
of bump along together, almost randomly.
Given that investment management is at the heart of how
society allocates capital, this is a problem.
“We find a weak relationship between pay and performance,
but a strong relationship between pay and size, measured as fee
revenue,” Markus Ibert of the Stockholm School of Economics, Ron
Kaniel of Rochester University, Stijn Van Nieuwerburgh of New
York University and Roine Vestman of Stockholm University write.
Using public tax return data (in Sweden all tax returns are
public), the study identified 529 Swedish mutual fund managers
and then compared their earnings to the size, revenue and
relative performance of the funds they steer.
The study found a “strong” relationship between pay and the
size of funds under a manager’s control, with a one standard
deviation increase in revenue driving a 25 percent increase in
That makes sense, given that most mutual funds charge a flat
fee on assets under management, and shows that the fund firm and
the manager benefit together from growth.
That said, fund firms capture the lion’s share of increases
As for performance, a one-standard-deviation increase in
abnormal return in a manager’s fund only drives a 2.5 percent
increase in pay. On other measures, the pay-for-performance
effect is “no longer different from zero,” according to the
So the reward for increasing funds under management is 10
times greater, on a like-for-like basis, than that for
increasing returns for investors.
But wait, I can almost hear you say, surely funds under
management rise with good performance, and thus drive
compensation? Well, not in this sample. The study found no
evidence that positive performance by a manager in a given year
drove an upswing in funds under management in that year or the
Fund managers get rewarded, according to the study, for
inflows unrelated to superior performance, for running
additional funds (which may dilute performance, other studies
have found) or for taking over management of different funds
with higher fees.
BEST PAID BEST, NOT BY MUCH
There is, the study showed, stronger evidence of pay for
performance over longer periods, but that may be driven by
sample issues and the size of increasing pay “remains modest.”
The best-performing fund managers are paid better than the
worst. Managers in the top quartile make 9 percent more than
managers in the bottom fourth. That’s meaningful, but hardly the
kind of bump you would expect if the best interests of savers
were properly aligned with the people who manage their money.
The study neither suggests remedies to this situation, nor
underlying causes. The results, however, may not prove but do
rhyme nicely with the idea that many fund managers aren’t
putting their best efforts into buying the securities which will
go up most but into managing their own career risk.
The well-known phenomenon of closet tracking may well be
related to the pay figures. Managers, many of them, tend to only
take small bets against the index, a strategy which minimizes
their risk of seriously lagging the markets and finding
themselves out of a job. It also, of course, not only means that
consumers are paying for active management while getting an
expensive index-like fund, but that strong outperformance is
As for the relationship between inflows and pay, it strikes
me as possible that this is largely driven by events outside a
manager’s control. Retail investors chase returns, but usually
in absolute rather than risk-adjusted terms. That means they
plunge into what was hot last year, rather than allocating to an
asset class and seeking out managers who create abnormally large
returns relative to risk.
And again, managers will have a natural tendency to buy what
is going up within their index, guarding against lagging badly
enough to be vulnerable to getting fired.
It is a heck of a way to organize an important industry; it
is hard to blame investors who throw up their hands and just
stick their money into index funds.
(Editing by James Dalgleish)