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Kay review calls for overhaul of fund manager pay

A Government-commissioned report has called for an overhaul of fund manager pay as part of a package of reforms aimed at better aligning the interests of asset managers and investors.

The John Kay review of equity markets, published this week, calls for regulatory authorities to ensure fiduciary standards apply to all relationships in the investment chain, including asset managers, brokers, platforms, IFAs and the end investor.

Kay, a professor at the London School of Economics, warns the asset management industry is dominated by short-term thinking with too much emphasis on relative performance, creating a “misalignment of incentives”.

The review calls for asset management firms to align their fund managers’ remuneration with the interests and timescales of clients, rather than the short-term performance of the fund or firm. “A long-term performance incentive should be provided in the form of an interest in the fund (either directly or via the firm) to be held at least until the manager is no longer responsible for that fund,” says the report.

The study warns the time horizon over which the performance of asset managers is judged is too short, with fund managers fixated on outperforming their peers rather than absolute performance.

Kay suggests this means returns are based on the managers’ skills in anticipating their competitors’ actions rather than identifying the fundamental value of companies.

Kay says the close attention to short-term performance encourages benchmark-hugging by fund managers, worried about underperformance on a monthly or quarterly basis.

The paper suggests that defining ‘risk’ as tracking error relative to a benchmark is reducing the level of genuine active management undertaken by the industry.

“We were told that the result of all these pressures was frequent resort to ‘closet indexation’,” the review adds.

IMA director of corporate governance and reporting Liz Murrall says fund manager and client interests are already aligned under the current system: She says: “Managers are paid according to the performance of the funds under management so the better the company does, the better the client does.”

Murrall notes that deferred bonuses and clawback arrangements are used by many asset managers.

However, Hargreaves Lansdown head of research Mark Dampier argues the asset management industry needs to change hits approaches renumeration, especially when it comes to performance fees being paid after three months.

He says: “The remuneration is way too short-term. It should be at least three years before any performance fee is paid to a manager, in my view. Such fee are just not aligning the fund manager and the client.”

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