TORONTO (June 22, 2017) - How do you motivate people? Countless studies have indicated the same basic fact: people are not usually motivated by money alone. Of course everyone needs money to sustain their lifestyle and plan for the future, but it is often other factors that compel employees to come in each day and do good work to help their organizations succeed and their clients prosper. Likewise, the sense of satisfaction that advisors receive when they help clients achieve their financials goals trumps the remuneration they receive. Any payment system where rewards are based on the quality of service is a good one.
On the other hand, sometimes a select few receive tremendous rewards regardless of results produced. We see examples of these situations all the time in the business section of the newspaper. In these cases incentives have little chance of producing any lasting positive effects. If clients are left paying and paying without seeing results then the problem is exacerbated. Incentives need to be aligned.
The truth is that many investments provide little added value and once people realize that the Emperor is not wearing any clothes, they will eventually become extinct.
There are myriad of financial products available. Mutual funds are the most convenient form of investing as investors can allocate among different asset classes based upon different qualitative and quantitative parameters, not just performance. To really understand the industry you have to understand how fund companies and their portfolio managers get paid and for what. The concept of “pay-for-performance” among mutual fund managers barely exists; in fact, if there is one thing fund managers are not paid for, as a general rule, it is performance.
A ground breaking new study, “Are Mutual Fund Managers Paid for Investment Skill?” (February 2017 - Ibert, Kaniel, Van Nieuwerburgh and Vestman), used publicly available tax returns of 529 mutual fund managers in Sweden to show the interests of fund companies and their portfolio managers are very much aligned; but the connection between the mutual fund managers and investors is muddled.
In a nutshell, they discovered that there was a very weak relationship between pay and performance, but a very strong relationship between pay and the size of the mutual funds as measured by fee revenue. This makes sense because most mutual funds charge a flat fee on assets under management, so as assets grow the managers remuneration climbs along with it. Compensation was only weakly related to superior manager investment performance.
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 year after. However, fund managers were rewarded more for running additional funds or for taking over management of different funds with higher fees. The best performing fund managers are paid slightly better than the worst, but successful asset gathering was better rewarded. Consequently, closet indexing is becoming more rampant since performance and salaries are loosely connected. The real problem is while fund managers are protecting their own careers, clients are paying for active management to get index like results; minus the fees of course.
It is hard to blame investors who throw up their hands and just buy ETFs. Thankfully there is a true pay-for-performance model offered by Provisus Wealth Management for clients and their advisors on the Transcend platform that is set to revolutionize the investment landscape. Transcend’s novel spin on performance fees is to use them as way to present an attractively low base fee of 0.25% on equity funds to clients (lower than the fees charged by most equity ETFs in Canada). If the fund performs better than the benchmark, a performance fee equal to 20% of the fund’s performance above the benchmark will be charged. Operating on the philosophy that it will earn its fees when client portfolios outperform industry benchmarks, the firm is redefining the nature and delivery of financial services and directly aligning its interests with the clients.
Pay-for-Performance™ will be a critical part of the compensation landscape going forward. Not because today’s investors need to be bribed to move their money into these types of vehicles. But, rather it will be because a static, inflexible, unchanging fixed fee strategy with no connection to the results achieved will be at distinct competitive disadvantage in a world as unpredictable and fast changing as ours.
This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.
While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.
For more information, visit transcend.ca. Financial advisors can visit transcend.ca/advisor