Category Archives: Investment Management

Perspective on Financial Alignment of Interests

Alignment of interests is a key to success. This almost sounds too obvious to even state, but the truth is that firms don’t always operate with this principle. One senior executive I interviewed at a very large institutional asset management group (> $500 billion in AUM) described a mal-aligned situation at Janus Capital. Janus employees were paid what many considered to be a very high percentage of total income as current compensation. There was not enough emphasis on compensation directly related to investment performance and company operating performance. Others apparently thought the same way as suggested in a shareholder lawsuit alleging that the Janus Board did not live by its “pay for performance” commitment . Janus apparently recognized this as an issue and in March 2012 came out with a preliminary proxy statement resulting in a new compensation philosophy aimed at aligning shareholder and employee interests better. Kudos to both parties for working to try and align interests better.

This begs the questions: What does an aligned compensation system look like? Aligned with whom? Shareholders? Investors? What amount of compensation should be relatively fixed and paid currently and what amount should be paid in variable compensation? What should the variable compensation look like? Should everyone in the firm be treated the same way? We won’t attempt answers to all these questions. We take the position here that the alignment question relates to employees of the firm being aligned with shareholders – employees “win” when shareholders “win.” We also believe the question of alignment exists between investors and employees – whether the measurement is performance versus a benchmark (public equities/fixed income), profits above a preferred rate of return (hedge funds and private equity/real estate) or a straight profits participation (venture capital), the investment professional should be incented to share excellent investment returns with the investor of capital in a “win-win” structure, consistent with thinking from Stephen Covey and others.

The first alignment scenario bears our attention (shareholder-employee). What about the basic question of fixed compensation versus variable compensation (bonus profits pool for the company and long-term incentives for investment performance)? The CFA Institute compiles information on types of compensation for equity and fixed income investment professionals (segregated by portfolio managers, research analysts and traders). According to the most recent information published (The CFA Institute 2007 Member Compensation Survey), equity investment professional compensation is split as follows (% of overall compensation):

Compensation

Key insights here are that the portfolio managers, those most typically responsible for investment performance, have the highest level of variable compensation (cash bonus and long-term incentives). We think this makes sense relative to research analysts and traders who are usually a step removed from portfolio performance responsibility. The key question for the cash bonus is how much of this is based on investment performance and operating performance versus other metrics such as revenues (which generally aligns with the business development function of asset gathering), client retention (which aligns with the client service function). To be most effective, the cash bonus needs to be truly variable to important metrics such as investment performance (adjusted for risk) and entity operating income (investment fund and/or company entity) to create accountability around revenues and expenses – the efficiency of delivery of the funds. The above data should be used as a frame of reference when developing compensation systems for investment professionals, not as an absolute. Clearly, companies may have adjusted their compensation structures subsequent to the Global Financial Crisis. Having said that, principals at Atherton Consulting Group have done some separate research in the San Francisco Bay Area on compensation shifts (and other changes) updated through early 2010 and found only a small aggregate reduction in compensation levels and only a slight shift in the composition of pay.

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ihttp://www.law.du.edu/documents/corporate-governance/say-on-pay/swanson/Plaintiff-s-Brief-in-Opposition-to-Janus-Capital-Group-Inc-s-Motion-to-Dismiss-Swanson-v-Weil-Civil-Action-No-11-CV-02142-WYD-KLM-2012-WL-4442795-D-Colo-Sept-26-2012.pdf

Business Strategy Issues for Investment Leaders

Last summer and fall Atherton Consulting Group interviewed twenty top leaders in a variety of investment-related businesses (see chart).

Atherton Consulting Group lists the businesses below and desires to respect the confidential nature of these conversations.  As such, we will not attribute specific issues to the organizations unless approved by that organization, or reference the executives interviewed.

  1. Advisor Partners
  2. Bailard
  3. Blue Oak Capital
  4. City National Bank
  5. Comprehensive Financial Management
  6. Dodge & Cox
  7. First Republic Investment Management
  8. Forward Funds
  9. Goldman Sachs Wealth Management
  10. Index Universe
  11. J.P King & Associates
  12. Mercer Consulting
  13. Nelson Capital Management
  14. Osborne Capital Partners
  15. Private Ocean
  16. Sonen Capital
  17. Sterling Stamos
  18. Transamerica Investment Management (most recent firm executive was with)
  19. Wells Fargo Asset Management
  20. WHV

 

Investment survey breakdown

Investment survey breakdown

The intent of the interviews was to get a sense of the key strategic issues these leaders are working with and, in some cases, struggling with.  Results were highly insightful with the potential for meaningful rethinking and potential reshaping of business models.  We will post the key insights from the interviews over the course of several blog writings.

Certain perspectives arose out of those conversations.

Firms are either moving toward manufacturing of products or distribution.  It is rarer for firms to tackle both these days.  Firms that both manufacture and distribute aren’t totally abandoning their models, but are looking at ways to focus on where they add the highest value – a rethinking of their models.  One example is the increasing use of sub-advisors on investment products (think of Wellington Asset Management, GMO or Acadian).  So what does this mean?  For one, firms have increasingly decided to focus on what they are really good at, instead of trying to do all things well.  While there is certainly debate (due to mixed results) of whether to use sub-advisors or in-house investment teams, in theory this separation practice bodes well for the end consumer (investor) – better investment results with more efficient operations allowing potential for lower costs (or higher profits to investment entities).

 

As a focused distributor or manufacturer seeking partners, a key challenge is to find groups that have the right cultures and complementary skill sets.  There is a decidedly different skill set involved to be a world class investment manufacturer (investment analysis and judgment, process selection, sourcing best ideas, portfolio construction, risk management) than there is to be a great product distributor (network and business development, problem definition and problem solving, contract negotiations, relationship skills, communication).  Some implications of this are that we may see increased Chief Investment Officer outsourcing (e.g., PIMCO All Asset Fund of Funds using Rob Arnott’s group at Research Affiliates, Mercer taking over the CIO function of DB plans that are winding down).  In other words, you do what you are good at and we’ll do what we are good at.  Firms are taking an increasing perspective that they can’t be all things to all people (with some noted exceptions).

 

The appeal of increased separation of the investment groups from the distribution groups is also supported by culture differences.  Previous consulting work I have been involved with evaluated the sub-cultures within investment organizations.  There was a clear distinction between the values of the investment and distribution sides of the business.  Investment sub-cultures are characterized by values (in order) of analytic/research, discipline, creativity/innovation, meritocracy, long-term perspective/vision and passion/energy.  These make a lot of sense and align with what I have seen in successful investment organizations.  The flip side to this is that if these are not some of the highest values in the organization, those businesses tend to be “sales” focused.  As a contrast, the top values (in order) of distribution sub-cultures are competitive/win, passion/energy/positive, humor/fun, respect, appreciation, and empowerment.  Effective sales organizations I have seen have a healthy respect for fun, are incredibly competitive (particularly with themselves, but also across the sales group and with outside firms) and display outwardly a positive temperament (cynics tend toward the legal staff).

 

If the investment and distribution groups are housed in different companies (as in the sub-advisor scenario), the “friction” resulting from cultural differences is likely to be minimized.  If the groups are under the same roof, the resulting “friction” manifests itself in the need for respect, appreciation and empowerment by the sales team from the investment culture – traits not commonly expressed by innately introverted analytical investment types. The keys to success of the separate company investment and distribution functions will be based on real aligned interests between the firms, true competency differences, great trust and respect for the benefits of different cultures.  The point here is to know what you and your partners are good at, have complementary skill sets and competencies, structure an aligned interest relationship and know how to create mutually advantageous collaborations and partnerships.

 

Future blogs will cover additional timely and impactful themes surfaced during our interviews last year, including alignment of interest issues, the state of innovation in the industry and individual firms, technology strategies, the impact of regulatory compliance changes and what these all mean for investment and wealth management leadership.   We hope you enjoyed our initial blog post.  E-mail jkeene@athertonconsultinggroup.com if you want to discuss how we can help you with strategy and leadership development, including performance-focused executive coaching.