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):
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.