The global research company has revealed that the way European fund managers are remunerated could be ruining their clients’ chances of enjoying stable long-term returns.

Morningstar found that over a third of UK and continental European companies are rewarding their fund managers based on their performance over a 12-month period only.

The report also shows that over 40 per cent of respondents have increased salaries in a bid to retain their portfolio managers.

Niklas Tell, director of fund analysis at Morningstar in Stockholm, said that most funds are sold as long-term investments and so shorter-term performance bonuses could prompt managers to take risks that run contrary to a long-term investment perspective. He called for a reward structure that closely aligned the interests of fund
managers and investors.

Compounding the short-termist culture is a high rate of manager turnover. Morningstar found that less than 25 per cent of European fund managers have been running the same fund for five or more years.

The pay practices highlighted by Morningstar are being fuelled by the trend towards establishing boutique-style departments within fund management houses for different asset classes. These specialist units offer fund managers an unconstrained environment designed to give free rein to their best investment ideas.

Investment companies have been upping the ante on pay and creating boutique structures in a bid to stop their star managers from leaving to set up hedge fund operations.

Managers cannot be faulted for making efforts to retain key staff but it is ironic that the salary levels and bonus structures deemed necessary to keep fund managers happy and to boost performance could be undermining the very search for stable alpha that all investors crave.

Consultants escape scrutiny

It is over three years since Paul Myners’ report on UK investment practices was published and pension funds are slowly adopting some of his key recommendations.
According to research by the broker firm, Instinet Europe, progress is patchy. The training of trustees has increased at 63 per cent of the 101 schemes surveyed, up from 48 per cent of schemes a year ago. But there has been less action on Myners’ proposal that pension funds measure the advice of their consultants. The report found that 62 per cent of funds still have no way of measuring consultants, which, at least, is a 23 per cent decrease from last year.

However, Instinet said that most pension funds appreciate the need to measure their consultants, even if they are not yet doing so.

The lack of movement on measuring consultants is somewhat surprising in light of the finding that pension funds’ continue to increase their reliance on the advice of consultants.

Forty per cent of pension funds interviewed had increased the amount of investment consulting advice their trustees receive.

The desire to embrace new investment strategies and asset classes was prompting pension funds to seek additional external advice.

But the report said that pension funds are struggling to find reliable methods of measuring the advice they receive from consultants due to the absence of a common industry approach.

Without any widely-accepted standard of measurement, Instinet said there is no way for the pension funds to know whether the advice they are receiving is worth the fees paid and represents best value for members.

Transaction costs, which Mr Myners’ considered “substantial and subject to insufficient scrutiny” are receiving greater attention. Instinet said that 10 per cent of pension funds are separating transaction costs from their fund manager’s fees. The survey noted that 61 per cent of pension funds over £1bn in market value sought a breakdown of transaction costs, compared with 45 per cent of funds worth less than £1bn.

While 43 per cent of schemes compared transaction costs of different managers by using cost analysis tools or the services of a specialist, 48 per cent expected their managers to show they were trading at best value.


Henry Smith, editor, henry.smith@ft.com

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