The New Pay Model for Asset Managers | Chief Investment Officer

Fund manager pay is set for an industry-wide overhaul in the next few years as investors and regulators demand more transparency, according to a report from PwC.

“Beta masquerading as alpha will be less significantly rewarded.”With asset management margins falling and operational costs rising even as total industry assets increase, staff pay will fall relative to assets in the next five years, the accountancy and consulting firm predicted. PwC foresaw a 59% increase in total investable assets to $102 trillion by 2020, making asset management the “biggest single component of the financial services sector.”

“Increased costs and pressure on fees will squeeze margins,” PwC’s report stated. “At the same time shareholders will demand improvement in returns. As a result, pay may not increase at the same rate.”

The link between staff rewards and client outcomes should deepen, the report said, rather than corporate performance-tied compensation, “over which many employees have limited direct influence.” The rise of “passive and alternative strategies” will also drive firms towards compensation based on team performance rather than star managers.

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Already many firms are paying employees via deferrals into their own funds or company shares, PwC reported. “Around four in five firms have broad-based deferral plans in operation and, of these, 50% now operate deferral into funds,” the company said.

At the same time, demands from investors and regulators for better transparency and governance will lead to “an increased requirement for significant levels of pay to be robustly justified,” the report continued. “Beta masquerading as alpha will be less significantly rewarded.”

Asset management firms should also prioritize talent development to solidify succession plans for critical staff members, PwC said. More than 80% of companies surveyed said they had a formal succession plan in place for employees, but “only a small number” made appointments through these processes in 2014.

“Preparation can be key to reducing reputational harm and maintaining investment performance in the case of a high profile departure,” the report stated.

Developing and maintaining a good workplace culture will also be important for asset management firms to succeed in the long term, PwC argued. “An inclusive, satisfying working environment with career development opportunities not only contributes to keeping talented individuals happy, but also attracts investors who reason that an organization with an ethos based on teamwork and synergies is more likely to generate new ideas and bring them to fruition,” the report said.

Princeton University’s endowment paid at least $299 million, or 1.4% of total assets, in fees to 160 outside managers in fiscal year 2015, the Ivy League university told US legislators in response to a US Senate inquiry.

The figure does not include performance-based compensation, Princeton added in the letter. The endowment earned 12.7% in investment return in 2015.

“PRINCO seeks to structure fees in a manner that helps align interests… and create a disincentive for advisors to take undue risk.”The US Senate Finance Committee and the House of Representatives’ Ways and Means Committee recently asked 56 private schools with assets north of $1 billion to explain how they manage and spend their endowment money. Princeton’s $22.7 billion endowment is the fourth largest in the US, according to the 2015 NACUBO-Commonfund study.

The university reported that fixed fees to external managers have increased over the last two years, despite little change in the overall number of managers. Management costs increased from $245 million in 2013 to $266 million in 2014, while the fund employed 161 and 159 external managers in each year respectively. The endowment gained 11.7% in 2013 and 19.6% in 2014.

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“PRINCO [Princeton University Investment Company] seeks to structure fees paid to outside advisors in a manner that helps align the interests of the advisors with the interests of the university and create a disincentive for advisors to take undue risk,” the letter said.

Internal costs of PRINCO staff and other departments decreased slightly over the last three years. The university paid $21 million to 42 staff members in 2015, a decline from $23 million in 2013.

The NACUBO-Commonfund report revealed in January that US endowments recorded the lowest fiscal-year returns last year since 2012—an average of 2.4% net of fees. The drop also pushed 10-year gains down to 6.3%, from last year’s 7.1%.

“2015’s lower average one-year return is a great concern,” said John Walda, NACUBO’s president and CEO. “Lower returns may make it even tougher for colleges and universities to adequately fund financial aid, research, and other programs that are very reliant on endowment earnings and are vital to institutions’ missions.”