Why haven't mutual fund houses already linked their fund managers' pay with their performance?

According to an article published by Moneycontrol recently, SEBI's Mutual Fund Advisory Committee is pondering over appointing a sub-committee to frame guidelines.

Perhaps the regulator wants to introduce stricter norms clearly highlighting do's and don'ts.

While some experts believe such rules might instil discipline, improve governance, and help protect investors' interests; others believe the capital market regulator is now micromanaging the mutual fund industry.

Is the regulator really trying to micromanage the Mutual Fund industry or is it attempting to make fund managers more accountable for the investors' money?

RBI's regulations on the compensation structures of CEOs of private sector banks probably inspired the suggestions of the Mutual fund advisory committee. As you might be aware, RBI recently decided to link the remuneration of bank CEOs, directors, and risk management staff to the financial performance of a bank.

At a time when the asset quality of a bank is deteriorating, CEOs and directors getting a substantial rise in their pay isn't a justified sight. Case in point, following RBI's norms, Yes Bank clawed back the bonus paid to Mr Rana Kapoor in the past, owing to the bank's poor performance.

The recent episodes of debt fund fiascos have exposed the lopsided nature of the mutual fund industry. It's been found that instead of accepting the responsibility of the fund managers' actions, mutual fund houses have preferred to riposte with disclaimers and scuttle behind the fine print. If you recall, recently some fund houses have ungraciously advised investors "not to treat every chest pain as a heart attack".

It seems the mutual fund advisory committee of SEBI wants to get the mutual fund industry out of its comfort zone and, albeit subtly, send out a strong message to fund managers.

Has this development gone down well with the industry?

A mutual fund industry executive expressed his concerns about the idea of linking fund managers' pay to their performance. "If SEBI implements such norms, good fund managers may not want to stay in this business", he said speaking to Moneycontrol (on the condition of anonymity),

SEBI has time and again introduced several regulations to reduce costs involved in mutual fund investing.

However, it's still unclear how the capital market regulator will implement the suggestions of the advisory committee if it decides to accept them. The capital market regulator will also have to clarify if it's planning to link the fund managers' pay to the relative performance (scheme performance vis-a-vis that of its peers) or benchmark-based performance.

Another question is---will the regulations govern fixed pay or just the variable pay?

And perhaps, this is where experts are apprehensive about the advisory committee drawing parallels between the banking business and the asset management business. They believe, banking is a conventional and stable business as compared to the business of asset management, which is subject to the high volatility of financial markets.

The final guidelines, in this regard, would be worth tracking, as and when they are formalised.

Will performance-linked remuneration norms affect IFAs and mutual fund advisers?

Implementation of these norms can be a double-edged sword. Fund managers are likely to become more accountable if their pay is linked to the scheme's performance. But, there's also a possibility that they might become more concerned with the near-term performance, thereby losing focus on long-term performance.

Just as RBI did in the case of the top bosses of private sector banks, if the capital market regulator decides to make 50% of the remuneration of fund managers a performance-based variable component and further caps it at 200% of the fixed pay, the small-sized fund houses stand on shaky ground.

Fund managers with a proven track record will seek a higher fixed pay if their variable pay is capped. Smaller fund houses may have to compromise on their profit margins if they decide to rope in/retain talent.

Mutual fund investors and advisers will have to keenly watch whether performance-based remuneration norms lead to higher churning or not, because of the possibility that the fund managers might focus more on generating returns. In market downturns, they might refrain from betting on lucrative opportunities, fearing a possible underperformance in the future.

Mutual fund advisers will have to get smart and thoroughly understand the investment philosophy, processes & system followed by the fund house before recommending mutual fund schemes.

Similarly, if introduced, one has to keep a hawk-eye-view of how the performance-based remuneration affects the expense ratio.

Noteworthy, professionally run fund houses that are concerned with protecting investors' interest could already be following the performance-based remuneration practices. For them, SEBI's awaited guidelines would be nothing more than the formalisation of what they have been doing already.

Consistent performers might pay IFAs lower commissions, but these may not put you in an awkward position in front of your clients. Those offering commissions generously could leave you to fend for yourself if something goes wrong. For e.g., look at how the certain fund houses washed their hands off the FMP debacle.

IFAs may still have to face the ire of investors no matter what the weather in the markets ---rain or shine.

SEBI's intent is pro-investor but in the larger interest of the mutual fund industry. Let's see what new result, the proposed norms, will bring. We will be tracking this story for you.

Add Comments