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What Fund Manager Bonuses Tell Us

Most investment shops reward managers for short-term results, and few consider risk-adjusted returns.

Leo Acheson, 03/09/2017

This article was originally published in the March 2017 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor here.

We believe that shareholders of actively managed funds must maintain long-term investment horizons to reap the rewards of active management. Likewise, investment firms should compensate their managers based on long-term performance. Last year, we published a study that compared the performance time periods used by the top 20 active management shops when determining portfolio manager bonuses. We've expanded that research to include the top 30 active investment firms. We've also noted which shops emphasize risk-adjusted returns as opposed to total returns or cite risk management as a component of manager compensation.

The exhibit excludes firms that utilize multiple subadvisors, which contend with numerous compensation plans. It also leaves out firms that don't explicitly link compensation to fund performance and companies that lack detailed information regarding their compensation structures in their Statements of Additional Information.

After extending last year's research to include the 30 largest active management firms, the story with regard to investment time periods considered has remained consistent. Most investment firms base portfolio manager bonuses on performance over one-, three-, and five-year periods. Very few asset managers take a longer-term view. In fact, of the 30 asset managers listed here, only four explicitly consider returns beyond five years. (To see a PDF version of the exhibit, click here.)

Focused on the Long Term
Lazard, Oakmark, and T. Rowe Price have exceptionally long-term investment horizons. Each firm determines compensation on fund performance relative to appropriate benchmarks or peer groups over one, three, five, and 10 years, with an even weighting on each time frame. Their inclusion of a 10-year evaluation period is unusual in the industry and is in shareholders' best interests, considering the long-term nature of most mutual funds.

American Funds' structure also stands out in its long-term orientation, which has been one of the keys to its investment success. The firm pays bonuses based on one-, three-, five-, and eight-year returns relative to a benchmark and competitors. As shown in the exhibit, the firm uses a progressive weighting scheme, meaning it places increasing weight on each succeeding measurement period, which also represents an industry best practice.

The industry in general has increasingly favored the long term. Many firms that historically compensated managers based on one- and three-year results have begun phasing in five-year returns. Recently, J.P. Morgan said it added a 10-year measure when evaluating managers, though the firm has not yet added that language to its SAI.

is a fund analyst on the fund-of-funds research team for Morningstar.

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