Paper Examines Mechanics of Portfolio Manager Compensation, Performance-Based Pay

Professors from Northeastern University and the University of Florida released a paper recently on portfolio manager compensation in the United States. The authors note that while much of the academic literature assumes that the compensation structure of investment advisers and individual portfolio managers coincides, their evidence suggests otherwise. Among their top findings:

• A majority of mutual funds report that their portfolio managers receive variable bonus-type compensation as opposed to a fixed salary.
• The bonus component was explicitly tied to the fund’s investment performance for 79.0% of sample funds.
• For about half the sample studied, the portfolio manager’s bonus was directly linked to the overall profitability of the advisor.
• Only 19.6% of sample funds explicitly mention that the adviser considers the fund’s AUM when deciding portfolio manager bonuses. 

As to the mechanics behind portfolio manager compensation, the authors wrote that portfolio manager compensation contracts are designed to mitigate conflicts of interest in the absence of alternative monitoring mechanisms. They observed that performance-based compensation contracts are costly to implement and are optimal only in situations where conflicts of interest are severe. The authors also found scant evidence of differences in future fund performance (gross or net of fees) linked to any compensation structure after controlling for a list of advisor, fund, and portfolio manager variables used in their analysis. They did find that performance-based contracts were associated with higher fund advisory fees (either in percentage or dollar value). However, funds tended to make up for the advisory fee disadvantage by charging lower marketing and distribution fees, resulting in no difference in total fund fees charged to investors whether or not the compensation contracts included performance-based pay.