Its aim, it says, is to help clientsof fund managers achieve their financial goals and to make investment better for them, for companies and for the economy, so that everyone prospers.To spell this out, in April Mr Godfrey published 10 principles built around putting clients interests first and managing their money carefully. This includestelling clients what all the costs and charges would be, but it was the sting in the tail that really caused the problem: every signatory has to say how they apply these principles, how they watch out for conflicts of interest and what processes they have in place to ensure compliance.
This was too much for some. The Association was acting more like a regulator than a voluntary body, they complained. After all, they and other members fund it to the tune of £10m a year. It’s supposed to promote their interests, not stifle them with bureaucracy. And by 31 July, only 25 of the 200 membershad signed up to the principles.
Then, in September, the Association created an executive remuneration working group to propose “a radical simplification of executive pay”. Pay in all companies has evolvedover many years and high pay is often criticised. Mr Godfrey said that people fear that fees are earned for “mediocre performance flattered by favourable external factors” rather than for genuine added value. Is it time for a complete re-think? What’s the purpose of pay anyway? And what makes it complex?
The working group was set up with a cross-section of people, each representing a different part of the investment community, and each with first hand experience of high pay:
■ Daniel Godfrey was widely reported to be on an annual salary of £533,000 and his interim successor, Guy Sears, is presumably on something similar.
■ Russell King earns fees of £150,000 a year from chairing the Remuneration Committees at Aggreko and Spectris, plus more from being a director at Sepura and Interserve.
■ David Tyler receives annual fees of about £1m from chairing both Sainsbury and Hammerson and from being a director of Burberry.
■ Edi Truell’spay is not known but he’s made so much from private equity that it’s probably irrelevant. Until May this year, he was chief executive of Tungsten, but his inclusion is because he now advises London and Lancashire pubic sector pension funds on how to beef up their investments.
■ Nigel Wilson, chief executive at Legal and General, took home £4.2m last year and his potential package is much higher.
■ Helena Morrissey’s pay is not publicised but is probably in the same ballpark. She chairs the Investment Association and is chief executive of Newton Investment Management, part of the massive BNY Mellon group.
A question: when you read this list, did you subconsciously assume that the opinions of those paid more would carry more weight? Executives often value their pay not so much for the money but for how they think they are regarded by others. This is one reason, it’s said,why high pay keeps rising. Complexity of pay could be the wrong target.
Back to first principles
Last year, the Investment Association took over the role of advising companies on how they should pay their senior people. One pay principle, for example, is that salaries should be tailored for the role. And, it points out, it’s simply not on to find out the range of salaries that other companies pay and then plump for the middle amount. Why? Because it leads to excessive salary increases: if everyone chased pay up to the median, the median would be ratcheted up and salaries would leapfrog each other.
Another principle is that the reward for performance should be a “significant proportion” of total pay. Shareholders want simplicity, so there should only be two elements: a bonus to reward that year’s performance and share awards for the longer term “to reward the successful implementation of strategy and the creation of shareholder value over a period appropriate to the strategic objectives of the company”.
Aberdeen Asset Management (ADN), one of the dissenters said to be responsible for Mr Godfrey’s demise, simplified pay in 2009 by scrapping its LTIP, which is essentially a share award linked to future performance. Now it only awards bonuses, based on the previous year’s performance. Above a certain threshold, three quarters of its annual bonus has to be deferred as shares. These are then released in equal tranches over each of the following five years.That way, the argument goes, additional performance conditions aren’t needed because the share price itself will adjust according to how the company performs. And the high proportion of the bonus that’s held back will counter short-termism.
Simple? Well, there have to be safeguards, such as clawback. Aberdeen, for example, will reduce or cancel the outstanding part of a deferred bonus if there’s been serious misconduct, or if the performance has been mis-stated, or if risks have not been managed properly. But how these are interpreted is a matter of judgement and company directors are no more immune to cognitive bias than anyone else. As long as the participant is neither dismissed nor resigns, the deferred shares are almost guaranteed.
In general, policies on leavers are not straightforward either. Will leavers’ share awards be released earlier than for the remaining executives? And what will prevent the executive from selling the shares immediately? It’s no good saying that they will be cancelled if he or she resigns because at this level, dismissals often become resignations and then, to maintain goodwill on both sides, are negotiated into mutually agreed departures where the share awards still stand.
LTIPs under threat
Already, what at first sight looks simple is getting more complex. The more stringent the clawback and holding periods, the more uncertain the pay becomes and the more executives discount or ignore their share awards and push for more pay in cash.
That uncertainty becomes even more marked with LTIPs because in addition, they’re jam tomorrow: if the performance conditions aren’t met, they won’t ever pay out. It’s this that makes LTIPs so cost-effective. Shareholders might like them, but many senior executives don’t. Directors struggle to find the right performance conditions and critics argue that they pay out windfall amounts when share prices soar. It’s been suggested that the Association’s review will signal their demise.
But that would present a problem. If deferred shares acquired through bonuses become the only mechanism for increasing executives’ stakes in the company,then to be meaningful, bonuses need to be sufficiently large.A low bonus might not beat the threshold for any of it to be deferred; and if it just does, a small deferral would leave executives with little at stake to lose.
Discretionary bonuses like Aberdeen’s, though, result in a paradox. You’d expect bonuses to go up or down in proportion to profits, but the opposite often happens. In 2014, Aberdeen’s underlying diluted earnings per share fell, but the total bonus bill as a percentage of pre-bonus operating profit edged up.
There are structural reasons for this. The revenues of investment management companies are driven by the amount of assets under management. The change of sentiment towards emerging markets in 2014 resulted in Aberdeen suffering a net outflow of funds and hence the fall in profits, even though many of its funds outperformed their benchmarks. Those investment teams no doubt expect to be paid consistently from year to year, with higher performance resulting in higher bonuses. To meet those expectations, bonuses need to be relatively stable. So as assets under management decline, pay becomes more uncertain and were bonuses to be cut too much, employees might be tempted to jump ship to another fund manager where assets (and so pay) are growing. Aberdeen identifies loss of key staff as a major risk. It says: “investment, reputation and client retention could be damaged by significant changes in investment personnel”. In other words:if asset outflows were to be matched by bonus cuts, there’d be an increased risk of a vicious circle setting in.
But in that case, how much of a large stable bonus really is a bonus? Martin Gilbert, Aberdeen’s chief executive, earns a bonus of over £4m. Part appears to substitute for an LTIP and, since he’s been paid this in each of the last four years, part could also be a quasi-salary, paid as a bonus to enable most to be deferred. This might not fit with others’ perceptions of what a bonus should be paid for.
When a bonus is not a bonus
Quasi-salaries also run rings around some of the Association’s pay principles. Expectations set in. Salary comparisons don’t hold if salaries appear to be low but are really going up because of a quasi-salary. That’s why looking at total pay is so important. Attempts to limit the ratio of bonuses and LTIPs to salaries flouts that second principle of pay for performance being a significant proportion of total pay. It’s been tried in banking: top salaries have gone up (no doubt, pushing up those in other companies too) whilst bonuses have gone down. The net effect is that in downturns, more pay is guaranteed and so will be more expensive for shareholders.
Some argue that LTIPs have a place where bonuses are low. Others that they make pay more complex. There’s no easy answer because companies themselves are diverse and one size won’t fit all. Pay is also complex because paying for performance is itself complex.
So how will the Investment Association propose to simplify pay? The initial thoughts of the working party are due in spring 2016. They will be eagerly awaited.
