Strategy should lead compensation: Ambachtsheer

A fund’s overall investment strategy should lead how senior staff are compensated, a recent survey into pension fund pay levels found. KPA Advisory Services recently asked 37 funds with combined assets of more than $2.2 trillion about how they structured their pay for senior staff and published the results in its latest monthly, The Ambachtsheer Letter.

The publication is authored by KPA Advisory Services president, Keith Ambachtsheer (pictured), who is also the director of the International Centre for Pension Management at the University of Toronto’s Rotman School of Management.

The survey of funds across Canada, the United States, Australia, New Zealand and Europe found that, while pension fund employees were paid well relative to other occupations, their compensation levels were less than those in similar positions in the commercial financial services industry.

Some of reasons for this discrepancy between pay levels could be due to externally-imposed constraints on fund compensation, the authors of the survey said.

The authors questioned the wisdom of these constraints and said they should be carefully examined.

A strong driver for compensation levels was also if a fund decided to take certain investment activities in-house, especially in terms of pursuing private markets strategies.

A high-level of compensation was found in Canadian funds where this in-house move has been more aggressively implemented. To compete with the broader market for people with these investment skills meant funds had to employ more people and pay them well.

Recent studies, in particular a paper by Alexander Dyck and Lukasz Pomorski, have examined the economics of moving private market investment strategies in house.

Dyck and Pomorski’s report titled, “Is Bigger Better? Size and Performance in Pension Plan Management”, found that dispensing with external advisors and moving private markets investment in-house was net-value adding, largely due to significant savings in fees.

“This is a strategic issue the senior managements and boards of all large-scale funds should address,” the authors said.

The authors also looked at two key areas of reform that have challenged industry in the wake of the global financial crisis. Firstly, benchmarks for staff compensation and how this relates to market downturns and, secondly, ensuring pay incentives do not lead to excessive risk taking.

In recent times the bonuses senior staff have received, despite market downturns, have attracted controversy.

Most funds when asked what investment benchmarks they used to calculate pay said they orientated the benchmarking heavily towards market-relative investment policy proxies rather than absolute return targets.

While this approach has meant excess return generation continued to be rewarded, even in a market downturn, some observers have noted it has resulted in senior staff receiving bonuses in a context where fund members have seen negative returns.

The authors note both the market-relative and absolute-return approaches are legitimate. But instead of choosing one benchmark over another, they recommend a relative weighting of these two approaches.

“As a practical matter, there is a strong case for weighting the market-relative approach more heavily,” the authors say.

“However, we also believe that attaching some non-zero weighting to whether or not the fund is generating a return in excess of some pre-established target sends out a strong and positive ‘solidarity’ message to the fund’s stakeholders.”

Grappling with how to deal with risk and incentives for staff has proved a difficult challenge for the industry thus far, the survey notes.

Funds need to develop robust risk-adjustment protocols to ensure incentive compensation does not encourage excessive risk, but few funds surveyed have begun to do this.

A major reason has been the design difficulty presented by trying to separate skill-driven outcomes from risk-driven ones.

“The survey findings confirm that this continues to be an under-explored area in the pension fund management industry,” the survey said.

“A major industry effort is required to develop and implement risk adjustment protocols that help separate the skill/risk mix in realised returns and in performance-based compensation.”

For more information on the survey findings into pay levels in the pension fund industry visit