Pay for performance

In 2014, the Ontario Teachers’ Pension Plan (OTPP), considered by many to be the best pension plan organisation in the world, paid salaries, incentives and benefits to its 1109 employees of C$300.5 million.

As chief executive, Ron Mock, got a base salary of C$498,654 and total direct compensation of C$3.78 million – which included long-term incentive payments of C$1.961 million. Neil Petroff, the executive vice president of investments, got paid C$4.48 million, including C$2.722 million of that in long-term incentives.

These sound like grand figures. And indeed they are. However, what is behind the figures is more interesting than the numbers alone.

The total investment costs of OTPP, including staff salaries was C$460 million. On assets of C$153 billion, that’s about 28 basis points.

Conversely, the $295 billion CalPERS, which is restricted in what it can pay staff due to its public sector identity, paid $159.3 million in salaries and wages in 2014 – around US$60 million less than OTPP. But it spent a massive $1.347 billion in external management in the 2014 financial year. Which means it is paying costs of about 45 basis points on external managers alone.

In a cost review, CalPERS identified that 91 per cent of total costs were from external asset management fees, and of that 87 per cent of those external fees were from private assets and hedge funds. The fund, which has a 20-year investment return of 8.5 per cent, has since been recalibrating its portfolio, including its private equity and hedge fund programs, to bring costs down.

But OTPP doesn’t need to compromise investments in potential high-alpha generating investments – 38 per cent of its portfolio is in natural resources, real assets and absolute return strategies, and the 45 per cent in equities is split between public and private markets.

It has generated an annualised rate of return of 10.2 per cent since 1990.

Why the differential?

The comparison of these two funds reveals so much about organisational design and strategy, the inputs to pay structures, and the subsequent value generated. It is naïve to consider salaries on face value.

The difference in the cost structures of these two large pension organisations is largely due to internalisation, particularly of private assets investments, which means paying high salaries to investment professionals. But as much analysis has shown, it is this exact function that is the differential in excess return between funds.

The article Is Bigger Better? Size and Performance in Pension Plan Management by Alexander Dyck and Lukasz Pomorski, shows that a significant source of excess total fund return is the large-scale implementation of private markets investment strategies by specialised in-house pension fund investment teams.

And going deeper, the major driver of success was a reduction of overall fund costs, with external funds management costs considerably greater than the differential in in-house investment staff pay.

Seemingly then, pay differential among organisations is often dependent on the active versus passive management component of a fund’s investments, the extent to which it is insourced, and the private versus public assets split.

OTPP advocates that to get upper-quartile performance, you need upper-quartile people, and to get upper-quartile people you have to pay them upper-quartile salaries. OTPP is the best-performing fund in the world, by many measures. So some attention should be paid to this argument.

Global pay practices

Keith Ambachtsheer’s new book The Future of Pension Management, has a chapter on the pay practices in the investment functions of 37 pension funds from three continents with assets of $2.2 trillion.

Ambachtsheer observes that the biggest driver of high pay is the total headcount of employees directly or indirectly involved in the investment function. And this is tied to the strategic decision by funds, mostly Canadians, to insource private market functions.

“It comes down to organisational culture and the approach to what the job is. Pension funds need to define the business model, the metrics of success and how they relate to pay. Canadians are clearly the outliers in how they pay their people. Why? It is driven by the governance model of needing to be competitive within the organisation. It doesn’t work to have smarter people on the outside. It’s a competitive environment and they want to decide whether to outsource or insource,” Ambachtsheer says.

“We now have a lot of data through CEM that shows if you internalise high cost areas, like those investments charging 2 and 20, then costs reduce by 90 per cent. That’s a 4.5 per cent competitive advantage. Then the question becomes: if the board knows that competitive advantage can exist, what should they do? This will only work if a board truly understands what the economics looks like and they have the people to make it happen.”

Wealth across the globe is more concentrated than at any other time in human history, including the Roman times, with Oxfam reporting that 62 people in the world have the same wealth as the bottom half of the population.

Pay, and what you are paying for, are very sensitive issues.

The global pension study by Ambachtsheer reveals the median of the top five executives’ average compensation was $416,000, which is around 10 per cent of the average compensation of the top five executives for major commercial financial institutions.

 

Investment management comparisons

In Australia, Macquarie Bank’s chief executive, Nicholas Moore was the highest paid executive from a listed financial services company, in 2015 he got paid A$16,495,070. And of the top 50 highest-remunerated executives from the ASX in 2015, nine worked in financial services.

The 2015 Dawson Partnership survey of investment management industry salaries in Australia found chief executive officers’ fixed component varied from A$320,000 to A$800,000 with a short-term incentive component of between 20 and 150 per cent, and a long-term component of 10 to 150 per cent. Chief investment officers’ fixed component salary varied from A$350,000 to A$700,000 with a short-term incentive component of between 50 and 30 per cent, and a long-term component of 50 to 300 per cent.

P&I recently reported that Larry Fink, chairman and chief executive of Blackrock, got paid $26 million in 2015. This was made up of a $900,000 base salary, an $8.72 million cash bonus and deferred equity of $4.095 million. The remaining $12.285 million was a long-term incentive.

But you can’t compare the salary of a chief executive of a pension fund to a broader listed company or even a financial services company, says Justine Turnbull, partner at Seyfarth Shaw and a specialist employment lawyer who has worked for listed companies and superannuation funds in Australia.

She says traditionally, super fund CEOs have been more like administrators than a typical CEO, with little need within the businesses for change and innovation, the usual domain of a CEO. Rather, super fund CEOs have been conservative.

“The CEO has no work to do in getting the money into the fund. But there are certain aspects such as managing people, technology, and a level of sales and marketing that are similar functions,” she says.

But the purpose of superannuation is investing over a long time horizon which is very different to a trading investment environment and requires a different skill set and focus.

More global comparisons

The total amounts paid to executives in Ambachtsheer’s global pension study varied significantly, as did the structure of pay including the base and variable components.

Ambachtsheer found the median top-five total pay, across the 37 funds, was $461,000 with a wider middle 50 per cent range of $362,000 to $669,000.

The median chief executive pay is split 50:50 between base salary and compensation based on organisational/personal and investment performance.

For investment professionals the split is more like 25 per cent base and 75 per cent variable.

CEM Benchmarking, which specialises in benchmarking cost and performance of investments and administration of pension funds globally, conducts an annual benchmarking of what it calls the “global leaders” group.

In 2014, CEM asked the group some ad hoc questions regarding remuneration, and specifically about bonuses paid to staff.

Of the 22 funds involved in the study, staff at 21 of the funds were eligible for bonuses, based on non-investment objectives, portfolio or asset-class performance and total fund performance.

Some of the funds – about eight – had secondary targets to meet before the total fund performance bonus was paid. This included that the total fund performance had to be positive, and if it wasn’t the bonus was deferred until the returns were positive. Others required that individual targets must be met before they could receive the total fund bonus. In some cases the individual targets were non-investment objectives related to compliance or ethical issues.

The median level of bonus a chief executive at these funds could earn was 188 per cent, and for a chief investment officer it was 90 per cent; and all of them had a cap on their bonuses.

Mike Heale, partner at CEM, says whether an organisation pays variable incentives can be cultural.

“In Sweden it is 100 per cent fixed pay, it’s in their culture. In the Netherlands it is about 80 per cent fixed pay. In the US there is a politicalisation of pay, and Canadians have about 25 per cent base and 75 per cent variable.”

[In the Netherlands, Heale says, there is the “stupid man rule” which means no public service employee can get paid more than the Prime Minister – which is around $150,000. President Obama’s salary is around $395,000].

Australian remuneration structure

In Australia, executive pay and structures at superannuation funds are also highly variable.

On the bonus front, the heads of the investment teams at AustralianSuper are able to earn performance pay up to 40 per cent of their base pay, or 60 per cent for the chief investment officer. At UniSuper the maximum performance based remuneration available to any executive officer, including the chief executive, ranges from 30 to 100 per cent of their fixed remuneration. Some Australian funds, such as Cbus, don’t pay bonuses at all.

It is the structures of pay, particularly how bonuses are constructed and benchmarked, that needs much work in the superannuation executive arena.

Importantly, observers of governance and organisational structure, such as Ambachtsheer say that the variable component of pay should be spread over at least four years.

Turnbull is in favour of long-term incentives with some deferral of a short-term incentive. This is particularly relevant, she says, in the context of superannuation business linking incentive pay to the goals of the member, and that members’ interests are met over the longer term.

“Generally in Australia there is an over-focus in the exec rem space on short termism, and we would do better in all industries including the superannuation industry to have a longer-term focus,” she says.

“The philosophical objection to bonuses falls aside when you can link performance goals for bonuses to members.”

She believes incentives play a crucial part of pay and can drive performance but the industry needs improve in terms of how hurdles are set, the time frames of incentives and how they are aligned with the member interests.

“This is a competitive environment for talent, superannuation funds need to step up,” she says. “If the remuneration structures don’t evolve we just won’t get the talent that we need. There’s non-monetary benefits in those environments and the funds are seen as nice places to work, and we shouldn’t undervalue that, but if we want to try and drive top performance there has to be an at-risk component of pay.”