It’s time to end guaranteed compensation for mutual fund managers

By Money Matters Editors

One long-standing investment community practice in need of revision is the management fee, particularly among mutual funds.

The practice of financial managers charging a 1.0 percent of even a 0.7 percent management fee - exclusive of performance – has to end.

The reason? The fee simply amounts to guaranteed pay, regardless of performance. With the fee, if a mutual fund does well, the management team collects a fee; if the fund does horribly, the team collects a fee, usually with comments asserting that ‘the fund would have performed better during the year, but market conditions were against us.’ Where’s the incentive for stellar performance under that system? Little exists.



Pay for performance, not guaranteed compensation

What’s a better system? Paying mutual fund managers a very modest salary – like under $75,000 per year – not the $400,000 and $500,000 and up salaries one typically sees – and then may a sliding bonus, based on performance. If the fund achieves its investment objectives, a 100 percent bonus is paid to managers – some total that would bring them close to their former pay. However, if the fund doesn’t achieve its objective – no bonus is paid. The new standard is an application of the true merit standard for fund managers: you eat what you kill.

Mutual funds have done a fair job reducing expense ratios in the past two decades, but much more reduction is needed. And most certainly what has to go is a fee that guarantees that the fund’s managers are issued their high salaries, even if the fund’s investors don’t make any money. That’s absurd, it’s anti-merit, and it’s yet another extension of players in the investment community ‘preaching capitalism, but practicing socialism’ – i.e. saying its o.k. for others to have to live under pay-for-performance standards, but not themselves.

The hope is that competitive pressures among asset classes will compel mutual funds to make this long overdue change. And when they do, the investing public will be that much better off: they’ll know that the only time their mutual fund manager is making serious money is when they, the investors, also are making serious money.