New pay plans give portfolio managers bigger piece in fortunes of entire firm

Asset management firms are taking a hard look at how they compensate their portfolio managers, and a number of large firms have shifted to new pay structures.

Firms such as Janus Capital Group Inc., Morgan Stanley Investment Management, Citigroup Asset Management and Robeco Investment Management have recently altered their compensation plans to give portfolio managers a greater stake in their firms' overall businesses.

The changes, which mostly affect bonus and incentive payments, vary slightly from firm to firm. But the goal appears to be consistent — to clearly reward portfolio managers more for solid long-term performance and align the interests of portfolio managers with those of the firm's clients and shareholders.

"It's a very appropriate shift in industry practice, and it's a good thing that firms are paying out their portfolio managers more objectively based on defined metrics," said Alan Johnson, managing director of New York-based compensation consultant Johnson Associates Inc.

Historically, he said, many large asset management firms have linked a portion of portfolio managers' pay to broader corporate numbers, such as a company's bottom line or assets under management. "That completely ignores the reality of the business," he said, adding bonuses can often be paid out from companywide bonus pools. "There can be timing differences between investment results and a company's overall financial health — but no matter what your bottom line is, you have to pay your investment people when they put up great numbers."

Most of the firms that have fine-tuned their compensation measures for portfolio managers have emphasized long-term performance as a driver of bonuses and incentives.

Gary Black, president and chief investment officer of Denver-based Janus, began reviewing compensation practices when he joined the firm in April 2004. Earlier this year, Janus implemented a new compensation plan that "de-emphasizes" factors such as revenue and how many assets the portfolio manager may oversee, said Mr. Black.

"The new plan emphasizes the managers' performance, especially their long-term performance, but it also focuses on consistency," said Mr. Black, adding that three-year numbers are particularly accented.

Janus' new compensation plan now pits portfolio managers against their peers, as well as benchmarks, and the lion's share of the bonus portion of their compensation is directly linked to outperformance. And if portfolio managers can consistently outperform their peers for three years or more, they can accrue additional "points" toward their compensation.

"The longer the portfolio manager can deliver performance, the more they can get paid," said Mr. Black.

Janus also has a performance "bar" that portfolio managers must meet to trigger incentives. If they don't outperform the median managers in their respective categories, they only receive their base salaries for that year.

Such quantified and performance-based compensation should prove to be both an effective recruiting and retention tactic for money management firms, said Debra Brown, managing director with executive search firm Russell Reynolds Associates Inc.'s investment management practice in New York. "Most portfolio managers like to be paid for performance — it really gets their juices going."

Ms. Brown said last year was the most competitive employment market in the asset management industry in the past five years, another reason firms might be reviewing compensation structures. According to the search firm's latest Investment Management Recruiting Trends report, there was a roughly 15% increase in the hiring of senior asset managers last year over 2003, while annual compensation levels were up 15% to 20%.

Both Morgan Stanley Investment Management and Citigroup Asset Management made recent adjustments to their compensation structures to emphasize long-term investment performance.

Joseph McAlinden, CIO of Morgan Stanley Investment Management, said that last year the New York-based firm put a new compensation system in place for most of its 400 investment professionals. A portion of Morgan Stanley's "above-base" compensation is now more formally linked to investment performance over one-, three- and five-year periods, said Mr. McAlinden.

The firm also revamped the way its pays the tax-deferred portion of the bonuses, which until last year had been paid mostly in company stock and options. Under the new system, only half of the deferred compensation portion is paid in Morgan Stanley stock. The other half is invested in MSIM products — and the investment staff is required to put 25% to 50% of this portion of the bonus into the strategies they manage. The remainder is invested in MSIM strategies of their choice.

"This gives our portfolio managers more of a stake in the business," said Mr. McAlinden. "It provides closer alignment of portfolio manager and client interest, and it also provides them with a cumulative and long-term interest in the organization as well. So far, we have received some resounding positive feedback."

Brad Thomas, managing director for human resources at Citigroup Asset Management, said the New York-based firm also adjusted its compensation structure to reward portfolio managers more for long-term outperformance of peers and benchmarks. Like Morgan Stanley, the firm now puts 25% to 40% of its employee bonuses in Citigroup Asset Management strategies rather than Citigroup stock. Half of this portion of the bonus now goes into portfolio managers' respective products, while the other portion is placed in a composite Citigroup product.

"In this regulatory environment, aligning the interests of all the parties involved is crucial," said Mr. Thomas. "If it all fits together, the clients are happy because they're getting good performance and the portfolio managers get paid for the performance that they've produced."

Mr. Thomas said Citigroup began reviewing compensation practices early last year and implemented the changes in January. With Legg Mason Inc. taking over Citigroup Asset Management, it has not yet been determined if the system will continue. However, Mr. Thomas said Legg Mason officials have indicated the system is "consistent" with that company's own compensation philosophy.

Robeco Investment Management also adjusted compensation to offer more boutique-like incentives. William J. Kelly, CEO of the New York firm, said while the base salary and bonus of portfolio managers are largely intact, he designed a new "phantom equity" component for portfolio managers that functions as if the employees own a portion of Robeco's equity.

After acquiring privately owned firms such as Boston Partners and Weiss Peck & Greer and Sage Capital Management, Mr. Kelly said "equity has been taken off of the table" for employees. "That is a long-term incentive to keeping investment people together in these organizations and providing long-term stability," said Mr. Kelly.

Robeco placed 20% of its overall equity into the hands of its employees, with 80% to 90% given to the firm's investment staff. The equity will cycle itself out over a five-year period, and is "highly levered on the upside and is heavily weighted toward options."

"People are not really getting a piece of what Robeco already bought, but incentive to increase the value of the organization," said Mr. Kelly. "Day to day, you want to make sure that the investment people are very much aligned to our clients, but then longer term, I want to make sure that I don't have these people lifted out or looking for more money if they feel they're undervalued. I don't want to mark people to market."