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Morningstar has consistently stressed that share-
holders of actively managed mutual funds must
maintain long-term investment horizons. Short-term
market fluctuations can cause even the most skilled
managers to perform out of step with competitors at
times. It’s more likely that a talented manager
can identify long-term drivers of value, and investors
should prepare to wait patiently for their theses to
play out. Likewise, investment firms should compen-
sate their managers based on long-term performance.
Most firms tie manager bonuses directly to fund
performance versus an appropriate benchmark or peer
group. However, firms evaluate results over different
measurement periods; some emphasize shorter time
frames, while others focus on the long haul.
This study compares the performance time periods
that the most prominent active investment shops
use when determining manager bonuses. Table
1
includes the
20
largest managers of active mutual
funds, excluding firms that use multiple subadvisors,
which contend with numerous compensation plans.
Most of the information in Table
1
came directly from
each firm’s Statement of Additional Information.
The majority of investment firms’ compensation plans
base portfolio manager bonuses on performance
over one-, three-, and five-year periods. Very few asset
managers take a longer-term view. In fact, of the
20
asset managers listed in the table, only three explicitly
consider returns beyond five years.
An Exceptional Focus on the Long Haul
T. Rowe Price and Oakmark stand out for their long-
term focus. Both base compensation on fund
performance relative to appropriate benchmarks or
peer groups over one, three, five, and
10
years,
with an equal weighting on each time frame. Their
inclusion of a
10
-year evaluation period is unusual
in the industry and is in shareholders’ best interests.
American Funds’ structure also stands out in its long-
term orientation, which has been one of the keys
to its investment success. The firm pays bonuses based
on one-, three-, five-, and eight-year returns relative
to a benchmark and competitors. (Prior to
2016
, the
firm determined bonuses by evaluating returns over
one, four, and eight years, with greater weight placed
on the four- and eight-year periods.) As shown in
Table
1
, the firm uses a progressive weighting scheme,
meaning it places increasing weight on each suc-
ceeding measurement period, which also represents
an industry best-practice.
While there’s still room for improvement, the industry
in general has increasingly favored the long term. For
instance, Wellington, which serves as the subadvisor
for all of the Hartford’s funds and many prominent
Vanguard funds, historically compensated managers
based on one- and three-year results. However, in
2012
, it began phasing in five-year returns, which will
be fully implemented by the end of
2016
. More
recently,
JPM
organ has added a
10
-year measure
when evaluating managers, though that language
has not been added to the firm’s
SAI
.
Can’t Shake the Short-Term
Despite the general trend to favor longer-term returns,
short-term results continue to influence bonuses at
most firms. Of the asset managers included in Table
1
that determine bonuses based on performance, all but
two—Fidelity and Putnam—consider one-year returns
when determining bonuses. The former rewards man-
agers for three- and five-year returns, while the latter
only looks at results over three years. Their decision
to eschew near-term performance is commendable.
Two firms stand out for having manager-compensation
structures with unusually short-term focuses.
Waddell
&
Reed skippers receive bonuses based on
one- and three-year results relative to peers, with
an equal weighting on both periods. The firm has a
history of not keeping up with industry best-
practices; Morningstar has previously criticized it for
poor oversight of its captive advisor network and
subpar risk management. Additionally,
PIMCO
’s com-
pensation plan is based on one-, two-, and three-
year performance versus predetermined benchmarks.
Who Is Really in It for the Long Haul?
Morningstar Research
|
Leo Acheson