Compensation expressed as a Percentage of Assets Under Management Needs to be Evaluated

Michael Travaglini  announced his intention to retire as Executive Director of the Massachusetts Pension Reserve Investment Management to join Grosvernor Capital Management.  With remarkable candor, Travaglini explained to the Globe; “it’s an entirely personal (decision) one.  I have a wife and three children and I’m going to provide for them.”

Simply put, it appears that he wants to make more money.  No one can fault a guy for wanting to provide for his family.

Nonetheless, Mr. Travaglini’s career evolution and ambitions raise a significant issue pertaining to compensation and fees in the world of the pension industrial complex.  With $15.6 trillion of assets held by retirement funds (both public and private), everyone wants a slice of this staggeringly huge pie.

Scanning the landscape of various players in the pension market place reveals a common methodology for calculating fees: a percentage of the assets under the control or management of a vendor.  Custodians, record-keepers, administrators, investment managers of all stripes (long-only, private equity, venture capital, real estate, funds of funds and hedge funds), in one way or another, try to tie their fees (whether an annual fee or performance based fee) to the size of the pool of assets they oversee.

In fact, the bonus element of Mr. Travaglini’s compensation arrangement reveals that this culture of compensation tied to the size and performance of an asset pool has even injected itself into government.  Public servants can now expect a performance bonus.  Does that mean that Deval Patrick should get a performance bonus if he increases employment in the Commonwealth?  What about Ben Bernanke and Tim Geithner, should they get a fee based upon the size or growth of GDP?

Admittedly, the examples of Patrick, Geithner and Bernanke are ridiculous.  But, we must ask the question, why is providing Travaglini a performance bonus not equally ridiculous?  For some reason, it appears to be more acceptable that he and his staff be eligible for a bonus.

The standard response is that bonuses are needed to attract talented professionals;  otherwise, the private sector will attract the top talent.  I don’t buy that explanation.  First, even with the bonuses paid to either Travagliani or his staff, the private sector pays many multiples of what is offered by state government.  Second, the likes of Patrick, Geitner and Bernanke, and countless other public servants could all make more money in the private sector.  Nonetheless, they choose public service.

Whether consciously or not, it is now accepted practice that many retirement plan service providers are entitled to bonuses and compensation tied to performance and the size of asset pools.  The great irony, however, is that over the past few decades, many of these services have become commodities.  Practically, everyone is doing the same thing.  There are few secrets in the pension industry.

Custody, record-keeping and administration services are almost identical from bank to bank, consultants hype the same or similar analysis and methodologies, and certainly indexing is the same all over.

In light of these accepted compensation practices, the earnings of many members of the pension industrial complex have sky rocketed beyond belief.  In his best seller from the 1940’s, Fred Schwed asked, “Where are the Customers’ Yachts”.  Today, the yachts seem somewhat quaint, now we can point to private planes, ranches in Montana and vineyards in Sonoma or Burgundy.

While compensation has hit the stratosphere, we need to acknowledge that many retirement funds (both public and private) are experiencing severe underfunding.  Let’s not forget, the service providers are being paid by the retirement plans.  Every dollar paid to a consultant or fund manager is a dollar out of the pocket of a pensioner — especially in times of underfunding.

The system is out of balance.  There is no easy prescription for a quick fix.

At a minimum, those people who have assumed stewardship roles over funds, whether as trustees or fiduciaries, must begin holding service providers more accountable on issues of compensation.  As an industry, we must seriously examine the role of bonus fees and asset-based compensation arrangements.  They must be the exception not the rule.  An overall reassessment of these compensation arrangements will no doubt lead to significant compression of fees.  As John Bogle has proselytized for years, reduced fees over time result in higher investment returns.

Finally, as for Mr. Travaglini, while he might not be satisfied with the long term prospects of his current compensation package, he must have realized that the non-financial compensation he has received from the Commonwealth has been invaluable.  Under the current system, he will leverage his years of public service, including the many contacts that he made at public funds across the country, into a lucrative career selling the services of Grosvenor Capital Management.  Compensation is a broad concept.  Not everything can be reduced to dollars and cents.

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