New SEBI rule for fund manager compensation

The Securities and Exchange Board of India (SEBI) has said that a minimum 20% of the compensation of mutual fund managers and other key personnel in an asset management company (AMC) should be in the form of units of the mutual fund schemes they manage. Key personnel here refers to the likes of chief executive officer, chief investment officer, research head and their direct reportees.

What’s new in this circular? Isn’t pay linked to performance?

The compensation of fund managers — at least the variable pay component — is linked to performance. What SEBI has done here is crystallise the rules and extend it beyond fund managers to so-called key employees. Moreover, SEBI has specified the rules of allocation of this 20% by saying that is should be proportional to the assets under management of the schemes in which an employee has a role or oversight. For example, a CEO who has overall oversight will have 20% of her compensation spread across all the schemes. On the other hand, a fund manager who manages only one fund will have at least 50% of this type of compensation in the scheme she manages and the remaining in other schemes of the mutual fund that are riskier. The regulator has also specified that these units offered by way of compensation are locked-in for three years.

What has led to such a decision from SEBI?

The SEBI circular said this was to “align the interest of the key employees of the AMCs with the unit holders of the mutual fund schemes”. In other words, SEBI wants fund managers to have skin in the game, or demonstrate to investors that they have confidence in the schemes they manage.

This could also be a fall out of the events at Franklin Templeton which shuttered six debt funds in March 2020. A forensic audit alleged that some employees of the mutual fund redeemed their holdings just before the closure of the six schemes. Even earlier, there have been allegation of front running by mutual fund employees.

How will this help retail investors?

This move by SEBI will boost the transparency of fund manager compensation. It helps build accountability. It ensures that fund houses actually link the pay of fund managers to performance and go beyond lip service. Besides, since a whole lot of employees’ compensation is linked to how well a mutual fund is doing, it could encourage whistleblowing if wrongdoing is happening. It will give a lot of psychological comfort to investors that their fund manager has skin in the game. Whether it will lead to higher returns is something we will have to wait and see.

Why is the mutual fund industry unhappy then?

The common refrain from mutual fund CEOs has been that SEBI’s intention is good but the rules are too clunky to follow. For instance, a money market fund manager (where annual returns may not be more than 6-7 per cent) might have a huge risk appetite and channel all her investments in equity funds. This rule by SEBI, which in effect specifies percentages of investments in different schemes, could conflict with the personal finance goals of the fund managers. This could even lead to a flight of talent from the industry, warn fund house CEOs.