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Mutual Fund News

Even in a bear market, some fund managers saw a bonanza

Six- or seven-figure paycheques common, especially for those who gathered in assets

What they don't tell you about compensation

Poor mutual fund returns have disappointed lots of investors - but their pain hasn't been felt by all fund managers. After all, pay for some has continued to climb. The reason: fund manager compensation is tied not to fund performance but to the continually rising value of assets under administration, fed by ever-growing ranks of aging baby boomers.

Canadians had their savings savaged by the bear market of recent years. Mutual fund executives never shared the pain.

Wrenching as it may have been, the past five years have been nothing short of a compensation bonanza for money managers, while a disaster for a great many faithful clients. Fuelled by an aging population that keeps socking away a portion of their paycheques, the industry has never seen better times.

Many mutual fund investors left their monthly statements in piles of unopened mail, refusing to acknowledge their dwindling fortunes. Global equity fund holders suffered through a 20.2-per-cent slump in 2002 and an 11.6-per-cent slide the previous year, while the average Canadian equity fund owner got tagged with an 11.3-per-cent loss in 2002 and 2.8-per-cent drop in 2001.

Fund executives couldn't wait to tear open their pay envelopes, although much of their compensation reflected their dealmaking ability as the industry coalesced around its largest players.

IGM Financial Inc. chief executive officer Jeff Orr, for example, earned more than $1.5-million a year by forging the largest fund company in the land out of Investors Group and Mackenzie Financial. CI Fund Management Inc. CEO Bill Holland also took home more than $1.5-million as he bought rivals and sold a stake in his company to Sun Life Financial Inc.

The sting for investors over their lost savings gets even sharper as they learn that as part of the drive to pull in assets, many U.S. fund families broke the rules by allowing insiders, such as favoured hedge funds, to market time their investments. In doing so, the mutual fund industry violated its trust relationship with clients, putting the interests of a few professionals ahead of ordinary, long-term investors. A Report on Business investigation of Canadian mutual funds over the past four years suggests the same type of market timing occurred in some of this country's largest funds.

The market timing scandal even has the pros calling the system rotten, and ripe for change.

A recent survey of 131 of the largest U.S investors -- buyers of the mutual fund company's pension offerings -- done by Greenwich Associates found 60 per cent of clients "see the controversial trading practices as widespread in the industry, and not just the actions of a few mutual fund companies."

"The suspicion that a large number of mutual fund companies are doing this has real consequences," says Chris McNickle, a Greenwich Associates consultant who worked on the study. "If the problems are systematic, switching from one mutual fund complex to another might not resolve the issue. To some investors, it seems there is nowhere to run."

Why is it that mutual fund executives prospered through a period when their portfolios flagged, and their industry was rocked by scandal?

It's simple: Fund executives get paid for bringing in assets. Every dollar of savings that investors entrust to fund companies typically means 2 or 3 cents in annual fees, good markets and bad.

"The mutual fund industry is primarily a marketing business. Performance is just one component of the way funds are sold," says Ken Hugessen, head of the Canadian compensation practice at Mercer Human Resource Consulting. "To the extent you need performance to help gather assets, performance does matter. But the name of the game is gathering assets."

And no one can argue with the Canadian fund industry's ability to gather assets. Ten years ago, there was $131.5-billion floating around what most considered a mature mutual fund industry, according to data collected in 1994 by the Investment Funds Institute of Canada. By 1999, assets had more than doubled to $346.1-billion. And last month, domestic mutual fund companies were calling the shots on a record $473.7-billion.

During that decade, the top 10 Canadian fund companies went from controlling 64 per cent of industry assets in 1994 to 81 per cent of the money in May.

With cash piling in at a rate of $2-billion a month for the past five years, rare was the mutual fund company CEO who didn't take $1-million annually through the worst of the bear market. Equally hard to find was a portfolio manager who didn't make steady gains on take-home pay that was just over $300,000 in 1999.

"In broad strokes, the A-level performers continue to be well paid," says Jan Stewart, a partner in executive recruiting firm Egon Zender who specializes in financial services jobs.

Five years ago, at the height of the tech boom, bonus and salary for Canadian portfolio managers added up to an average of $312,000, according to a survey of mutual funds, insurers and pension funds done by consultants at Greenwich Associates.

By 2003, the average fund manager earned $426,000 and had spent nine years on the job. Stars in the mutual fund industry, the best-paid sector in money management, stood to make over $700,000 last year. Among portfolio managers, performance of their specific funds counted for just over 50 per cent of bonus pay, according to research by Greenwich Associates. But the rest of the payout reflected overarching business issues, such as attracting new clients.

"There's no simple way" to align the interest of investors and fund managers, says Mr. Hugessen, no way to easily tie together fund performance and compensation at fund companies. He says it's shortsighted to adopt the aggressive approaches used by sophisticated players, schemes that see money managers take a portion of the gains they earn for unitholders. Such practices would end up leaving investors even poorer, while putting far more cash into the managers' pockets. For the mutual fund industry, Mr. Hugessen says: "I'd give hedge-fund-style, 20-per-cent performance fees a big thumbs down."

In fact, Canada's pioneers in performance fees seem intent on having their cake and eating it, too.

BluMont Hedge Funds of Toronto features four offerings from money manager Veronika Hirsch. Three of these funds pay the company a 2.5-per-cent annual fee, a fairly standard toll for fund investors, while one fund sports a slightly lower 1.5-per-cent fee. On top of what already qualifies as a normal industry rate, the four BluMont funds reward Ms. Hirsch with 20-per-cent of the annual gains.

However, in a move that does align the interests of all concerned, if the BluMont funds take a hit, the loss is carried over to the next year, and deducted from any performance fees that Ms. Hirsch earns.

In the United States, executives became fixated on adding more and more cash to the portfolios they oversaw, and generating more and more fees. In order to keep boosting assets under management, some of the largest fund companies accepted money from hedge fund and other professional players making short-term bets, knowing that the pros' gains could only come at the expense of long-term investors.

"There are certain types of funds in the industry where this sort of questionable conduct is not tolerated, but it is not yet entirely clear who those are," said John Webster, also at Greenwich Associates. "Each fund will need to prove its innocence, and go through a rigorous internal and perhaps even external audit. The unfortunate reality of these findings is that everyone is tarred with the same brush."

From an investor's point of view, Mr. Hugessen points out that the future of the fund industry does hold out the promise of more emphasis on beating benchmarks, and downward pressure on fees. He sees a win for investors in the growing specialization of funds, with rock-bottom fees on index funds. In his own portfolio, the Mercer executive blends these indexed funds with hedge fund-style portfolios that boast pay-for-performance structures.

The industry also needs to fix its own house, say experts, such as Greenwich Associates. Fund companies need to show clients that they've got a zero tolerance policy on inappropriate fund trading, backed up by termination of employees who permit such practices, and repayment of any money that was lost by long-term investors. In addition, governance experts say the industry needs to start winning back trust by adopting some form of daily fair-pricing on its funds, along with minimum holding periods for clients, and the assurance that can come from independent boards.

What bear market?

By increasing the assets under management, some mutual fund executives saw their compensation rise during the worst market in 70 years.

($'000)

....................................................1999.....2000.....2001.....2002.....2003

AGF Funds

Blake Goldring, chief executive officer.......$900...$1,955...$2,203...$1,001...$927

C.I. Mutual Funds

William Holland, CEO...........................563.......963.....1,669.....1,591.....1,800

Dynamic

Ned Goodman, CEO, Dundee Wealth.........676.......257.......291.......561.....1,036

Investors Group

Jeff Orr, CEO.........................................................1,182.....1,500.....1,584

Sanford Riley, former CEO....................1,236.....1.518

Mackenzie Financial

James Hunter, CEO............................1,046.....1,615.......686.......924.......983

Mavrix

Mal Spooner, CEO...............................n/a.......n/a..........88.......305.......347

Bank of Montreal

Bill Downe, Deputy Chairman................1,324*...1,600*.....1,433*....3,600*....4,344*

Bank of Nova Scotia

Robert Chisholm, Vice Chairman.............1,021.....1,370.....1,365.....1,293.....1,511

CIBC

Gerry McCaughey, Vice Chairman...........5,671.....2,931.....2,209.....1,117.....2,948

Royal Bank

Peter Armino, President, RBC Investments....................................n/a......2,482

Reay Mckay, Vice Chairman....................778.....1,080.....1,285

Toronto-Dominion Bank

Fred Tomczyk, Vice Chairman..................n/a......n/a.......1,209.....1,500.....2,401

Average portfolio manager.................$313....$412....$366....$366....$426

*in U.S.

Series schedule

Monday

Rapid trading in mutual funds bears marks of market timing.

Mechanics of market timing, who does it, and why

Yesterday

Proposed rules for fund governance favour industry, critics say

Today

Not all fund managers have suffered the same pain as investors

Tomorrow

Fees and fund performance don't always go hand-in-hand

Friday

Segregated fund fees on the rise

Saturday

Dos and don'ts for investors

On the Web

Follow the mutual fund series this week on our website http://www.globeandmail.com

© 2007 The Globe and Mail. All rights reserved.

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