Fund Managers to Get Part Pay Via Scheme Units: Is This a Good Idea?

Do you seek a professionally managed investment? Are you looking for an inflation-beating return? You may consider putting money in mutual funds to achieve your financial goals.

However, you must check the fund manager’s track record and investment style before putting money in mutual funds. The capital market regulator, SEBI, has issued a circular stating that a minimum of 20% of the salary of key employees of AMCs such as CEOs, CIOs and fund managers must be through their mutual fund scheme units. It encourages accountability among fund managers by having skin in the game. However, is this a good idea?

SEBI passes rules to make fund managers accountable

You have SEBI passing a new rule regarding the compensation of key employees of asset management companies. It aims to align the interests of key employees such as fund managers with those of unitholders in mutual fund schemes. It is also called skin in the game, as this new rule makes fund managers accountable for their investment decisions. 

According to the SEBI circular, a minimum of 20% of the mutual fund manager’s compensation must come through mutual fund scheme units managed by them. Moreover, this rule also applies to other key employees such as CEOs, fund management and research team, dealers of the AMC, CIOs, sales heads, and compliance officers who are compensated through mutual fund scheme units where they play a role.

You have this rule restricting key employees from redeeming these mutual fund units for at least three years. Moreover, if a key employee violates the code of conduct or is involved in fraud and gross negligence, it leads to a clawback of units. The redeemed units are credited to the mutual fund scheme. However, you have exchange-traded funds (ETFs), index funds, existing close-ended schemes and overnight funds excluded from this rule.

Fund managers to get part pay via scheme units: Is this a good idea?

You have many investors believing this rule to be a good move as it forces key employees of AMCs to make the right investment decisions. It improves the confidence of mutual fund investors who know the fund manager and key employees have skin in the game. Moreover, there are penalties if the fund manager violates the code of conduct, ensuring compliance with these rules. 

This rule may increase mutual fund penetration in India as investors gain confidence knowing that fund managers invest in mutual fund schemes managed by them. It may also increase the return of mutual funds over some time. 

Mutual fund managers earn a significant compensation component through ESOPs (Employee stock ownership plan) and bonuses. However, this compensation is linked to the fund manager’s performance, measured by the extra return generated by the mutual fund. The new rule by SEBI won’t make much of a difference in incentives. However, it could lead to better governance of mutual funds preventing fiascos that dent investor confidence. 

You have SEBI’s new rules on part compensation of key employees of AMCs through mutual fund units, facing strong opposition from some CEOs and fund managers. It leads to a view where there may be some problems in the implementation of these rules. For instance, junior research staff and heads of support functions earn lower pay than the senior employees.

It may lead to problems as these employees who don’t earn a high salary would have to lock in 20% of their income for three years. Moreover, you have a fund manager running a mid-cap mutual fund scheme having to invest a part of the compensation in these mutual funds, even if it doesn’t match the risk tolerance. 

The new SEBI rules may increase the cost structure of the mutual fund schemes as AMCs may have to hike the salary of key employees. A better approach may be using this rule on employees of AMCs earning a higher salary rather than all key employees. However, this rule will lead to better performance of mutual funds as crucial employees of AMCs act in the best interests of the mutual fund investors. In a nutshell, SEBI’s new rule on the compensation of key employees of AMCs may lead to better governance in the mutual fund industry. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in