Tuesday, January 27, 2009

ESOP Plan for Mutual Fund Compensation

Asset Managers are paid huge compensation in cash and most of the times it is proportional to the asset under management. To increase their earning Mutual Fund managers do all wrong things for the investors: They invest in risky securities and momentum stocks, do short term trading with more than 100% Turnover ratio just to increase trading and short term taxes. Why do they do that? Because most of the times they don't have big stakes in their own investment decisions. They just try to make money out of investors pocket.They are like consultants: if it is a success it is the power of the idea of the consultant; if it is failure it is the failure of the client's implementation. In either of the cases their compensation is not at stake. 

How we can change it and make the asset managers more responsible for the investors? The greatest investor of the world, Mr. Buffet has the answer. His company BERKSHIRE HATHAWAY INC. never charges any fees to its investors for the Investment Service it provides. This is because the promoter himself has a major stake in that company and as the people buy Hathaway stocks the stock value increases and thus rewarding the promoter. We can have a similar reward system in Mutual Fund compensation. Instead of 100% cash compensation the major part of Mutual Fund compensation should be through Mutual Fund stock options at a fixed future price(which is generally higher than present value)redeemable at future date only. This should encourage the Fund managers to take care of the Long term health and sanity of the fund and to make prudent investment decisions.


Venu Madhav Tammali said...

This is a great blog . great keep it up.

Abhisek said...

MF should also have High watermark rule for compensation as we have in Hedge funds.