The Question: Compensation

It is IMPOSSIBLE to go through a day and not hear something about what is becoming a dreaded word: COMPENSATION. The funny thing is that, throughout that same day, you will also hear that this is one of the bleakest periods in economic history--a veritable economic ice age--so it is ironic that anyone is making any money at all. One of the most interesting scenes that I can recall from the past few months: I was watching a video on CNBC.com (Please, personal feelings about CNBC aside, "fair" and "unbiased" was replaced with "selling" and "sensationalism" long ago) and I saw them run one of the congressional hearing clips with all of the big bank CEO's. Right on down the line, one of the congressional leaders, or, excuse me, "leaders," had these gentlemen recite their compensation for the previous year. Then their bonus. Then their compensation for the next year. Then their bonus. It was both funny and scary. Funny that time was being spent going up and down the line of say, 8-10 CEO's 4 times when each had the exact same answer, or, at least, nearly the exact same answer, to every question. Scary because, call me crazy, but CEO pay has always been set by corporate boards. If Congress, and true, they're using TARP as their "way in" in this case, starts setting CEO pay, I can't help but to think of it as a slippery slope. It's interesting how it all sounds so good, so "in the interest of the taxpayer," and yet, the taxpayer could quite possibly never be made precisely whole again in some of these cases. If you really think, it seems that Congress is capitalizing on an opportunity to seek greater and greater relevance, more and more TV spots, and an overall feeling that this nation will never be the same again unless they can save it. The funny thing, and correct me if I'm wrong, but I wasn't aware they were solely responsible for the greatest successes of this nation...

Anyhow, the point here is not to polarize our readership by going on a political tirade. I prefer to deal more in absolutes. Like, a 1.75 trillion dollar deficit (or projected deficit) is not good for the dollar. The Fed printing money will cause inflation and will require some NIMBLE maneuvering to quell before we wind up with an opposite set of problems. And, the compensation question. It is an important question, but not with regard to Edward Liddy and the pre-debacle standing contracts at AIG. That is just a CIRCUS. Nothing more. The compensation question I think about regards asset management, most specifically that of hedge funds employing the 2 and 20 strategy. 2 percent of assets under management. 20 percent of profits. Superficially, this appears to be "performance based compensation." Looking deeper and applying a little bit of thought, if that 2% figure can become large enough, say, off of a billion dollars (20 million), what is the incentive to do anything. Additionally, depending upon how the 20% is measured and what the term "performance" means, in a strong overall market environment (where indices themselves are up double digits for years in a row) that can add up to a lot. Call me crazy, but I thought the point was to pursue these "absolute" returns, good in any type of market, exhibiting low correlation overall...but the comp structure would seem to tell me that the goal is to have the portfolio manager make an awful lot of money.

I have nothing against portfolio mangers making an awful lot of money. Absolutely nothing at all. However, these are smart people who have a deep understand of statistics and how to use them to their advantage. I would challenge any of them to measure their performance purely by the alpha that they generate, or, return that they generate for other reasons than taking more or excessive risk. A rising market raises all boats equally...it doesn't make sense to be paid for the portion of the performance that could be generated sitting in an S&P 500 ETF for basis points. Managers who are so great and so smart...they should have the guts to put their money where their mouths are, and they should not be paid any more than index funds for anything less than positive alpha. It's not fair that clients lock up their money for potentially years at a time, becoming part of that asset based fee. Managers should have the same skin in the game as their clients. There shouldn't be any caps...all I am saying is that excessive fees should be taken only for excessively strong, risk-adjusted performance.