Guideline 31. Alignment of incentives of external fund managers and objectives of the social security institution

Submitted by Anonymous (not verified) on Tue, 07/10/2018 - 09:46

The incentives of the external fund managers are aligned with the overall investment objectives of the social security institution.

Guideline code

INVEST_03700

Mechanism

The board, management or investment committee should establish targets, standards and benchmarks to evaluate the performance of external fund managers. These should be clearly understood and explicitly agreed by both the investing institution and the external fund manager.
The board, management or investment committee may use a policy of rewards and penalties to correspond to the performance of external fund managers above or below pre-set standards or benchmarks, noting that the performance evaluation period should take into consideration the nature of the assets invested in.
Employee ownership in external fund management companies may be considered by the board, management or investment committee as further indication of a greater likelihood of alignment of the interests of the external fund manager(s) with the interests of the social security institution.
Co-investment by the external fund manager in the mandate and performance fees may be considered by the board, management or investment committee as mechanisms with which to align the interests of the external fund manager with the interests of the social security institution.
Performance fees should be carefully constructed so as to avoid rewarding returns generated by market performance and not by the skill of the external fund manager. Poorly designed performance fees may create misalignment of the external fund manager and the investing institution. Features of an efficient performance fee generally include:

Customising the performance fee to reflect the parameters of the mandate;
Establishing a hurdle rate for performance which reflects the market performance the external manager may reasonably be expected to achieve;
Calculation over a period longer than one year to better reflect the investment horizon of the social security institution;
A high-water mark and cap to ensure fees are paid fairly over the time frame.

Where feasible, the base fee should reflect the actual costs of managing the mandate for the external fund manager and should not be based on the value of assets.
The features of the selected fee arrangements which are agreed should be clearly and fully documented in the agreement signed between the external fund manager and the investing institution.
Where the board, management or investment committee lacks sufficient resource, expertise or governance budget to make fully informed decisions about alignment of fees, the board, or the management or investment committee with board authorization, should seek expert advice or appoint external professionals to carry out these functions.

Parent

Structure

The board should establish the policy that sets the standards, criteria and benchmarks for the evaluation of the external fund managers, in terms of variables such as fees, returns and portfolio composition, including an appropriate time horizon for measurement.
Although the criteria regarding portfolio composition may be general, the board may wish to more closely define what specific elements it wishes the external manager to take into account when constructing its portfolio.
The management should ensure that this policy is implemented and adhered to by the external fund managers.