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Rotman Insights Hub | University of Toronto - Rotman School of Management

The $50-million secret to hiring the best pension manager

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Alexander Dyck

When it comes to pension fund managers, you get what you pay for.

That’s according to “Outraged by Compensation: Implications for Public Pension Performance,” a study conducted by Rotman School of Management professor Alexander Dyck that was recently published in the Review of Financial Studies. The paper considers the correlation between pension fund performance and the salaries of those who manage them, given that many comparable jobs in finance offer greater compensation than what many trustees are willing to approve. 

“Inabilities to meet market-based salaries have profound consequences for beneficiaries,” says Dyck. “This is important for anyone who is a member of a pension plan; you can be penny wise, and pound foolish.”

The paper ultimately concludes that what might seem like a steep increase in compensation can actually pay for itself many times over in the form of returns for beneficiaries.

“For a cost of US$300,000 [in the manager’s compensation] you can increase the reward for beneficiaries by about $50 million [per year], which seems like a pretty good trade off to me,” he says. 

Dyck was inspired to explore this subject as a board member of the International Centre for Pension Management, which includes representatives from 50 of the world’s largest pensions. He says he was struck by the significant discrepancies in performance between Canadian pension plans — which are often run by finance experts — and those of the American and European members, which are often run by representatives members.

“It got me thinking about the extent to which the systematic differences in how these pension plans are governed led to differences in the skills, the people they could get to work for them, and therefore their ultimate performance,” he says.

The study breaks board members into six occupational categories and found that politicians account for 6.4 per cent of board seats; budget civil servants (such treasurers, auditors, and finance directors) account for 34.4 per cent; other civil servants occupy 13.7 per cent of board seats; 23.1 per cent are professionals from a broad array of industries; 14.7 per cent are teachers; and 7.7 per cent are municipal workers

Dyck adds that most pension plan boards in the American public sector include members of the fund itself. For example, a public school pension fund is likely to include teachers, bus drivers and other school administrators, as well as local politicians.

In his paper, Dyck considers how salaries offered by various boards are coloured by their own experiences.

“In the U.S., teachers are not well compensated, so your reference wage would be fairly low; that conditions what you think of as a reasonable wage,” he says. “Another bucket we looked at were municipal workers, and that's not a very high paid group of folks, so it's a similar reference point.”

Another group that occupies a significant number of seats on pension fund boards in the United States are politicians, including governors, appointees and treasurers.

“It's very common in U.S. pension plans for the state treasurer to be a member of the board, and they're involved in the wage setting of all public employees, so it's natural for them to think about everyone else that gets paid by the state,” says Dyck. “They're going to find it nearly impossible to vote for a wage [for the pension manager] that's higher than the wage of the governor of the State.”

Such is not the case in Canada, where boards are more commonly made up of finance industry professionals. As a result, there are fewer objections to offering fund managers what would be considered a competitive salary in the field.  

“If you're working at the Canada Pension Plan, their top managers are making in excess of USD$1 million a year; if you're operating in the U.S. it's almost impossible to find anyone who makes more than half a million, and it's much closer to the USD$200,000 range,” says Dyck.  

Though it may seem high, Dyck points out that the salaries commanded by Canadian public pension fund managers are consistent with similar roles in the private sector on the other side of the border. Those who are managing billions in assets for investment firms or managing endowments for major Universities tend to earn similar compensation packages.

Though it might seem like an unreasonable sum when compared to their public sector salary, the paper offers a strong argument for insulating boards from external pressures, and offering fund managers a high degree of compensation. 

“By choosing to retain a representative board you might have a built in reluctance to write the right contracts to attract the right people that will serve your beneficiaries best,” says Dyck. “If you change the composition of the board to have people with different backgrounds, different reference wages, and insulate them from having politicians on the board, you end up with better performance.”

Alexander Dyck is a professor of finance and economic analysis and policy at the Rotman School and holds the Manulife financial chair in financial services.