SEBI guidelines on compensation

By Larissa Fernand |  28-04-21 | 
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About the Author
Larissa Fernand is an Investment Specialist. Follow her on Twitter @larissafernand

There is a term called dogfooding which conveys an impeccable logic. This is it: If you are employed at a dog food company, you should be feeding your dog the same food. Why? Because if the product is as good as your marketing and sales team says it is, you would buy it yourself.

The term dogfooding is now predominantly used as slang by software companies. Developers who do not use their own software on a regular basis are often unable to understand the problems users face. It is tantamount to a sign on the restaurant that says: The owner eats here too.

In the fund industry, it would correspond to whether fund managers have “skin in the game” or “eat their own cooking”, which translates into whether or not they invest in the funds they manage.

In India, a few asset management companies employ this principle. Should employees choose to invest in mutual funds, they “are encouraged” or “expected to” invest in the schemes from that AMC.

Now, the regulator has stepped in. A circular released by the Securities and Exchange Board of India (SEBI) on April 28, stated:

  • 20% of salary (includes perks, bonus, non-cash compensation net of income tax and statutory contributions like Employees Provident Fund) to be paid in units of mutual fund schemes in which the key employee has a role/oversight.
  • The compensation in units will be proportionate to the AUM of schemes in which the key employee has role/oversight. ETFs, overnight funds, index funds and existing close ended schemes will be excluded.
  • The units will be locked in for a minimum period of three years or tenure of the scheme whichever is less. Units cannot be redeemed during the lock-in period. But the AMC may provide facility to employee to borrow against the units in case of exigencies. Redemption of units within lock in period will not be allowed on resignation or retirement before attaining superannuation age as defined in the AMC rules.
  • To aid diversification of unit holdings, fund managers managing only a single scheme/category of schemes can received 50% of compensation in units via units of the scheme/category managed by him or her. If they choose, the remaining 50% can be paid in units of schemes with comparable or higher risk as per the risk-o-meter.

Frankly, it is no virtue.

Investors are right in principle to expect fund managers to be invested alongside them. It does instil confidence in the investor. Higher investment levels aren't a guarantee of success, neither do they assure you of an ethical or capable fund manager, but at least they show that managers believe in the funds and pay the same costs that the rest of investors do.

Kaustubh Belapurkar, director of fund research at Morningstar India, rightly says that managers investing in their own funds is a good signaling factor for investors. “We do positively view asset managers encouraging/mandating fund managers to invest in their own funds as a good stewardship practice. Having said that, it is worth noting that the individual risk profile of some managers may be different from the risk profile of the scheme(s) they manage.”

It could very simply be that the fund doesn’t suit that manager’s personal situation. There’s no sense in a 30-something manager investing heavily in his short-term bond fund.

If it is a sector or thematic fund, it may not go with the fund manager’s personal risk profile or may not fit into his own personal portfolio which may already have exposure to that sector.

Ditto in the case of a fund manager of an equity linked savings scheme, or ELSS. He may choose not to invest in the fund simply because he has maxed his limit under Section 80C.

Conversely, a fund manager may be heavily invested in his fund. But that doesn’t mean it’s a great fit for your portfolio. A fund manager’s style may be way too aggressive for your liking, even if he has all his savings in the fund, you may still want to steer clear.

Radhika Gupta, managing director and chief executive officer at Edelweiss AMC, articulated her thoughts brilliantly on this issue. 

SEBI’s circular on skin in the game is a good idea in spirit, however, it is going to be extremely problematic in implementation.

This circular applies not only to senior employees, but to junior research staff, dealers, and support function heads as well. There is a definite disparity in income between what a chief executive and a chief investment officer earns, as well as in their functions, obligations and responsibilities. Why is everyone clubbed together?

Why are those who earn much less forced to lock 20% of their income for three years? It will definitely hit their savings. An individual earning Rs 15-20 lakh will not be in a position to put away Rs 3-4 lakh with a 3-year lock-in. This will constrain his cash flows.

The circular suggests that we have to invest in all schemes basis weighted AUM. So if I run a 80:20 debt:equity business, that is my forced asset allocation. A mid-cap fund manager has to invest in his schemes or a higher risk grade. What if that does not fit his risk appetite? A liquid fund manager has to park money in liquid for 3 years.

What about a CEO or sales head? Do they have to invest in every single scheme of their respective AMC?

So what are the implications?

  • This is going to be very hard to implement.
  • We will be forced to pay everyone 20% more, hitting the business and cost structure. A lot of individuals will choose not to work for a mutual fund. Why should a marketing head or sales head or chief technology officer deal with such stipulations? They don’t make investment decisions for the organisation.
  • The compensation varies hugely basis the year and bonus outlook. How can these decisions be made at the beginning of the year?

If skin in the game was to be advocated, a simple rule would have done it. Employees earning more than Rs 50 lakh, maybe 50% of your investments (not assets) should be placed in your funds. It actually is much more simple to implement, and logically more sound.

The SEBI circular can be accessed here.

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manoj singh rathore
May 6 2021 01:24 PM
 I had to search to find this article. It abruptly vanished from homepage. I can see you have removed this, and still old articles are on homepage. Morningstar has learnt where it went wrong. So I need not write anything now.
sandeep deshmukh
May 3 2021 12:58 PM
 dear larissa,
nice to hear from you.
-there is a mention that higher investment levels aren't a guarantee of success (others have also highlighted this)
-there is something about a fund not suiting a manager's personal situation (odd logic)
-there is radhika gupta who has emerged as the poster girl for criticizing the rule
kindly read the article with an impartial lens (not as the author). analyse the tone and tenor, and gauge what the underlying sentiment is. it might not have been your intention to be anti-investor, but that is how the article comes across.
in the past, we have discussed the competence and integrity of your research team, and disagreed. once more, let's agree to disagree.
have a nice day!
Kaustubh Patil
May 2 2021 01:30 PM
 The whole issue surfaced due to the scandal at FT where the forensic audit by Choksi & Choksi ordered by Sebi found that few key managerial personnel of Franklin Templeton India withdrew their own investments before the fund house shut six of its debt schemes on 23 April (Ref MINT). So to argue that one should trust AMCs unconditionally would mean not having any regulator at all; hardly the way to go! From personal knowledge I know that Singapore has extremely tight financial regulators.
The tone of the article is against the new regulation and Morningstar is entitled to its views; however it needs to examine if it is living by its motto of investor first by not whetting the article against its professed standard.
ninan joseph
May 2 2021 12:27 PM
 My personal views.
Fully agree with the author. Skin in the game theory is applicable if we think all Fund Managers have zero integrity.

If someone is investing in a funds just because the fund manager has invested in it is making the biggest mistake ever. I think it was Feroze Aziz of Anand Rathi Group who used to tell on TV interviews that their owners have invested 100% in their own model portfolio. All this is good and nice to know, but I for one will never invest in a fund just because their entire team has invested in their own product.

Money is a personal matter, no one can force anyone to invest in any fund just because they work. Asking employees to put a certain percentage of the money in their own fund is uncalled for. Just because you are an employee does not mean that he has so much surplus cash flow. I know relationship managers who advise clients are the worst in their own personal matters. Ask one RM if they have written a WILL, the answer will be no but they will advise their clients regarding succession etc because it is his job.

As the author has said, the heart is in the right place. If I am an employee I will not like someone forcing me to invest my hard earned money in a particular fund just because I am working for an Are we all cheats? If this is the premise, why invest.

In 1990s it was ok if India loses the cricket match, but Pakistan should not win. This theory must have changed since. Dr should invest in all pharma co which he is prescribing to patients? In Singapore, when I took their public transport while entering we need to tag our card to the front machine, there were no conductor or ticket inspector. When I asked someone why so, they said, we believe in our customers. They will not cheat. Just for one or two stray individuals who might cheat why push in an army of ticket collectors. But unfortunately in India, in our trains, every passenger is checked with his ID. If there is no trust go invest directly
Dhawal Parikh
May 1 2021 02:12 AM
 Hi Larissa,

Thank you for replying to my observation.

(1) Whether Radhika Gupta wrote specifically for you or for social media is not relevant. Her views are against the guideline. And by giving her space, you have endorsed them. Don’t think you gave her space because you disagreed with her views, right?

(2) Subject in Morningstar mailer: Bulletin: SEBI's compensation guideline is extremely impractical.
In the article: Frankly, it is no virtue.
I have quoted what is written, not misquoted you or taken words out of context.

(3) Even Nassim Nicholas Taleb doesn’t claim that ‘Skin In The Game’ will guarantee success. So why use that as an argument to downplay the importance of ‘Skin In The Game’. That is just not the reason for investing with investors.

(4) If 75% of the article slams a rule enforcing skin in the game, and 25% supports it, then what should be the interpretation?


Dhawal Parikh
Larissa Fernand
Apr 30 2021 08:58 PM
 Dear Dhawal and Sandeep,
Thank you for sharing your feedback. We welcome the views of our readers.

* No, we did not “get” Radhika to write. Her thoughts were circulated on SM and we requested her permission to reproduce it here.

* We are not against skin in the game. As the last paragraph said, a simple rule would have achieved it.

* The part of it not being a virtue has been explained. There are funds that have not performed well that also had employees' money invested in it. It is not a guarantee of success. Of course, if you just take my statement it out of context. it does sounds jarring.

*Our agenda has always been the investor first. You interpreting the above in the wrong way does not change that.

Once again,
Thank you for taking the time and making the effort to share your views.
sandeep deshmukh
Apr 30 2021 08:01 PM
 i applaud morningstar's courage to defend its friends in mutual funds. any investor will say fund manager should gain and lose with him. mutual funds will obviously resist responsibility. there are 2 sides here, mutual funds and investors. morningstar had to make a choice and it has brazenly chosen mutual funds.
Dhawal Parikh
Apr 29 2021 08:36 PM
 Your reaction to SEBI guideline is startling. Language used like Extermely Impractical, It Is No Virtue, shows where your heart lies. Don’t know why I misunderstood that Morningstar is in favour of investors. Your concern for AMC is visible. You even got an AMC person Radhika Gupta (you say-articulated her thoughts brilliantly on this issue) to tell us how SEBI guideline is flawed. In India, Morningstar has different agenda. It was first noticed in your reaction to Franklin Templeton event, and now this.
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