For mutual fund and ETF firms to succeed in intermediary distribution, they will increasingly require wholesalers to be more responsible for selling both types of products, while also increasing the quality of assets raised - and for this added responsibility, wholesalers should have their compensation plans restructured.
kasina, the search and consultancy company, says the traditional gross sales-based plans are not keeping pace with changes in the industry, including the emergence of ETFs sold through advisors. It will be difficult to maintain existing levels of wholesaler compensation without changing the fundamentals of compensation plans.
External wholesaler compensation plans based heavily on gross sales are not aligned with firm goals and also do not adequately reward the wholesalers for selling ETFs alongside mutual funds. ETF gross sales are not reported in the same way as funds and don't have the economics (basically, revenue structure) that support gross-sales incentives. The research presents that fund managers and ETF sponsors need to consider de-emphasizing gross sales as the primary metric - they should focus on changing the goals (focus on the quality of assets and advisors) and the structure (more weight on quantitative metrics in the discretionary bonus).
Gross Sales: An Incomplete Metric
Even as the bull market plows forward, it is unclear whether mutual fund and ETF providers are growing their business as well as they could be. Since 2Q11, publicly traded asset managers have seen their compensation and benefits expenses rise from 31% to 36% of asset-based fees. This indicates that firms have not been able to scale operational efficiency, as it applies to compensation. During this time, the mix of wholesaler compensation has tilted even further toward gross sales.
As wholesalers are pushed to reach even higher gross sales in order to hit goals and maintain compensation levels, it is logical to conclude that the focus is on the quantity of sales rather than the quality. The mix of assets under management at the firm is ultimately responsible for how profitable it can be, but wholesalers are only paid on adding assets to the mix. If each incremental sale is not incrementally beneficial to the firm's bottom line, it is likely that wholesalers will not be able to be compensated as much for meeting goals.
For ETFs providers specifically, there is no luxury of gross sales as a metric for sales because of the opacity of sales reporting. These firms must be more creative when thinking about how to compensate wholesalers, while catering to their competitive nature. Fund managers thinking about ETFs also need to consider compensation plans that incorporate a sale that will be difficult to reward through gross sales compensation.
Making the Transition
The goals for changing compensation plans is are fairly straightforward. The first is to have an alignment of compensation paid on sales with the financial impact of those sales on firm profitability. The second is to maintain the competitive spirit of wholesalers and to pay the best performers at least as much as they earn today. To address this change, kasina thinks that fund managers and ETF providers need to consider de-emphasizing gross sales as the primary metric. Like most issues in the industry, there is no single solution, but there are steps that firms should pursue to better incentivize wholesalers for working with the home office and targeting more profitable relationships.
A more substantial base salary tied to AUM is one way to incentivize wholesalers to build quality relationships. In order to alleviate concerns about wholesalers simply sitting on a large base of assets, there should still be a commissionable component to the plan - but it may make more sense to use net sales instead of gross sales. Finally, the bonus should also play a larger role, particularly to reward activity that is difficult to track, such as ETF sales. There is no single comp plan that will work at every firm, but there are adjustments that can be made in most instances that will bring plans into greater alignment with the successful growth of the broader firm. Yes, wholesalers should be compensated for winning new business, but the longevity and stability of those wins will be judged over time and are only profitable over time. The goal is to incentivize them to bring the most lucrative assets and nurture the strongest relationships. This means paying more on net sales and/or AUM, rather than gross sales. The strong wholesalers will pursue a quality base of business that should generate asset-based compensation that pays them in a compounding manner.
Jeffrey Strange is a director at kasina.