Evaluations

Recently, I attended a seminar at Callan College on being a trustee of a pension fund. Part of the training involved evaluating fund managers. Fund managers are the people you hire to invest the money in your trust fund. The instructors stressed how easy it is to be swayed into only looking at how much gain those managers have made over an annual or five-year basis, but that it is a mistake to evaluate only on quantitative measures. The qualitative factors are much more important, even though they are harder to evaluate. Some of the top fund managers have down times which are beyond their control.

It reminded me of people who are so short-sighted they want to evaluate teachers only on student test scores. They count only what is easy to measure and miss the most important factors. I’ve heard lots of people talk about the teacher who made a difference in their lives and I never heard any of them tearfully remember how Mr. Smith raised their test scores.

At the end of the training, there was a final exam. We students were divided into small groups to act as boards of trustees for pension funds. Each “board” was given a scenario which required us to make several decisions using the skills and principles we had acquired during our training. We then orally presented our decisions before a panel of judges consisting of our trainers.

Part of my group’s scenario involved hiring a fund manager and deciding on a fee. One option was a flat fee and the other was a smaller base fee with bonuses dependent on the amount of fund gains above a set minimum growth. Most of my group felt the bonus fees would encourage the fund manager to do better. I forcefully argued that we were hiring a professional and paying him a reasonable fee to do his best. Paying a bonus would end up costing us more without giving us more than a manager should be doing anyway. Upon evaluation, if we felt the manager was not doing what we felt was the professional work expected of him, he should be fired. If we needed to pay a bonus to get him to do what he was supposed to do, then we were not doing a good job of evaluating. As fiduciaries we should not be paying more than we needed for his best results.

Since I argued so forcefully, the group insisted I make the presentation to the judges. I was nervous. I understood that in the current business model, bonus is king, so I braced for the rebuke. But I believe you must stand on your principles, so I presented to the judges the same as I spoke to my group.

As I finished, the room was dead silent. Suddenly one of the judges slapped the table in front of him and exclaimed, “Absolutely correct! Never agree to a performance bonus!” To the nods of his fellow judges, he explained that paying a bonus will entice a fund manager to skew your fund assets toward earning the bonus, and then when the market makes a minor turn, you will end up with massive losses. You want a well-rounded, diverse portfolio. A bonus tends to skew your portfolio narrowly toward maximizing the bonus leaving you, as a trustee, worse off.

I was stunned. As I sat down, all I could think about was where are these people in the debate about tying teacher pay to test scores? We say we want our students to receive a well-rounded education but all we talk about are test scores in reading, writing, math and sometimes science. And the new mantra is to skew things even more by paying a bonus mislabeled as “merit” pay. It should be called what it actually is – child abuse. It denies students a well-rounded education and sets them up for difficulties later in life.

But who am I to criticize those titans of industry who depend on golden parachutes and manipulations to enjoy a bonus based on this quarter’s return? They brought us the financial miracle we see in our 401k accounts. Or, perhaps we need to reconsider…