By Charles Skorina
May kicked off, as always, with the Woodstock of Capitalism in Omaha.
This is also the season when we find out what CEOs made last year; it fascinates plutocrats and proles alike, including us. We recruit executives for institutional money managers, so we eagerly scan the proxy filings to see who's making what. There's never any suspense about Mr. Buffett's pay, though. He makes billions for his shareholders, but every year accepts an almost laughable $100 thousand emolument for his efforts. He actually makes rather more than that (as we'll see below), but he's a good example of the mysteries surrounding CEO compensation. In this letter we'll take a close look at the latest CEO compensation at publicly-listed money management firms. Inspired by an act of Congress, we'll also consider the relationship of pay to shareholder returns. If there are any more Buffett-like CEOs, we'll flush them out. If, as we suspect, there are some anti-Buffetts who are generously compensated while the stock price shrivels, we'll finger them too. Introducing the Skorina 50
Most are "pure" asset managers, but we also include some big banks and insurance companies which have major AM platforms among all their other lines of business. We limited our list to firms which have been publicly traded for at least five years, for reasons which will become apparent. Then we try to measure how their pay is justified by the returns they generated for their stockholders. Actually, this was Congress's idea, but we're going to play along and see if it makes sense. First: who made more and who made less, in raw dollars:
The Skorina 50: CEOs ranked by 2014 Total Compensation
N.B: *Morgan Stanley AUM - discretion & supervision
N.B: CIFC Corp has no designated CEO. Mr. Vaccaro is Co-President and CIO
In lonely splendor at the top of our list is Mario Gabelli, founder and CEO of GAMCO (from "Gabelli Asset Management Company"). That's just where he sat on our last year's list, and on many other lists. He received a princely $88.5 million in 2014.
Mr. Gabelli is a great admirer of Warren Buffett, by the way, and made the pilgrimage to Omaha this month. His Gabelli Asset Fund started buying Berkshire Class A shares in 1985 when they cost about $2000 each. Today they trade at more than $215,000. They're both Columbia MBAs and both follow a similar value-stock investing style.
So, is he overpaid, as some might argue? He founded the company and owns most of it, and his pay formula resembles a hedge fund manager's. He collects no base salary or bonus, but takes 10 percent of the company's pretax profits off the top.
Whatever his virtues as investor (and philanthropist), his unusual pay formula virtually guarantees that he will rack up an unseemly looking pay-to-stockholder performance ratio, as we'll see below.
At the bottom of our list is Roderick "Ric" Dillon who runs Diamond Hill Investment Group, which isn't even in Manhattan or Connecticut, but in bucolic Columbus, Ohio. (We refer carelessly to these people and firms as "Wall Street," but that's just metonymy. Also, we just like to say "metonymy.")
Mr. Dillon made a relatively modest $1 million in 2014. But look at how his shareholders have done: 26.4 percent return over five years.
That's much better than the broad market, and nearly twice the return to Mr. Gabelli's shareholders. So, is he more fairly paid? This question foreshadows our next chart: a ranking by pay-to-performance ratio.
The Skorina 50: CEOs Ranked by Pay-for-Performance
Ratio indicates $ millions of CEO comp per 1 percentage point of annualized shareholder return. Ranked from low to high. SH = Shareholder
Now things look very different. Mr. Dillon, who sat at the bottom of the raw-dollars ranking, now vaults to the top, while Mr. Gabelli, with his $89 million payday, falls to near the bottom: 45th out of 50.
A rule is born:
What is this mysterious pay-to-return ratio you speak of? Who came up with that?
Well, Congress did...sort of. A comparison of pay to stockholder returns will be mandated in future SEC filings. The ratio we've calculated isn't explicitly mandated, but it's an obvious and logical way to quantify the relationship that Congress wants to highlight: compensation vs. five-year shareholder returns for the company and selected peers.
Michael Corkery wrote a good story on this development for the New York Times DealBook.
Harken back with us to the fearful days following the 2008/2009 financial meltdown. A new administration turned to the task of fixing blame and, incidentally, assuring the country that such a crisis could never, ever happen again.
Congress duly heaved up the 2010 Dodd-Frank Act, consisting of 849 pages, 16 titles, and 225 rules to be imposed by 11 agencies. One of those rules, it turns out, had to do with certain disclosures in corporate proxy statements.
Last month, four long years after passage of Dodd-Frank, the SEC decided (by a 3-to-2 vote) to implement it. It will require companies to explicitly disclose "total shareholder return" adjacent to compensation.
If you're an avid reader of proxies, you know that many companies already provide at least some of that information voluntarily. But this proposed rule would generate a compulsory, uniform, one-size-fits-some format, probably beginning in the 2016 fiscal year.
TSR is good for you:
"Total stockholder return" is just stock appreciation (or depreciation) plus dividends, expressed as an annualized return over some period.
We've calculated that number for our 50 money-manager corporations over 5 years as proposed by the SEC.
This is why we excluded some firms and CEOs whose stock wasn't trading before 2010. That includes some big ones, such as KKR and Carlyle Group.
As far as we can make out the SEC does not literally require computation of a pay-for-performance ratio like ours, but such an analysis is certainly implied. Our simple calculation just makes the comparison explicit.
What we can't do is anticipate exactly what the numerator will have to be.
What we have used is the so-called the SCT number (because it appears as the total comp number in a proxy's Summary Compensation Table).
Anywhere you turn--to Bloomberg, Reuters, Dow Jones, or wherever--you'll see the same number cited as a CEO's annual comp. It's official, but it's a compound of many things, including stock options which are contingent on uncertain future events.
Dodd-Frank and the SEC would like to see a pay number which pertains more strictly to the current year. Two other, narrower, definitions of pay have been proposed by various people: "Realized Pay," and "Realizable Pay." But until the feds decree otherwise, we'll stick with good, old SCT.
Rating the ratio:
Our pay-to-performance ratio is arithmetically simple, but what's it good for? A
s we saw above in the case of Mr. Dillon and Mr. Gabelli, it can upend a ranking of pay by raw dollars. Does that mean it's a better metric from the point of view of an analyst, an activist, an institutional investor, or even a humble retail investor?
In plain language, the ratio as we calculate it answers the shareholder's question: how many millions in comp did I have to pay my CEO for every percentage point of return he gave me?
In 2014 Mr. Dillon got $0.04 million (or $40 thousand) for every percentage point of 5-year return (of which there were 26.4). Mr. Gabelli got $6.3 million for every percentage point, of which there were 14.1.
Looking again at our chart, it's clear that the median value of the ratio is around 1.0. That means the median CEO in this group was paid about $1 million in 2014 for each percentage point of 5-year return to stockholders.
About a third of our CEOs have a ratio value within shouting distance of 1.0. This could be interpreted as meaning their pay is neither too big nor too small relative to the returns they generated, when compared to their peers in the same industry.
We think this kind of calculation is useful and illuminating up to a point. We don't think it is the definitive way to evaluate compensation.
Reverting to Mr. Buffett, we think it's interesting that the metric he's preferred to be judged by over the years is annual change in per-share book value. This was prominently reported at the beginning of each year's report. Only in 2014 (perhaps getting on board with the SEC) has the lead chart in the BH report also disclosed annual change in market-value per share.
Book-value return is a more conservative and stable number than shareholder return. The interesting point is that, over the long haul, the returns measured both ways are not that different. Over 50 years annualized growth in BH book value per share was 19.4 percent, whereas growth in market value per share was 21.6 percent.
Market value is far more volatile, of course, and the book-value number makes more sense to a Graham-and-Dodd fundamentalist like Mr. B. By implication, that's what he thinks he, as CEO should be judged on, and it's probably a key metric when he's looking at the pay of the subordinate CEOs who run his operating units (which can't be judged by market-price gyrations).
So, why doesn't SEC mandate that metric? Or various others in common use like five-year return on capital, return on equity, etc. Is it to accommodate short-term investors who aren't interested in the long term? If so, should the SEC be encouraging that?
Anyone with curiosity and a calculator can readily obtain all these numbers and many more. But it's the government's job to protect us, or at least to be seen to be doing something like that, so the regulations will continue to grow like Topsy.
Alan Johnson is managing director at one of the major compensation consultants, Johnson Associates in New York, and knows infinitely more about this stuff than we do. He was quoted by the New York Times, saying "If you are a serious shareholder, you know what the stock has done, and you can come to your own conclusion about whether the C.E.O. is the right leader."
What he said.
Perfecting the peerage:
We can't explain every anomaly in a ranking like this, but many of the outliers are explicable. The big banks and insurance companies, for instance.
We wanted to include them because they manage more than half of the Skorina 50's $27 trillion AUM. They are not strictly comparable to "pure" asset managers but, on balance, we thought it was worth including their well-paid CEOs in our list.
We included the big investment banks (Morgan Stanley, Goldman Sachs), commercial banks (e.g., Wells Fargo, Bank of America) and some big insurance companies (e.g., AXA, MetLife, and Prudential).
These firms have many ways of making money. The CEO is paid to wring good performance out of all the businesses, not just the AM platforms.
For example, the $1.6 trillion AUM in JPMorgan's asset management unit generated $12 billion of top-line revenue in 2014. That's only about 13 percent of the bank's total $91 billion revenue. So, although it's a major business unit, it's not yet wagging the dog.
But compare JPM to a major "pure" asset manager like Legg Mason. JPM has three times LM's $400 billion AUM, earning more than four times LM's $2.8 billion revenue.
Mary Calahan Erdoes, who runs JPM's asset management unit under Mr. Dimon, had total comp of $15.6 million in 2014, only about 60 percent of her boss's pay. But, since her unit doesn't trade as an independent company, there's no meaningful way to compute a Pay-to-Stockholder Return ratio for anyone but the CEO.
Ditto for Gregory Fleming at Morgan Stanley. He's another NEO (Named Executive Officer) whose comp is reported to the SEC. He made $17.4 million as head of wealth/investment management at MS, about 75 percent of the CEO's take. Clearly, the heads of asset management at these big financial-services companies are valuable commodities these days.
Generally, mega-firms in any industry will offer comp that is explained more by the size of their balance sheet than by share appreciation. That's why those CEOs are clumped together in the top half of the raw-dollar list, then mostly slide to the bottom of the pay-for-performance ranking. Most of the problem was in the denominator of the ratio.
In the JPMorgan annual report, CEO Jamie Dimon said: "...our stock performance has not been particularly good in the last five years. ... I believe that legal and regulatory costs and future uncertainty regarding legal and regulatory costs have hurt our company and the value of our stock..."
That seems to be the generally proffered explanation for poor stock performance by the big banks in this period. And, a handsome CEO comp divided by poor shareholder returns generates uncomfortably high pay-to-performance ratios.
But those legal and regulatory problems weigh most heavily on banks' core business of lending money (and, on some profitable sidelines such as proprietary trading).
In this environment, asset management (i.e., "fund management," "wealth management," "private banking," etc.) looks like an attractive business. It's not as capital-intensive as trading; diversifies earnings; and offers an attractive opportunity to cross-sell other products.
A notable exception to the big-bank blues is Wells Fargo. Mr. Stumpf holds his own quite well on our chart with a P-to-P ratio of 1.32. But the CEOs of JPMorgan Chase, Morgan Stanley, Bank of America, and Credit Suisse are all in the bottom tier with far higher ratios.
CEOs at some of the mid-size multi-line financial firms, however, such as City National, SunTrust, and U.S. Bancorp also look very good on a pay-for-performance basis.
The bottom-most P-for-P CEO, Brady Dougan at Credit Suisse, lost his job last year. We don't think our ratio did him in, per se; but troubles at CS certainly manifested themselves in shareholder losses. They are one of only three firms on our list which lost money for shareholders in a half-decade which was generally very good for stocks.
On the other hand, there is Mr. Lowenthal at (non-bank) Oppenheimer, whose P-for-P ratio was almost as bad as Mr. Dougan's. He's been on the job for 20 years and hasn't been shown the door yet. Why?
For one thing, their negative return in 2010-2011 was followed by a strong upturn. Annual shareholder return in 2012-2014 averaged over 13 percent for Oppenheimer, while CS managed only 2.7 in the same period. Mr. Lowenthal seems to have been fixing his problems after a bad patch; Mr. Dougan, not so much.
Is it just a coincidence that Wells Fargo is Mr. Buffett's favorite bank? He began buying in 1989 and kept scooping up more after the financial crisis, when it was cheap. He now owns almost 9 percent of Wells Fargo stock. He's the bank's biggest shareholder and it is, in turn, Mr. Buffett's biggest outside investment.
And Mr. Stumpf is well paid, with a package comparable to the other mega-bankers. But he averaged an annual return of 16 percent for his shareholders, while returns at JPMorgan and BofA were much lower.
We could cut out the banks and insurers to get a "purer" asset-management peerage, but where do you stop?
WisdomTree and BlackRock are both "pure" asset managers, and very good ones. They both sell a lot of ETFs, for instance; but BLK has a far bigger and more complex portfolio, requiring different kinds of senior management.
SEI started out as a software vender, and Schwab began as a discount brokerage. There are a lot of different roads to becoming a high-AUM asset manager, and different CEOs with different talents are needed to build and run them.
Now, here is a list ranked by 5-year shareholder return. (We also calculated three year returns to see the trajectory of performance)
The Skorina 50: CEOs Ranked by annualized shareholder returns 2010 - 2014
SH = Shareholder
The pure and the impure: of our 50 beat the S&P over five years. Most of them were pure asset managers. The big diversified companies, including all the "systemically-important" ones were mostly further down the list. With a couple of exceptions they all missed the S&P benchmark in this period.And, almost all the CEOs of those pure AMs had excellent (i.e., low) pay-to-performance ratios on our charts. Their salaries were easy to justify to shareholders on that basis.
As we see, the big, diversified firms had much more problematic pay-to-performance ratios. (Wells Fargo was an exception as we noted above.)
The proprietary SNL Asset Managers Index did just a hair better than the S&P, with 15.7 percent. That's also close to the return on the pure asset managers in our 50. That makes sense because our pure AMs are similar to the set tracked by SNL.
Our Skorina 50 returned a market-cap-weighted 10.2 percent annualized to stockholders over five years. This is very close to the S&P Financial Services number, which is unsurprising. Their mix of big diversified firms and smaller specialist companies is probably similar to ours on a market-cap-weighted basis.
Overall, pure asset managers generally gave their stockholders better returns than the big, diversified financial services firms in this period.
Managers-of-managers on a roll:
Vitus Investment Partners, a firm we'd never heard of, led the parade. They handed shareholders almost 60 percent annually in this period.
How did they do that? Virtus spun off from Phoenix Life Insurance and started trading on NASDAQ in 2009. They've acquired a stable of boutique managers and have also enlisted others as non-affiliated subadvisors. They sell an eclectic mix of high-rated retail funds: equity, fixed-income and real estate, and AUM growth has been very good.
Another high-flier on this list is Affiliated Managers Group which, as the name suggests, also pursues a manager-of-managers strategy, although they collect hedge fund managers.
Just a week ago the Financial Times pointed out that AMG and other multi-boutiques investing in hedge funds have been on a roll.
Virtus, WisdomTree, and American Capital all generated great stock appreciation, even though they are relatively small managers compared to some of the big dogs on our list.
But some of those AUM big dogs also got shareholder love in recent years. Ameriprise, Blackstone, Affiliated Managers, SEI, and Principal Financial all generated great stock appreciation, beating the S&P.
Four of those five big managers also sported very good-looking P-to-P ratios for their CEOs. The exception is Stephen Schwarzman at Blackstone. His $85.9 million comp in 2014 gave him a steep 3.15 P-to-P ratio and put him low on that list.
It was a very good year:
Mr. Schwarzman is said (by Forbes) to be worth $10.8 billion, mostly accumulated as his partnership share of PE deals over the past thirty years before Blackstone went public. We should note that his SCT comp in recent years was much lower than that colossal $86 million. As recently as 2012 it was "only" $8 million.
We have a specific focus in this report on shareholder returns and we haven't talked about some other really important things--like profit. Remember profit?
In 2014 Blackstone had a very good year. It was the most profitable publicly-listed asset manager in the world. Their net income was $4.3 billion, up 24 percent from the previous (also very good) year.
The annual report states that Blackstone has no compensation committee, although COO Hamilton James has a big say in what the senior execs will receive. Except for Mr. Schwarzman, that is. The report states that "As our founder, Mr. Schwarzman sets his own compensation..."
It's good to be the founder.
Mr. Schwartzman had a base salary of $350,000, as always. The other $85.5 million is "other" compensation consisting largely of "carried interest."
Carried interest arises when PE managers wind up a fund and return all capital contributed by the limited partners. Typically, the managers are entitled to 20 percent of proceeds from a fund, but only after fund performance exceeds a 7 or 8 percent hurdle rate.
Carried interest is essentially a performance fee. It's the "20" in the infamous "2-and-20" fees paid to most private equity and hedge funds. The "2" in 2-and-20 generates a steady revenue stream in good times and bad, but the "20" --carried interest--is subject to huge up and down swings. This year it swung way up.
The outside investors (limited partners) agree to that formula when they invest in each fund, and we can assume that the LPs in the Blackstone deals wound up in 2014 - and they included lots of worthy institutions such as college endowments and public pension funds - also got a nice return on their money before Mr. Schwarzman got his.
We note that Blackstone has had no trouble at all raising billions more in 2014 from investors who are eager to risk their money on the same basis.
But wait, there's more.
That $86 million is what Blackstone thinks should be disclosed as the total comp in the Standard Compensation Table in SEC filings. (And, as we've seen, Mr. Schwarzman has the final word on his own reportable comp). But he is also a partner, owning partnership units (which are sort of like shares of stock, but better).
If we're doing the math right, Mr. Schwarzman also got $570 million in dividends which the board declared on his partnership units. So, although only $86 million is official SCT comp on SEC filings (which is our source for all CEO comps), his total take-home for 2014 is actually about $656 million.
With each fund they launch, Mr. Schwarzman and his colleagues risk their own general partnership money alongside the limited partners.
Dr. Cliff Asness of hedge fund AQR Capital made the same point forcefully (as he tends to do) two weeks ago in a letter at his website. In relevant part he wrote:
The income [the media] report, probably just to make the numbers larger... is the sum of what the managers made from their hedge fund businesses (what their clients paid them), and what they made on their own investments in their funds (where many keep much of their own money).
... it's mostly just a list of who started out really wealthy and had decent returns and who we can also label a "hedge fund manager" ... It is voyeurism and mostly just an excuse to ... make tired snarky comments as if this were fresh and new stuff.
Observers will have different opinions as whether Mr. Schwarzman is being appropriately compensated as both investor and executive. But Blackstone's repeat business implies that the market is still happy to pay what he charges to get the results he produces.
Other pay-for-not-so-great performance:
That other "Black" outfit generated only mediocre shareholder return. BlackRock gave investors an annual 10.2 percent over five years when the S&P 500 was furnishing about 16 percent. But it's by far the biggest pure asset manager on our list--and in the world--with a stupendous $4.6 trillion AUM.
Mr. Fink earned a pretty respectable $23.9 million for his efforts despite so-so stock appreciation. Reading the proxy, we were bemused to note that BLK changed a key metric for Mr. Fink's stock grants. It eliminated stock price as a factor and replaced it with organic asset growth and operating margin. Apparently their board doesn't think stockholder return is as important in judging comp as Congress thinks it is.
Mr. Fink doesn't pack the billions of personal wealth that Mr. Schwarzman does but, with more than $400 million in BLK stock, he's not a poor man, either. He's been in charge since the IPO in 1998, as the stock price increased 20-fold, so he can take credit for much of the value in his own portfolio.
Besides, his ambitions may point elsewhere. In 2013 BlackRock put Cheryl D. Mills, a close friend and advisor to Hillary Clinton, on the board. Some have speculated in print that Mr. Fink yearns to cap his career as our next Secretary of the Treasury.
Finally, we note that Janus, with $174 million AUM, doesn't seem to have done much for its stockholders over five years. And that's even including the big run-up in the last quarter of 2014 after they made the head-lining hire of Bill Gross.
Richard Weil was recruited away from PIMCO in 2010 and was handed $20.3 million, including a $10 million signing bonus. The shareholders gave a thumbs-down to that package in a non-binding say-on-pay vote in 2011. Mr. Weil's comp was cut to $6.1 million in 2011 and then further cut to $4.7 million in 2013. But in 2014, as we see above, Mr. Weil's pay was up 75 percent year-over-year.
In our trek through the proxies we were especially impressed by the report of Janus's compensation committee, which discussed the theory and practice of executive pay and performance for a full 27 pages. Eight pages bore directly on pay for Mr. Weil.
The committee chair is our friend Dr. Lawrence Kochard, whose day job is running the excellent University of Virginia endowment, so we read it carefully and we commend it to our readers.
In figuring Mr. Weil's bonus, they gave 30 percent weight to "financial results for Janus shareholders," but shareholder return was not among the metrics. Instead, they looked at meat-and-potatoes stuff like operating income, margin growth, and strengthening the balance sheet.
Mr. Buffett would probably approve. Congress, not so much.
At the top of the letter we promised to consider the comp of America's most lovable CEO.
As all the world knows, Mr. Buffett accepts only $100 thousand per annum to run Berkshire Hathaway. At that, he may be overpaid, since he's publicly declared that he would pay them to let him do the job.
He is a frugal man, but he's still got expenses. There's a wife, children and grandchildren; and we presume he doesn't cook his own meals or cut his own grass. Not to mention all that Cherry Coke he consumes. His suits may always look rumpled, but they're still nice suits. How does he do it?
Granted, he's got all that BH stock: around $68 billion worth. So, all he has to do is sell a share of BRK-A (at $207 thousand per) now and then. But he doesn't. According to public records, Mr. Buffett never sells any. He does give some away as charitable gifts from time to time, but he never sells. The stock rose more than 25 percent in 2014, so he made many more billions. But you can't eat unrealized gains.
What about the Berkshire dividends? Nope. There aren't any. Mr. Buffett doesn't believe in them. All BH profits are reinvested in the company.
The secret seems to be that, back in the 60s, when he wound up his old investment partnership and put all his money into Berkshire Hathaway, he didn't quite. He just put most his money (about $25 million) into BH. He kept a few dollars in a side pocket. (It's not really a secret; his private holdings can be winkled out of certain SEC filings.)
After 50 years that private stake is now worth around $2 billion. It consists of old-school dividend stocks with a 3-percent yield. Even after taxes it gives him over $50 million per year without invading his capital.