Private equity firms entering the infrastructure assets class can better align their fund managers' pay with the risk of their investments by appropriately balancing the levels of carried interest, base salary and bonuses, according to Mark Hoble, a principal at Mercer Consulting in London.
“I think the 2-and-20 is sort of taken as gospel and what we’re saying is that that might not be appropriate given the risk and reward profiles of the assets,” Hoble told InfrastructureInvestor.
In September, Hoble, a human resources consultant at Mercer, co-authored a report on fund manager compensation in infrastructure funds.
For relatively safer assets such as utilities and toll roads, Hoble said pay packages should lean more heavily on short-term compensation consisting of base salary and annual bonus, and rely less on longer-term “at risk” capital like carried interest. Conversely, as the risk profile of the fund's investments increases, the amount of short-term compensation should decrease and the amount of longer-term compensation should increase.
“By doing that we are changing the risk profile of the [compensation] package to be more aligned with the risk profile of the asset,” Hoble said.
The bonus should be based on a metric such as cash distributions from the assets purchased, Hoble said. “It incentivises less risk taking.”
Longer term compensation plans like carried interest should likewise vary in accordance with returns suggested by the fund’s risk-reward profile. Hoble said managers of lower-risk funds should earn a carry of 10 percent and managers of higher risk funds similar in their returns to buyout funds should earn carry in the area of 20 percent, with medium risk managers falling somewhere in between. He recommends a similar strategy for management fees, which could vary between 1 percent and 2 percent over the same spectrum.
Hoble also believes that varying the amount of time fund managers have to wait before they receive any carry can be a key driver of effective compensation. For lower-risk funds with a more long-term investor base, he recommends a longer time frame before managers are awarded any carry, such as seven years. As funds invest in riskier assets and acquire a more short-term investor base, the carry distributions can start earlier, at five years into the life of the fund.
“The clients we’re working with, executives in funds, discount their carry. Too often it’s seen as a fairly inactive part of the package, whereas if go into a buyout fund, the carry is a very tangible thing. One can see significant reward in short term,” Hoble said.
Co-investment and match of funds should be brought to reflect the risk profiles of the infrastructure fund by awarding lower matches such as 1:1 for low risk funds and higher matches like 5:1 for high risk funds.
Infrastructure fund manager compensation: varied with risk