Provocation: Carried Interest and Talent Management

Ashby Monk

I’ve got a provocative question today that will no doubt result in some angry and curse-laden emails from my friends in the asset management community. But this is, after all, a venue for sharing thoughts and ideas…so here goes:

Will President Obama’s plan to end the tax break on carried interest result in more talented individuals going to work at talent-starved pension and sovereign funds?

First some background: Obama is looking to raise $18 billion by taxing the carried interest (or compensation based on the profits achieved) of private equity managers, real estate investors and venture capitalists as ordinary income (~35%) instead of the long-term capital gains rate (15%). As such, these private sector investors may soon take a big hit to their take home pay. And, given that pension and sovereign funds don’t pay their staff (that I know of) with any form of carried interest, the gap between the compensation of public and private investors operating within these asset classes will shrink.

So, I’ll repeat my question: Will Obama’s plan help public investors bring some of these talented individuals on board? I can’t say for certain, but my rudimentary understandings of labor markets tells me that this move may at least bring some of the public investors closer to the market clearing wage in these industries. And, if it happens, then this new proposal could in fact have some real implications for talent attraction.

Over the past decade, I’ve had the opportunity to speak with hundreds of senior public pension and sovereign fund executives about their internal operations and challenges. Through all these conversations, I’d say the single most pressing issue facing these managers is how to attract, incent, and retain the human capital they require to run a modern institutional investor. It’s a huge problem with many facets. One of the main issues, however, is the discrepancy of pay between public and private managers. When the private sector pays multiples of what you pay, the private sector wins. It’s that simple.

And this leads me to the real provocative punchline: By taxing the carried interest of these investors, the federal government will raise revenue, and the public pension funds may end up being able to hire the talented individuals they require to achieve the returns they need to prevent a state bailout. That’s sort of a win at the federal and state levels.

But, alas, I’m not so naive as to think this is how it will play out. For example, instead of leaving their New York PE shop for Alaska or Montana, many of these individuals may simply leave the country altogether. At the very least, then, it’s a nice provocation for your Thursday afternoon. (Cue angry emails.)

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This website is a project of Professor Gordon L. Clark and Dr. Ashby Monk of the School of Geography and the Environment at the University of Oxford. Their research on sovereign wealth funds is funded by the Leverhulme Trust and The Rotman International Centre for Pension Management.

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