Under the new performance regulations, public fund managers' "maximizing compensation strategies"

Under the pressure of new regulations that directly tie fund manager compensation to long-term performance, how to maximize the probability of beating the market while minimizing the risk of pay reduction has become the core topic in the public fund industry.

On December 25, a latest research report from the Zheshang Securities strategy research team provides a clear set of "strategies" for fund managers through deep backtesting of historical data: highly diversified holdings, increased management scale, maintaining team stability, and strategically changing performance benchmarks are key to enduring cycles and adapting to new rules.

According to the report, the new performance evaluation system establishes a "tiered compensation adjustment mechanism" that directly links fund manager pay to the rolling three-year performance of the fund under management. The mechanism stipulates that if a fund's "three-year product performance falls more than 10 percentage points below the performance benchmark and the fund's profit margin is negative, the manager's performance-based compensation must drop significantly compared to the previous year, with a reduction of no less than 30%."

This strict constraint means fund managers must not only pursue relative returns, but also strictly control downside risks, particularly avoiding "significantly underperforming" the benchmark. Zheshang Securities analysts Liao Jingchi, Wang Daji, and Gao Qisheng noted in the report that this change is profoundly impacting fund investment strategies. Simulation backtests of general equity funds from 2022 to 2025 show that traditional investment models are facing challenges, while certain fund characteristics show greater survivability.

Bull or bear market determines survival? Overall underperformance rate is highly correlated to market conditions

The report indicates that whether a fund can outperform its benchmark is closely tied to the macro market environment. Data shows that between 2022 and 2025, the proportion of general equity funds underperforming their benchmarks was 5.9%, 47.1%, 72.3%, and 47.6%, respectively.

This fluctuation is highly correlated with the A-share market's three-year rolling annualized increase. For example, in 2024, the market's three-year rolling annualized growth rate was the lowest (11.6%), with the highest proportions of funds underperforming and significantly underperforming their benchmarks (and thus possibly facing pay cuts), reaching 72.3% and 51.1% respectively. In contrast, in 2022, the market's three-year rolling annualized growth rate was the highest (24.9%), and the proportion of funds underperforming was the lowest.

An interesting phenomenon is that, due to the rolling three-year evaluation mechanism, the first year of a bear market (such as 2022) had the highest outperformance rate, because the previous two years of bull market performance provided a support; while the first year of a bull market (such as 2024) had the highest underperformance rate, as the previous two years of bear markets dragged down overall results.

Active vs Quant: Active fund underperformance rate is higher than quant funds

Backtesting shows actively managed funds have significantly higher underperformance rates than quant funds. From 2022 to 2025, the underperformance rates of active funds were 6.2%, 48.1%, 74.5%, and 50.0%. By comparison, quant funds in the same period had rates of just 3.5%, 39.4%, 52.3%, and 27.1%.

The report suggests this mainly benefits from two features of quant funds: first, highly diversified holdings that effectively avoid irrational behavior and specific stock risks; second, systematic trading strategies that avoid interference from human emotions.

Quant funds execute trading strategies through systematic algorithms, avoiding interference from human emotion factors, are highly disciplined, have no obvious industry bias, and holdings are highly diversified, requiring the market to maintain adequate liquidity.

“Not betting on sectors” is safer: Broad market funds have lower underperformance rates

The report divides funds into "broad market funds" (benchmarked against broad-based indices) and "non-broad market funds" (usually industry or theme funds). Data shows that non-broad market funds have higher overall underperformance and significant underperformance rates than broad market funds.

Especially in bull markets, if their heavily invested sectors don't keep up with market rotation, non-broad market funds may miss trends; and in bear markets, their typically held high-valuation growth stocks face greater drawdown pressure. This suggests that for fund managers seeking stable outperformance, excessive bets on single sectors are not optimal.

Diversified holdings are key: more diversification, higher probability of outperformance

A core finding of the report is that diversification is an effective way to reduce risk and increase the likelihood of outperformance. The report screened for funds holding more than 200 stocks and with less than 2% weight in their largest holding, finding such "diversified holding funds" have underperformance and significant underperformance rates both lower than the overall market, even slightly better than quant funds.

Zheshang Securities specifically stated in the report: "Funds holding more than 200 stocks have lower rates of underperformance and significant underperformance in backtests than the full market, slightly better than quant funds." As holdings become more diversified, the effect is stronger.

The report says, "If we screen for funds holding more than 500 stocks, highly diversified, in 2022-2025 their underperformance rate is even lower than the overall market, and in the relatively weak markets of 2022-2023, they completely outperformed the benchmark."

The report believes diversified holdings "effectively avoid large swings of single stocks impacting fund net value," thus improving portfolio stability. For fund managers intent on avoiding pay cut triggers, this is a highly attractive defensive strategy.

Scale is an advantage: large funds have lower underperformance rates

Fund scale is no longer a burden of “a big ship is hard to turn”; instead, it becomes an advantage. Backtesting shows size and probability of underperforming the benchmark are clearly negatively correlated.

Order of underperformance rate: large funds (>5 billion) < medium funds (1-5 billion) < small funds (100 million-1 billion) < micro funds (<100 million).

The report is blunt: "The fund’s underperformance rate is generally negatively correlated with size; the larger the fund, the lower the underperformance rate, while those under 100 million have the highest rates of underperformance and significant underperformance." Specifically, underperformance rate follows "large < medium < small < micro." Data show that funds over 5 billion in size underperform at lower rates than market average, while those under 100 million are "significantly higher than the overall market."

Zheshang Securities analyzes that scale advantage mainly comes from three aspects: first, large funds "due to higher trading volume and stronger bargaining power, can get lower commission rates"; second, they often have "stronger research capability"; third, they can "construct more diversified portfolios to reduce unsystematic risk."

"Technical" operation: changing benchmarks can effectively reduce pay risk

The report finds that while changing performance benchmarks doesn’t necessarily increase outperformance rates across the board, its core value lies in risk control. The report stresses, "Funds that have changed performance benchmarks may not differ much from overall market in underperformance rate, but can significantly reduce significant underperformance rate, i.e., minimize pay adjustment risk." "Significantly underperforming" is exactly the clause triggering 30%+ pay cuts.

This means fund managers can proactively manage their relative performance results by selecting benchmarks that fit their strategy and expertise better. The report says, "Fund managers who care about benchmarks and relative returns can 'reverse’ disadvantage by choosing a more suitable benchmark." Under the new rules, choosing the optimal benchmark is "crucial" to fund performance and manager pay.

The importance of stability: frequent manager changes increase underperformance rates

The stability of fund managers is also shown to be a key variable affecting long-term performance. The report finds that products with frequent manager changes have much higher probabilities of underperforming the benchmark.

According to the report’s statistics, "Compared with the overall market, funds with frequent manager changes show obviously higher rates of underperformance and significant underperformance in backtests." On the contrary, "funds that have never changed managers" in most backtest years have underperformance and significant underperformance rates that "are generally flat or lower than the overall market."

The report analyzes that the reasons may be "strategy switching and portfolio adjustment costs from frequent manager changes." A stable management team has a "strategy consistency advantage," effective control over transaction costs, laying the foundation for long-term stable returns.

Other findings: manager tenure has no significant impact

Additionally, the report has some other noteworthy findings. For instance, the length of a fund manager’s career does not seem to be a decisive factor.

The report notes, "The length of fund manager tenure shows no significant difference from the overall market’s underperformance rate"; senior managers with more than 10 years on the job have "no significant advantage over those with less than three years" compared to the whole market.

Also, "whether the fund includes Hong Kong stock positions shows no significant difference from the overall market's underperformance rate, mainly depending on AH relative strength."

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