Emma Dunkley reports from Global Pensions' annual Transition Management Forum held on September 9, 2009 at Plaisterers' Hall, London
The transition management industry has experienced unparalleled volatility over the last year, said Mercer Sentinel principal Andrew Williams. Despite this, Williams explained the role of transition managers and their importance within the pension fund industry. For example, he said consultants do not often have the robust cost strategies that transition managers can provide.
Transition managers can transfer one manager’s portfolio to another, and can identify where certain stocks should be allocated among many managers, which can be a tough administrative task. He also said transition managers can execute large trades in a short time and in a controlled manner. He added: “Transition managers play a vital role in the industry, so with large-scale asset transitions, a transition manager is important.” But he said that there is the need to establish a performance database. “We owe it to ourselves and the industry to have a database with performance figures.”
Barclays Global Investors head of transition management Europe Lachlan French explained the risks involved in a portfolio restructuring project and ways to mitigate these risks. He said that although the industry has experienced unprecedented volatility from the end of 2008, this has settled back down to more normal levels, which is good for clients looking to restructure their portfolios.
The events of the last 12 months have caused a reassessment of risk attitude and a focus on which risks to analyse. For example, transition risk includes risks surrounding asset allocation, sector and stock risk, high liquidity risk and counterparty risk. In order to mitigate some of these factors, he said risk management can provide an overlay of futures, swaps, or optimised trade scheduling.
A panel of industry experts addressed the issue of how to measure and compare the success of a transition, when the transition manager at present decides the outcome based on whether it beat its benchmark. However, the panel said this is not the best industry benchmark for measuring success, and highlighted that other industries are able to objectively assess performance. Credit Suisse head of European transition management sales Steve Webster said: “This should’ve happened a long time ago, but its development now shows a sign of maturity.” However, he said that all benchmarking exercises provide a struggle, because benchmarking needs to capture the information from quality data.
Russell Implementation Services Limited EMEA managing director Ian Battye asked whether benchmarking is defining a desire to allow comparability between rival transition managers in order to choose between them, or to compare the pre-estimates of transition managers and compare how close they came to achieving this.
Inalytics chief executive Rick Di Mascio said due diligence is around choosing a fund manager and then assessing whether they did a good job with the money. He said: “We want to apply these standards to our industry, to help pension funds with due diligence when selecting a pension fund manager and whether the outcome was down to luck or judgement.” He added that “we are very close” to finalising the “league table” of transition managers, and said this is now dependent on the goodwill of the transition management industry.
Investors’ point of view
Universal-Investment head of transition management solution Juergen Winter discussed the investor’s experience of using transition managers and how to use them. He said that sell-side providers have direct access to liquidity and risk management expertise, although they have possible conflicts of interest, while the buy-side has access to multiple sources of liquidity and has low conflicts of interest.
He explained how to set up a transition panel and the factors involved in the process, such as discussing with transition managers their model, experience and liquidity, explaining the legal framework within the master fund, and the due diligence process needed prior to establishing a master agreement. He also outlined the various implementation risks, such as trading, and operational risks, such as settlement issues and project management.
J.P. Morgan managing director and head of transition management EMEA Michael Gardner explained the use of derivatives within a transition event, in order to mitigate risk or tracking error. He said that in the last 12 months, the choice of model used to define tracking error or risk has been of high importance. He said funds could use futures and exchange-traded funds to manage risk, although these hedging index tools can also have tracking error.
He said: “Futures are a good low-cost way to gain exposure, but need to go through futures and options clearing. Also roll costs could accumulate.” Alternatively, ETFs have no administrative burden in this sense, but could be more of a cost for short-term hedging. For example, if the size of the order is significantly large, this would require the creation of units, which would be more costly. “Futures are inexpensive upfront while ETFs are more expensive upfront.”
While hindsight has become the typical benchmark for due diligence, industry players are pushing for greater transparency on cost estimates and performance results, said Inalytics director Graham Dixon. He explained that the T-Charter, launched in 2007, is a code of best practice for transition managers, which stipulates that managers have to disclose conflicts of interest, cost estimates, and remuneration. He highlighted that not all transition managers are the same, with some better at managing certain asset classes and many having different skill sets.
With all these differences, Dixon asked what is the benchmark for due diligence on transition managers? He said: “This is about data available from transition managers and their results, from a trustee perspective, to carry out the due diligence – but they are frustrated they haven’t got the data to carry this out. This data should be ‘GIPS (Global Investment Performance Standards)-like’ – full and fair.”
Hewitt Associates senior investment consultant Robert McElvanney explained the reasons for having a panel of transition managers, when this is appropriate and how to select a panel. He said the benefit of having a panel is that once it has been selected, you do not need to repeat the selection process for future transitions. He said a panel can act quickly while bringing a wider variety of skill sets. However, he said as establishing a panel is initially more time consuming and costly, it requires ongoing maintenance and is more open to potential information leakages.
He said that large funds with an active structure would suit a panel, as these funds make changes to asset allocation more frequently, while this is not appropriate for funds with static asset allocation as the cost of the panel would be unjustified.
A year after the crisis
Credit Suisse’s Steve Webster discussed the transitioning of equities amid the fragmented equity markets over the last 12 months, which have forced managers to develop new approaches. The impact of the banking crisis has seen a reduction in the number of transition providers from 14 to 10, along with a decrease in programme trading providers. Nonetheless, Webster said there has been an increase in demand for transition management, as a result of increasing allocation changes and market volatility.
Developments in technology have meant that trading is no longer done in one destination, especially in the US, meaning that if providers are not linked to this destination, they cannot see a price. He said trading algorithms are able to meet the challenges of de-centralised liquidity and increased volatility. He added: “Transition management utilises liquidity. Greater liquidity will lead to faster progression, with less execution costs.”
State Street Global Markets head of EMEA transition management Rick Boomgaardt discussed transitioning fixed income securities in challenging markets. He said that despite the last 12 months presenting the toughest conditions for the fixed income market, demand for fixed income in transition management is stronger than ever. He explained that during the crisis in the fourth quarter of last year, it was tough to value a corporate bond. As a result, finding the right counterparty to deal with is very important. He said: “Concentrated execution with a single dealer is sub-optimal – it doesn’t make sense to have a single counterparty.” He said this should be replaced with a multi-dealer agency approach with fixed income.
Citi head of US transition management sales Sarah Kirschbaum discussed the need for specific skills when transitioning global mandates, as these portfolios entail greater risks. She said that while it is hard to judge tracking error risks, transition managers understand the sub-categories of risk, including tracking error in certain regions, currencies, sectors and industries.
She said: “With a global mandate, usually more partners are involved, so communications and coordination needs to be perfect and every counterparty experienced.” In terms of FX risks for global portfolios, she said many transition managers will offer to trade at a benchmark, at a particular time or fixed rate. She said clients also need to consider whether providers have the tools to identify the financial and operational risks, such as whether their systems function in all market places, if they have experience across them, and what third parties must the provider use to execute a global mandate.
Russell Implementation Services EMEA managing director Ian Battye explained the need for an interim management solution when a manager’s control over a portfolio needs to be removed. He outlined various solutions, such as continuing business as usual without notifying the manager or custodian, freezing the portfolio, or transition legacy assets to passive managers, such as ETFs or index futures. He also suggested transition legacy assets to interim portfolios with target tracking error relevant to the benchmark. He concluded that interim asset management was the most effective option, in terms of sound governance, low management fees, cost effective transactions, and flexibility.
Mellon Transition Management director Mark Dwyer discussed how beta overlay using derivatives works as an effective transition management risk mitigation process. Dwyer said that when an asset manager is terminated and a new one has yet to be selected, you can make a temporary move to full indexation or instruct your transition manager to provide a derivative overlay. This allows a client to put on a hedge while liquidating a portfolio, and then select an alpha manager while simultaneously picking off the overlay exposures. He said the risk of this is in the potential tracking error. He said: “While a simple futures overlay can hedge a global benchmark, there is an element of risk you are assuming.” In order to have an efficient low cost derivative, it needs to be based on an efficient low cost market, although certain emerging markets, for example, are not that liquid. “Exchange-traded derivatives offer a simple, low-cost way to manage risk. We could have offered swaps and options, but pension funds are more reluctant to do this.”
The round table discussed what buy-side and sell-side can offer pensions funds in the transition market and whether the banking model has been damaged by the redundancies earlier on in the year. J.P. Morgan global head of transition management John Minderides said that bond pricing has related to performance and that the pull-back of some providers is not a reflection of the model. He said: “It’s not about sell-side versus buy-side; it’s more about the profitability of the business.”
Sarah Kirschbaum said that over the last five years, a lot of problems with both the buy side and sell side models have been addressed, while regulatory changes have affected the way firms do business. She said: “The consideration isn’t buy-side against sell-side, but what kind of modeling makes sense to you.”
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