In January 2008, Global Pensions launched the inaugural New York Transition Management Forum New York. It was attended by pension fund managers, asset controllers and industry professionals from all over the US. Reporting by Elizabeth Pfeuti
Kevin Byrne, managing director, BNY Global Transition Management, began his presentation by explaining how the process worked and what steps a pension fund should go through to engage a provider.
Byrne told the audience a pension plan's custodian might not necessarily have the skills needed to efficiently complete the deal, so a specialist with risk and project management skills should be employed to ensure a cost efficient transition.
A transition manager would calculate a portfolio's optimal trading points and identify the hidden costs along with what a pension fund would expect to pay.
Byrne illustrated the various stages a transition would go through, highlighting the importance of sufficient preparation and evaluation of assets before any transactions should be carried out. Finally, a detailed analysis should be conducted after the transition according to Byrne.
By viewing the estimated and actual costs, it would be possible to measure the manager's success and provide an essential benchmark for subsequent actions. A pension fund should expect full transparency before feeling comfortable and engaging a transition manager, concluded Byrne.
Panel discussion: transition management for pension funds
A panel of industry experts discussed when a pension fund should bring in a transition manager. They debated whether a panel or systematic approach was more appropriate.
Paul Sachs, principal, Mercer Sentinel Group, said a pension fund should engage a transition manager as soon as it was envisaged such a transaction would take place.
Sachs said due to the rapidity with which asset transferrals occurred and the universal shortage of lead-in time, if a pension fund had a team on standby it would be beneficial in terms of being able to address strategy issues.
Lance Vegna, director and head of Credit Suisse Transition Management and Pension Strategy, commented trustee and retirement boards usually left the procurement of a manager to the last minute, but really portfolio analysis required a larger time frame.
David Hanlon, director, sales and marketing, Mellon Transition Management Services, commented there was a risk of information leakage if a pension fund brought in a manager too early, but Vegna responded that explicit portfolio details should not be given out in the tendering process.
Sachs added a uniform model portfolio should be issued to establish which provider could give the best offer as initial planning would not require great detail.
The panel agreed adequate due diligence on any manager before signing a contract was key to a successful transition.
Questions to ask potential managers centered on the rebates and commissions they received when selling on the pension fund's assets. According to the panel this could throw up hidden costs or show possible conflicts of interests and fiduciary duties.
When and how to rebalance?
Rebalancing triggers and techniques which would require a transition manager were examined by Will Feehily, managing director, and Will Kinlaw, head of advisory research, both at State Street.
Kinlaw talked the audience through a model to indicate a portfolio's optimum balance and the loss of returns a small percentage difference could make.
He explained after the initial allocation of assets, portfolio distribution could drift due to trading circumstances and affect its profitability.
State Street's model, however, also showed at what point it would be necessary to address this drift so as to not attract excessive trading costs which could wipe out any benefits of the rebalance.
Kinlaw also mentioned how current trading and rebalancing could have a knock-on effect on future trading. Any rebalancing of illiquid assets in the portfolio would have to be addressed in this process.
The model used a heuristic process designed by financial risk theorists Harry Markovitz and Erik van Dijk. Feehily said this process was becoming more popular as pension fund investors became more sophisticated.
The transition manager as fiduciary: what does it mean for investors?
The topic of fiduciary within the transition managment space was addressed by Jamie Cashman, director of marketing, Mellon Transition Management Services, and Steven Glass, JD head, Plexus Plan Sponsor Group, Inc.
Cashman began by explaining how the concept had gained prominence after the US government passed the ERISA legislation.
He emphasised the Employee Retirement Income Security Act (ERISA) meant a transition manager had to act entirely in the best interests of the pension fund and this could create problems.
Cashman identified the process of principal trading, where the manager would buy securities directly from the pension fund.
This, he said, could suggest the fund may not get the best deal available. He added that in this fiduciary capacity, the transition manager would have to admit it if this was the case.
Glass said employing a transition manager did not absolve trustee boards of the fiduciary responsibility which would require them to bring in the 'best fit' provider.
Research and analysis from Plexus on many US transactions showed each transition to be different in the mapping out, execution and result stage, so early planning would help funds make an informed decision.
The process of principal trading was also raised by Glass who questioned whether the manager purchasing the securities could act impartially.
Agency vs. principal trading: how they serve client needs and how pre-hedging is defined
Ross McLellan, senior managing director, State Street Global Markets, entered the agency vs principal trading debate with a presentation showing what pre-hedging meant to a pension fund.
He explained under the agency basis, the transition manager would act as a broker and sell a pension fund's assets at the best possible price.
Under the principal agreement, the manager would buy the holdings itself, raising the debate over whether as a purchaser the manager could act in the pension fund's best economical interest.
McLellan pointed out transition managers were privy to a great deal of information about a pension plan's portfolio and therefore should use the utmost discretion.
He added certain transactions could be carried out as principal trades without the clients' knowledge, which strengthened the case for transparency in the industry.
Can pre-hedging benefit or harm the client and why is it so controversial?
Steven Glass of Plexus Plan Sponsor Group returned with further information on prehedging, the process whereby a transition manager agrees a fixed price for a security before the transaction begins, rather than basing it on exact, current market rates.
Looking at the potential benefits and harm the process could bring to investors, Glass created three scenarios: the good, the bad and the ugly.
The major benefits of pre-hedging, according to Glass, related to risk in the market; by carrying out this process, pension funds could see their assets safeguarded from much of it.
The bad, or downside, would see markets impacted by managers pre-hedging stocks and paying a price which would force some rebalancing of a portfolio.
The ugly aspect would occur if a transition manager acted inappropriately by misrepresenting the price of a security to a pension fund. As the basis for principal trading put the manager and pension fund in adversarial roles, it would be essential to have a fully transparent understanding between the parties, as pension funds were not in a position to monitor trades carried out by transition managers, according to Glass.
During the following question and answer session, Cashman and McLellan added the relationship between transition manager and pension fund should be based on mutual trust and good faith.
The road to the UK's T-Charter and assessing transition costs
Rick di Mascio, chief executive, Inalytics, and chair of the T-Charter committee, took to the stage to share with the audience the challenges faced when trying to reach consensus on the UK industry-wide document.
Di Mascio began by explaining, through Inalytics research into transition deals, he had discovered how the range of different practices across the industry required some kind of guidance over consistency of standards.
Lack of transition experience was cited as a reason for this along with lack of transparency. He said the T-Charter's voluntary status was the reason for the code's success, as lawyers had been unable to agree and regulators were unwilling to enforce it.
Despite it being a UK-based document with no legal status, the T-Charter, according to Di Mascio, was now being used when issuing RFPs.
This would either entail the client stipulating any applicant be a signatory or it being used as a guide to what questions to ask when assessing tenders for the mandate.
Di Mascio sparked a debate on pre-hedging by saying research by Inalytics showed many transactions carried out in this sector were done very badly, but none of them were adversely affected by the process.
Di Mascio declared it a 'nonsense' to forbid pre-hedging, saying poor project management and a lack of communication with the client was often the reason a deal went badly.
He concluded comparing pre and post trade portfolios was the only way to truly benchmark whether the transaction had been successful.
Panel discussion: transparency and the role of the T-Charter
Representatives from the industry took part in a debate, led by Di Mascio. The panel was initially asked whether the UK-based T-Charter had affected how transition managers in the US conducted their business.
It was agreed most global companies had run all proposed articles by the US part of their business. Mark Kelcher, chief executive officer, Mellon Transition Management Services, commented the document needed some development to help increase transparency and disclosure, but essentially the process had the same issues the world over.
Glass at Plexus pointed out there was no independent process to verify results and this would continue to cause problems until corroboration could be achieved.
Di Mascio asked the panel whether fiduciary was a real consideration, or whether it was just used as a security blanket. John Minderides, global head of transition management, JPMorgan, argued in the UK it was impossible to function in this sphere and ignore fiduciary duties.
McLellan agreed in the US the industry was regulated by ERISA's ruling on fiduciary responsibilities which, the panel explained, would prohibit certain trades.
As the discussion moved to cost structures, Kal Bassily, global division head, BNY Global Transition Management, commented all providers should use the same method to evaluate pre-trade estimates.
Kelcher added there were other qualitative measures to consider, not just the lowest cost estimate. Di Mascio thanked the 17 signatories of the TCharter for their efforts in passing the charter, highlighting the part played by Global Pensions in bringing the document the public area.
Mitigating risks during transitions
Lance Vegna of Credit Suisse illustrated various risks associated with asset transferrals and how they should be approached by a pension fund and its transition manager.
Vegna began by explaining how tracking errors, trading execution and market exposure could not only affect the performance of a pension fund portfolio, but could impact significantly on a transition; these factors should be addressed by managers in the initial planning stages.
In periods of higher volatility, such as the current environment, Vegna said it was essential to identify operational risks which could spell disaster or success for the transaction as early as possible.
Vegna explained how potential issues, such as withdrawal penalties or tie in periods for commingled funds could hold up the transferral of assets, throw out the whole timeline and ultimately cost the pension fund more than the original estimate.
He continued that each transition was different and would have to be tackled in a bespoke manner. He added that early preparation could mitigate much of the 'surprise risk' element.
Due to the increasingly complex way assets had become allocated using various asset classes, hedging and swaps, Vegna said it was vital transition managers communicated effectively with their clients to understand the risk involved in shifting their portfolio and available solutions.
Paul Sachs of Mercer claimed picking the right team to carry out the transition was the most important decision a pension fund could make.
Sachs said this could be carried out by having a 'bench' or panel of experts on hand to step up at any given moment.
There would be a range of benefits to having this team on standby, including a quicker reaction time to short-notice transitions and a better chance of securing a good contract as the various panel members would compete vigorously for each mandate.
The process of picking the right manager for each transition was they key to a successful selection and subsequent transaction, according to Sachs.
Large funds with a diverse range of assets or employing active managers would have more occasion to retain such a panel, but Sachs said defined benefit (DB) and defined contribution (DC) schemes were using now the service equally.
He claimed there was a trend for public schemes to be slightly ahead in employing a transition manager, but said this was mainly due to private schemes 'buying in' expertise over 'renting' when the occasion arose.
Sachs concluded a good 'bench' would include a range of managers who would actively compete for a contract to ensure a cost effective and better risk controlled transition.
During the ensuing question and answer session, Sachs said such a panel should be reviewed every year to 18 months to ensure the right fit.
He added identical masked portfolios should be used when issuing tenders to the panel to ensure uniformity of measuring how each manager would tackle the transition and prevent information leakage.
Fixed income transitions
As the day had mainly discussed transition management in terms of equities trading, Kevin Byrne of BNY Global Transition Management took to the stage again to explain the process in fixed income terms.
Byrne said the premise of a transferal of holdings was the same for both asset classes.
A manager had to use all available tools to minimise costs and manage risks. However, he commented fixed income did not benefit from as extensive research into pre and post trade analysis as equities, so evaluation was not as easy to carry out nor was there as clear cut a risk model.
There were specific challenges to fixed income transitioning, according to Byrne, such as a lack of price transparency compared to equities trading, the unique characteristics of each market and smaller order size causing additional complications.
Byrne said unfortunately there was no single solution to these issues. In such fragmented markets, electronic trading platforms and easier access to multiple dealers' prices would make it easier to find levels at which to execute trades more quickly.
He added that a manager with good contacts who could make sales when necessary was essential, but costs for this skill should be identified and managed rigorously.
The global view
John Minderides of JPMorgan, concluded the forum by sharing a global outlook on the industry with the audience. He began by explaining the customary different asset allocations between countries which made the task of transitioning more complex for a global provider.
The unifying trait was negotiation to get the best price, which, according to Minderides, was common all over the consultancy world.
He warned pension funds to be aware when entering into fiduciary contracts and negotiate exactly what they needed to be in the document.
He said it was better to act on a positive than an exclusionary basis so as to not alienate themselves from certain solutions.
Minderides mentioned the Markets in Financial Instruments Directive (MiFID) should benefit pension funds, as it would compel managers to offer the best possible price of equities.
The forum closed with thanks from Alex Beveridge to speakers, delegates and organisers.
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