An evolving market of smooth transitions
Heather McKenzie talks to providers of transition management services and finds a variety of approaches being adopted
As an increasing number of funds in the Asia Pacific region review their portfolio structure or management, the use of transition management (TM) specialists to manage such restructures has grown. The transition management industry is well established in the US and Europe and is now becoming the norm in Asia.
"During the past two years, transition management has begun to take off in the region, driven by an increased understanding on the part of asset owners of what transition management does and its role and also how it adds value by enabling investment decisions to be implemented in the most effective way," says Kal Bassily, New York-based managing director and global head of BNY Global Transition Management.
Justin Balogh, securities trading head of the Asia Pacific region, State Street Global Markets in Tokyo, says the TM industry in the region is very competitive and the major participants that are active in North America and Europe are coming into the Asia Pacific market. "However, it remains to be seen how much market share can support all of them," he says. "Australia, for example, is saturated with transition management suppliers, but it is really only the top three or four that pick up the majority of business and in Japan, only two players dominate."
Providers of transition services come from across the investment industry, including global custodians, asset managers, investment banks and standalone transition service providers. What they all have in common is an aim to reduce costs, control the risk and provide project management during a fund's transition from one investment strategy to another, or from one fund manager to another.
John Moore, Sydney-based director of implementation services for Russell in Australia, says when comparing the general business models and historical knowledge base of TM providers, it is easy to understand how the approaches can vary greatly. "A typical custodian is very good at processing information and data; thus, these types of models are more operationally and transactionally based. On the other hand, fund managers are more in tune with managing performance and risk; thus, this type of transition provider, who developed out of managing assets, is more focused on, and delivers, a more sophisticated performance-focused solution."
Ravi Goutam, head of US transition management at Barclays Global Investors in San Francisco, says plan sponsors understand that the cost and risk of an unmanaged transition can be significantly higher than with a managed transition. "Hiring a transition manager allows the plan to put one party in charge of the transition and hold them accountable for the performance," he says. "This understanding has made the use of TMs commonplace globally and increased the demand for transition management services which in turn has driven the increase in the number of TM providers." Other trends such as the move towards liability-driven investment and investing in emerging markets are also driving the need for TM services, he adds.
BNY's Bassily says in Asia the bigger funds have historically invested in fixed income, but many are now beginning to invest in equities, particularly across borders. "This is helping to drive the growth in the use of transition managers, as is a trend for central banks in Asia and in particular in the developing countries to invest their reserves in global fixed income or global equities mandates rather than in money market instruments," he says.
"Employing a transition manager makes the implementation of an investment decision more effective and efficient. A transition manager will help the asset owner to capture the whole value of an investment decision, helping them to save money and enjoy the benefits of an investment restructure more quickly than if they undertook the transition themselves."
Simon Hutchinson, head of transition management (international) at Northern Trust Global Investments, who is responsible for EMEA and the Asia-Pacific region, says during the past few years there has been a big change in the way funds invest, moving from balanced manager approaches to more specialist investments and greater exposure to alternatives and LDI approaches. "This all increases the value and frequency of client restructuring," he says.
Another factor driving the growth in the TM industry, he says, is the greater acceptance among clients and consultants that a transition manager can add value in terms of reducing costs, making processes more efficient, and lowering risks and exposures. "There also has been a change in attitude towards transitions; previously a fund would sell its portfolio to cash and then give the money to a new portfolio manager, which would then reinvest it according to the new strategy. As knowledge of the transition management industry has grown, this has changed."
One of the main characteristics of transition management is its diversity - it is a highly customised business with no two transitions ever being the same, given the differences in the funds involved, their strategies and their differing goals.
"The key to success in transition management is to take a customised approach," says Bassily. "We have an open dialogue with the asset owners in order to understand their objectives, constraints in their investment processes and the characteristics of the transiting portfolio in terms of cost, risk, liquidity and general marketplace conditions. Every asset owner has different objectives and our job is to implement a transition within those objectives and constraints."
State Street's Balogh agrees transition management is a very customised business: "The events of any individual transition are unique, encompassing the portfolio, market conditions, the nature of the client, reporting requirements, deadlines and funding targets," he says. "This requires a great deal of flexibility and experience on the part of the transition manager."
Moore says because each fund has unique requirements, it needs to identify transition providers that can provide services to meet their various needs (not just on a one-off basis) and that have an "alignment of interests. By doing this, funds can gain the efficiencies of not needing to go to market for each event, know that the transition provider has the capabilities to meet the various needs, and is assured that the provider in always acting as its agent and in the best interest of the fund."
Rather than going through the onerous due diligence process required each time a transition manager is selected, funds are beginning to use TM panels, an idea that began in the US and is now a growing trend in Asia, says Northern Trust's Hutchinson. "Fund managers put out an RFP for transition managers and will then select three or four, all of which may offer different services. The fund only has to do the due diligence of the transition manager once, which saves a lot of time and effort. Given the frequency with which funds change their manager or benchmark, the panel approach is gaining in popularity."
Bassily says sovereign funds in countries such as Singapore and South Korea, and in Australia the most sophisticated funds, have adopted the panel approach. "One of the drivers of the panel trend is the acceptance of the approach by investment consultancies; they have embraced the notion of panels and as more endorse this approach, I think the market will see panels become the preferred format for transitions," he says.
Balogh agrees the use of panels is growing, but points up that it is not yet as dominant as those clients that select a single provider after a detailed search process.
"Even if a panel is used, it tends to be the large, more experienced transition management players that tend to win the bulk of the mandates - the cream rises to the top."
Balogh says just as investment managers are appointed on the basis that they can contribute to the client's performance objectives, provide fiduciary duty of care and demonstrate accountability, so too should transition managers. "As a transition manager we are being called on to manage traditional changes of asset management mandates as well as funding of new cash, liquidations, overlays, swaps and options strategies. Clients are now thinking about employing transition managers whenever they have to deal with significant portfolio events. A transition manager can preserve portfolio value through managing transaction costs."
Hutchinson agrees, pointing out that transition managers need skills in fund management across asset classes, project management and operations. "Project management is particularly important because for pension funds, a transition could have a significant impact on the fund. Pension funds have limited resources and the person managing the transition might well have a mix of roles within the company.
If you also consider the new rules and regulations regarding trustee responsibilities, pension funds do usually need help with transitions."
How to choose your manager
One of the key questions clients ask, says Russell's John Moore, is "how do we know if the advice you are giving is the best advice or solution?"
There is no quantitative answer to this question, he says. He says for clients to ensure that their TM provider is acting in their best interest they should:
always contract the transition provider as an investment adviser that will act 100% as the client's agent and fiduciary of the fund; require full disclosure of all revenue (both explicit and implicit) for the TM provider and its affiliates; and measure the transition event by implementation shortfall as defined by the T-Charter standard.These first two points, says Moore, are similar to what funds would expect of their ongoing investment managers to ensure they are acting in the best interest of the fund at all times. "While transition providers typically manage the assets for a shorter period, they are in control and have discretion over the assets in a similar capacity," he says. "So, funds should hold transition providers to the same level of scrutiny and should not accept anything less."
A final point, says Moore, provides a standardised way to measure full performance of the event, from the time of termination to the point of hand-off to the new manager. This is similar to the investment performance standards for investment managers and provides a consistency in reporting. Also, it is import to define what implementation shortfall means as without that, it can be "just about anything the TM provider wants it to be".
BGI's Ravi Goutam says while most transition RFPs seek to align the interests of the client and transition manager, not all transitions are actually implemented in this vein. "We suggest that investors can incorporate three simple yet effective selection criteria as safeguards to this end:
ensure that the transition manager is acting as a fiduciary in the legal definition; require that the transition manager disclose all sources of revenue related to the transition; and insist that the transition manager reveal the use of third-party brokers."Armed with a complete understanding of how their manager generates revenue, says Goutam, investors are better equipped to develop and implement transition strategies that reduce costs, minimise risk and avoid potential conflicts of interest when transitioning assets.
Code of conduct helps clients ask the right questions
In October 2007, 17 transition management firms agreed on T-Charter, a voluntary code of best practices for transition managers. The T-Charter is a minimum set of standards with which transition managers may choose to comply and is designed to enable clients to compare proposals from transition managers more accurately. The standards relate to issues such as disclosure and conflicts of interest, client confidentiality, resources, systems and processes, cost estimation, remuneration, dealing strategy and practices, evaluation, errors and compliance.
The charter calls for implementation shortfall to be used as the consistent measure for reporting the performance of a transition manager. It also dictates that a manager must disclose when it trades off the firm's own book in advance of the client's trades (pre-hedging).
The charter requires transition managers to disclose conflicts of interest and requires a clear audit trail of their transition activity available to the client upon request. The manager must also disclose all sources of client remuneration received by the manager and its affiliates before and after each transition management assignment.
Stacy Scapino, global director of the Mercer Sentinel Group, a unit of Mercer that was involved in drafting the T-Charter, says the charter gives funds with no knowledge of TM "a starting point for asking questions".
Not everyone welcomed the move, however. In a joint response to the charter, State Street Corporation, Barclays Global Investors and Russell Investments expressed their concerns "that in this case the standards for performance are not as strong as they should be and ultimately may not provide a sufficient level of protection or comfort to clients".
The three firms agreed the industry should unite around common standards, but added that the standards needed to "truly reflect" best standards, rather than just a level that all potential participants could achieve.
Mellon Transition Management, on the other hand, welcomed the T-Charter "as the most significant event in the transition management industry in Europe this decade". It said the T-Charter would address the difficulties associated with comparing the services and cost estimates from both buy-side and sell-side providers.