Doing it in phases
There is no doubt that reallocating millions in portfolio assets carries huge risks. But while transition managers can smooth the more complex asset shifts and keep costs and dangers to a minimum, there are often less expensive ways of dealing with change, say consultants.
Typically, pension funds are turning to transition managers in any of three situations, says Neil Walton, European partner at Mercer Investment Consulting. They may be revising their investment manager structure, revising their strategy – changing exposure to the underlying asset classes, or making phased changes, where a shift in asset allocation is split into tranches, usually in order to average out market volatility.
This last method of effecting a transition is gaining ground, he says. “Most people want to avoid timing the market because it’s very difficult to get right,” he says.
Senior consultant Michael Robarts is head of transition specialism at Hewitt Bacon & Woodrow in London. He says that while there is definitely a place for formal transition management services, the specialist providers are not called on nearly as much as they would have us believe.
“It is quite astonishing how many have moved into the transition management sector,” he says. “They are all trying to persuade us that life and the universe would not be the same without their services, when they all do pretty much the same thing.”
While he sees a place for transition managers in the more complex arrangements, he sees no particular reason in many less challenging switches why the incoming manager cannot deal with it. Admittedly, there is some crossing that a transition manager can do, he says. “But they’re not doing it for free,” he adds.
In any case, crossing is not the be all and end all of keeping transition costs down. Mike Davis, senior investment consultant at Watson Wyatt says: “Sometimes it can be said that if you maximise your crossing rate then that is the best way – that is not necessarily the case.”
If, for example, during a transition, a large number of stocks were crossed, then you could be left with a rump of stocks that were less liquid. So it is a balance, says Davis, a trade-off between immediacy and managing risk.
“You need to manage it as a project,” he says. “It could take a day, a few days, or longer than a week.”
Managing a transition can be very complicated and a major project that needs experience. “You definitely have to watch out to see that all transition managers have the appropriate skills,” he says. This is particularly important in a marketplace which has seen a lot of new entrants. The skill sets required of a transition manager involve a lot of different areas. Transition managers should have experience, access, good knowledge of their underlying client base, knowledge of trading and be a knowledgeable project manager.
To what extent can a consultant take the place of a transition manager? In the US, for example, Mercer offers its own transition and recapture services to companies moving retirement plan assets. But Walton says it is more common in the US than in Europe for consultants to offer transition management.
But some consultants have traditionally offered a form of overseer role, says Natalie Pilcher, director of implementation services at Russell. They will project manage a transition rather than actually carry it out.
Aconsultant can usually help a pension fund facing a transition by negotiating with the incoming manager, says Robarts. They have the influence to be able to get the terms right and the knowledge and experience to be able to cite precedent.
Very often, if a passive manager is involved, he says, that manager will be able to offer at least as good a service as a transition manager. “They all have very competent (transition) teams,” he says. Plus there is the advantage that the incoming manager is already known to the client, as they have been through the process of selection and have already got a management agreement in place.
One of the keys of any successful asset manager/client cooperation is trust, he says.
Walton says it can be hard to define what is a transition rather than just a readjustment within a pension fund portfolio. Generally, a transition management service consists of three phases – a planning phase, an execution phase and a reporting phase. “There are a number of situations where it’s not complicated enough (to involve a transition manager),” he says. Consultants can carry out the first phase, the investment managers the second, and the consultants
When a client is looking to engage a transition manager, Pilcher says it is important that they focus on finding a manager that has robust, all-round risk management services. “What you do tend to find is that once a pension fund has used a transition manager, and they’re happy with them, they will tend to revert back to them,” she says.
There are many dangers inherent in transitions. Pilcher cites two types – the explicit and implicit costs that can be incurred. An explicit cost, for example, could happen when firing one manager and hiring another. Stocks are sold, and stocks are bought. But if the new manager actually needs to buy some stocks which were sold by the old manager, then this can mean significant cost.
Implicit costs may be opportunity costs, such as if trades are delayed and assets remain sitting in cash. “Research has shown that can have a very significant risk,” she says.
A good transition manager has to be able to judge how to time the asset shift to minimise the market impact. “If you’re trading relatively illiquid stocks, you’re probably going to moving the market significantly,” she says. This then raises the question whether the changes should be packaged in bite-sized pieces to shrink the impact.
Consultants say there is still a need for more transparency within transition management services, particularly when it comes to accounting for the real cost of the service.
Performance may be reported to the client, but these numbers and what they are based on is not always clear enough. “Where there is a need for improvement,” says Davis, “Is in making sure there is more transparency in those assumptions (behind the initial estimate)… and that there is consistency of the format in how those estimates are presented with the format of the post-trade