The advent of the euro, as all those involved in the reallocation and investment of portfolios will acknowledge, has begun one of the largest recorded currency and asset switches ever in the global securities market. The arrival of the single currency could be dubbed a giant test in strategic transition management involving a variety of problems and solutions.
And, depending on your involvement in the fund management arena, the questions and answers to be resolved differ enormously.
Cost and performance considerations associated with fund transition management and asset allocation shifts are well documented. If a fund seeks to liquidate and reinvest or increase/decrease its assets, then transitional investment phases between the old and new managers cost money, with typical value losses of around 5% recorded.
The cost impact of asset allocation shifts may not be so great, but the principles of transition management remain. The poorer the transition the heavier the cost, particularly if time spent out of the market is prolonged, or sectoral and market biases develop during the change, distorting a fund's desired portfolio strategy. Add visible trading costs to these factors and the impact on a fund's performance can be dramatic.
The overriding issue that investors with funds in euro 'in' countries have had to address has been the much-vaunted 'big bang' of redenominating domestic and European assets into euro. With the close of books on December 31, 1998, valued in legacy currencies, and their subsequent conversion into the euro, one important issue has concerned the transition of outstanding transactions traded in the former and settled in the latter.
Positions affected by the bond, equity and cash redenomination process had to be adapted by managers and then reported, to include outstanding items, by asset managers and custodians.
And issues now coming to the fore include the fact that although Europe may now possess a single currency, securities settlement will still happen on a national basis, further complicating this new reporting process. Reporting is set to become a crucial client winner.
Francis Jackson, managing director of global institutional services at Bankers Trust, says: Custodians will still have to move cash into each marke t to settle trades, but we are offering one overall account and balance to customers, while handling the cash movements behind the scenes, as opposed to giving clients separate accounts for each market."
Jackson adds that the service is more difficult for the custodian, but a real euro boon to the client in reporting terms. "This is a firm commitment by us to offer enhanced euro transition products in the pursuit of new business," he says.
The next question lying before pension fund and asset managers alike concerns the rebalancing of portfolios to a pan-European weighting, with the accent particularly on those 'in' countries with a developed pensions system and a prevalent equity culture.
However intense the clamour may have been over the speed at which the shift would happen, analysts now concur on the enormous exaggeration previously involved.
Portfolio transition is now expected at a slower rate, although the rationale behind the above claims still stands, with Dutch, Swiss and Belgian funds heading the rebalancing race.
Matching of liabilities to retirement provision in less developed pension fund markets is still predominately domestic. And analysts believe this will remain so until increased 'single' capital market activity, economic development and regulation begin to resemble a truly European set-up.
For the Netherlands and Belgium, the euro transition issue is not one of having to increase equity investment, but more how to diversify strong holdings of euro-denominated European equities abroad. Principally, in the longer term this is expected to involve the sale of remaining domestic shares in favour of non-Emu equity. Mark Glazener, co-ordinator of the European equity department at Rotterdam-based Robeco, says clients are dividing between those moving to solely euro investment strategies, or switching to benchmarks on the MSCI Europe or Emu index, to enable hedging against the 'out' Scandinavian countries, the UK and Switzerland.
"There have certainly been some sectoral shifts though - for example from the dominant Dutch energy sector to the European technology sector, and funds making the euro shift are tending to reduce, say, a 50% Dutch guilder benchmark to around 7.5%. A good part of our clients are already reacting to the euro implementation, but there is still a hefty number who believe it is not yet necessary to move out of the domestic market. It is a question of how they view their liabilities," Glazener says.
Edith Sierman, head of European fixed-income at Robeco, says the euro bond shift has been more comprehensive: "Ninety per cent of our fixed income clients have moved to the euro index, particularly on the corporate bond side. And we are expecting this to steadily rise to 100% in time. Principally, they see no reason to stay within a small universe and carry the same risk as if they were in the euro universe."
The overall picture is one of intense future investment activity, and the custodians, brokers and transition managers of this world are sizing up the opportunities and pitching their trade tool stalls accordingly in this first euro quarter . The question now being asked is which transition method to choose, and why.
Daniel Wiener, managing director of State Street global brokerage, says the company will continue to offer what he dubs a 'well matured' crossing system for euro asset transition. "We believe this is ideal for euro asset transition, as the crossing network provides the ability to trade with order flow from over $450 billion of global assets managed by State Street Global Advisors." He adds that State Street has been managing transitions and has restructured in excess of $80bn over the past two years.
"The main benefit of using crossing is the ability to execute orders anonymously, eliminating market impact, which is generally the largest cost of restructuring. State Street does not charge for trades executed through the crossing network or a transition fee; the only explicit costs we charge arelevied as brokerage commission when trading on exchange. These are all disclosed prior to the start of the transition."
Wiener says that the business State Street has seen so far from eurozone countries is predominantly through asset allocation shifts while in the UK the large majority of transition is due to manager switches. "The real activity is still to come though, once fund managers have felt their way into the eurozone," he adds.
At Morgan Stanley Dean Witter in London, Tom Levy, head of program trading, says plan sponsors need to be aware of the nuances in the way in which transition management can be done. In this firm's approach it is a question of adopting the appropriate strategy or strategies. In each client's circumstance, there is a balance between the trading and opportunity costs, typically the trading cost will be higher if the deal has to be executed in a short time. Conversely, the longer the trading period, the lower the transaction costs can be, but the greater the opportunity costs (see graph). What suits some clients, won't suit others, Levy points out.
Within this context, Morgan Stanley offers clients a number of approaches as to how they can make their transitions, such as agency, where the client instructs the firm to trade a portfolio on a 'best efforts' basis, often against a particular benchmark. "This is becoming the most common way of doing things." It can mean low trading but higher opportunity costs.
The 'principle trade' approach can be high on trading costs but low on opportunity costs, as the client asks the manager to give a guarantee, such as price at close of market for the portfolio. "This clearly lowers the opportunity cost for the client."
A client wanting to make an asset allocation shift might decide to do so by building up a futures position and then trading this for the physical stock with Morgan Stanley. "This 'ex-change for physical' can be an efficient way of changing a position earlier and in a cost-effective way," says Levy.
The hybrid strategy can be something of a mixture of these. "Typically, where you are doing a major asset reallocation, then you might use a combination of all these when implementing strategies."
On the euro front, the firm has seen an upsurge in demand involving some large transactions. Levy says: "We have done some significant transactions already, but we think there are plenty more to take place in the next 12 months. We think we are probably nearer the start than the end."
Another player in the market, Frank Russell, is advocating a specialist transition management approach, citing it as a cost-effective method of executing such asset rebalancing.
Bob Werner, manager of portfolio transitions at Frank Russell in the US, explains: "We offer a service develop-ed in the US that examines the whole transition process including its objectives and constraints and then looks to create a strategy for all parties to work from. Typically , we will look at portfolio characteristics, the liquidity of individual positions and their relative difficulties in terms of market momentum to ensure the transition suffers minimal impact costs. And commission is only charged on trades completed, so this is a value added service."
Adrian Jackson, client executive at Frank Russell, UK, adds: "The ballpark is very much the same for manager or asset allocation switches, whichever seems to be the optimal diversification method for the fund. A Dutch fund manager, for example, may have the expertise to switch to more diverse investment strategies, but perhaps not the necessary depth of research and independent transition skills. We believe we can significantly reduce costs by managing the interim trading period using our market impact techniques."
Jackson concedes that on asset allocation shifts, in contrast to investment manager switches, business has so far been minimal. But he believes that once the euro market is up and running, the clients will be there to chase.
John Minderides, head of transition management at Barclays Global Investors, says: "As a large global fund manager with assets under management of $500m worldwide and $100m in Europe, we believe we have the size and the depth of service to eliminate many market impact costs through our internal crossing trade system or by dealing with associated traders. If it is a third party arrangement then fees are involved, but a large part is a fixed element and we work closely with consultants to keep the remaining costs down."
Minderides adds that so far, much of the trading activity has come from euro 'in' countries looking to hedge the euro against sterling in any tactical asset decisions, and big manager switches have been rare.
Nigel O'Sullivan, executive director and head of European pensions and insurance strategy group at Goldman Sachs, adds: "The fact that equity restrictions and currency risks in euro countries have lessened has immediately increased the external focus by European managers, and work we have done with Watson Wyatt shows the lack of importance now concerning the domicile of stocks invested in. We have very detailed analytics on trading and wide liquidity sources for transition, which judging by the amount of calls we are getting seems to indicate we are good at it and extremely competitive. And in this first quarter we believe the large amount of business we saw in the final quarter of 1998 will explode."
Furthermore, the issue of communicating necessary investment strategy changes for euroland to fund managers outside Europe is also now a priority for custodians, brokers and transition managers.
And structural changes resulting from possible competition between European exchanges and depositories could also begin to have an effect on the business in question - including the situation where securities listed on one exchange could settle on another."