Plus ça change plus...
Change can be good for business. And if you are a transition manager, then definitely. The widespread rethinking of portfolio composition by institutional investors has given a boost to the transition management sector, even if the market slump that precipitated it has eroded the pension assets themselves.
Transition management is a service now offered by various securities houses for pension funds or any large investor facing a major change in their asset allocation. The client could be a pension fund needing to invest a large cash injection into the bond and equity markets or a fund changing one or two of its asset managers. The transition manager project manages the whole transition, coordinating and executing all the individual securities transactions within it.
Simon Hutchinson has recently been appointed strategist for transition management in Europe at Northern Trust Global Investments. NGTI has certainly seen growth in its transition management business in recent years, he says.
“The market environment over the last few years has meant people are changing investment managers more frequently,” he says. “Consultants are more aware of how changing a manager can add value.” And in times such as these, every penny counts.
It is not just a matter of pension funds switching one manager for another. Institutions are diversifying from a set of purely balanced funds into, say, three or four different funds in different classes. “So the whole complexity of it changes,” says Hutchinson. This in turn raises the question of whether a third party, or transition manager, should be brought in to project manage the shift.
Increasingly, formal transition management services are being used. And not only to cut costs and project manage, but also so that institutions can be seen to be doing so. On the back of the Myners Report, controlling costs and knowing what your costs are has become a big issue for people, says Hutchinson.
“One big area of ours is the reporting side, in terms of everyone understanding what the objectives are,” he says. “Afterwards everyone understands what has happened.”
Tim Wilkinson, global co-head of transition management at Citigroup, says more and more potential clients including pension funds are seeing the merit in the service. “Also the fiduciary landscape is changing and there is a need to discharge fiduciary duties by making sure there is an audit trail,” he says.
Graham Dixon, head of European transition management at Credit Suisse First Boston in London, says the growth in the uptake of transition management services is partly due to the fact that providers have spread their nets. “Transition managers have made their services available for ever smaller schemes; the threshold has fallen markedly,” he says.
At the higher end of the scale is the enormous transition being undertaken in France by the Fonds de Réserve pour les Retraites. Goldman Sachs is working as transition manager for the launching fund as it gradually releases its e16bn into the market. According to FRR, this is the first time in the French and continental markets that a transition manager/broker has been used by an investor on such a scale.
Whatever the size of assets, managers agree all portfolio transitions are different.
“A plain vanilla transition doesn’t exist,” says Rick Boomgaardt, director, transition management at CSFB. “But the phases you go through are the same,” he says, citing the discussion with the client, the pre-trade analysis, the implementation stage, ensuring every trade has settled, and the post-trade calculation of the real cost.
Michael Marks, global head of transition management for Merrill Lynch Investment Management, says there are three core requirements a client has of a transition manager – that they minimise costs, control the inherent risks and manage the whole process.
“The emphasis might be more on one or the other,” he says. Clients turn to a specialist manager for transitions because their own resources are focussed on what they do. “They recognise they don’t have all the expertise, and they’re looking to outsource that functionality,” he says.
CSFB says the things that set it apart as a transition management provider are its people, technology, business model and access to market. In terms of technology, clients are able to log onto the web and see the whole transition process as it is happening. “They can see the same thing we see,” says Dixon.
And at CSFB, transition management is a segregated, dedicated business area, which is not the case at other firms, he says. “Rick and I are dedicated transition management specialists and are purely focused on talking to clients about transition management,” he says.
The most challenging transitions from a TM provider’s point of view are not necessarily the largest in terms of overall asset size, but those with a number of moving parts, says Boomgaardt. “If you have a lot of managers involved, multiple custodians, going across regulatory environments, and you don’t have the same beneficial owner – these are the ones that are challenging,” he says.
The issue of whether the broking desks of transition managers pre-hedge on their own account when undertaking trades for the client has become a rumbling issue in the industry. Last year, Morgan Grenfell was fined £190,000 by the Financial Services Authority for failing to act in its customer’s best interest. It had pre-hedged a trade which resulted in a client paying over the odds for a deal.
The FSA said that a firm which proposes to engage in pre-hedging should ensure that it informs the customer in advance. It is now clear to brokers and the transition managers who use them that they must disclose pre-hedging, but there is debate as to whether it can be carried out without disadvantaging the client.
Neil Walton of Mercer says pre-hedging should not happen in transition situations. “I don’t think it should go on,” he says. “If you’re looking to organise a transition, you should make it clear that there’s to be no rearranging of positions. If they do, they need to be very clear about why it is in the client’s interest. I struggle to see how that can be to your advantage as a customer.”
Wilkinson at Citigroup says pre-hedging is the antithesis of what transition managers are trying to achieve, which is transparency. The two problems with pre-hedging being carried out by a broker involved in a transition, are that firstly, this potentially costs the pension fund more, because the impact ends up being in the benchmark, and secondly, the impact is not known.
But Wilkinson points out that investment banks are often willing to use their own capital to help transitioning clients, by carrying principal positions on their own books. It is possible, though tricky, to make this work without arousing suspicion of a conflict of interest. The key is that the transition manager and the client should not give the principal desk any more information than absolutely necessary, when trying to access it as a potential source of liquidity.
When it comes to bond transitions, Dixon says you have to have even closer relationships with the managers involved than is necessary with equity transitions. This is because there are more opportunities for substitutions for bonds than there are for equities. There may be cases where costs can be cut by, for example, buying the same issue and yield as stipulated but with a slight different coupon. “You then have to re-engage with the manager,” he says. “You need a much closer dialogue.”
Also, the scope for using futures as means of maintaining exposure is greater in asset-shift, like equity to bond, he says.