Back to the road ahead 

Global Investor assembled the industry’s leading transition managers and consultants to a room in the City. The discussion of the year that was ranged from the pitfalls of virtual due diligence to the merits and limits of attributing implementation shortfall to individual algos and execution venues. 

PARTICIPANTS: Hugo Cox, Global Investor, Chair; David Edgar, Inalytics; Dan Constantine, head of portfolio solutions strategy, State Street; Andy Gilbert, EMEA head of transition client strategy, BlackRock; Paul McGee, head of portfolio solutions, EMEA, Macquarie Capital; Andrew Orr, portfolio transition manager, Citi; Craig Blackbourn, EMEA head of transition management, Northern Trust; Steve Webster, director of transitions and trading solutions, MJ Hudson; Chris Adolph, director of implementation services, EMEA, Russell Investments; Cyril Vidal, head of portfolio transition solutions, Goldman Sachs

HUGO COX: As more due diligence is conducted virtually what is lost and what is gained?

DAVID EDGAR: There’s no doubt transition managers have made great strides in showing their systems, meeting people and working through processes as best they can in a virtual world. But there’s also a pent-up demand for clients to get back into the transition manager’s office. I’m of the view that there’s nothing like seeing the animals in their natural environment, to use a wildlife analogy.

You want to see where they’re sitting relative to other teams, how close to the trading desks they are and what internal communications look like. There’s also an opportunity to sit down with the compliance team and have a look at procedures and process documentation and so forth, which might be harder to do virtually. So, while everyone is getting through this as best they can and we are able to help clients’ decision-making, clients do miss a lot by not having on-site visits. I foresee that the minute restrictions are removed there will be a stampede of clients’ feet to get on-site again.

DAN CONSTANTINE: We’ve been conducting due diligence exclusively virtually and we haven’t seen clients or consultants foregoing due diligence at all. Perhaps consultants have been a bit more flexible; we have seen a heavier reliance on RFPs, for example. To improve the virtual experience, we try to replicate what it would be like in-person: so, sharing content onscreen, being able to demo the systems virtually, and so on. Some of the best interactions are when our clients can sit down with portfolio managers, transition analysts, our trading desk – and compliance team – and see the systems live. So, we look to try to best replicate that in- person experience virtually.

ANDY GILBERT: If we can get a hybrid between virtual and actual that works for a client that’s great. You can bring in people from different locations virtually who can all contribute fully: everyone’s on a level playing field and that’s an advantage. RFPs shouldn’t replace due diligence sessions; you get so much from meeting the people, whether virtually or physically. And the due diligence session should corroborate what is written in the RFP. For example, if you have six team members or 20 traders, the client should meet them, see what they do and find out what technology they use.

PAUL MCGEE: I think client due diligence sessions and RFPs are more comprehensive and robust than ever, despite many sessions having to be conducted virtually. Clients are delving a lot deeper and we’re seeing a trend towards specialist due diligence sessions. Rather than clear out a whole day in your diary for a session with the entire operation, clients may now have separate sessions on business continuity, information security, compliance, risk etc. By conducting these remotely, we can cover different areas in real depth.

But there is no substitute for face-to-face meetings – for the client it means really getting under the hood of the firm, understanding where you sit, what’s your proximity to your traders, your support groups, and so on. So, we welcome that, as and when we can return to it. But until then, we shouldn’t underestimate the power of technology, which has allowed us to confidentially share firm policies or demo systems. And bear in mind the additional travel time required for in-person visits, all that is reduced with virtual sessions.

ANDREW ORR: Off-site team members have really benefited from this Zoom revolution. Prior to this, you would have a videocall to bring in off-site team members or partners. Now they are on equal footing, which brings a completely new dynamic and positive contribution. We have team members who sit in New York, Sydney or Singapore, who can join calls just as easily and frequently as the London team members. With regards to the question of due diligence, we are seeing more requests for due diligence information, a combination of question specific and the business overview, zoom and the, working from home approach has meant clients while still having the due diligence requirements are seeking in answers in a different manner. Not only is this a positive for the client, but also us, as we can bring in experts regardless of their physical location via zoom, for example, a European client looking to do an Asia small cap equity transition we can invite, trading, strategists and transition management members from the region.

I sense that clients are ambivalent about on-site visits. While some aspects of the face-to-face meeting will continue to have benefits. For individuals the ability to easily conduct a due diligence session from their home is very appealing. I am also sure that corporates will see the cost/benefit analysis of this approach going forward. However, during this pandemic, we have seen clients in person for due diligence meetings who we would not have expected to. However, I believe this is as much about the ongoing corporate plans, which means due diligence will continue regardless. To later subject matter, the accessibility provided by virtual due diligence have accelerated ESG focus, particularly on disclosure on environmental issues, sustainability, personnel and so on.

HUGO COX: How are transition managers handling increased ESG reporting requirements, including interim management needs?

CRAIG BLACKBOURN: At this time, ESG is affecting every part of the investment process and is not focused solely on the make-up of an investment portfolio. ESG is way more than simply an investment discipline. Clients want to know about employee equality, DE&I, vendor screening, real estate efficiency, technology standards and ensuring the ethos of external partners are duly aligned with those of our own organisation. At this time, ESG is very subjective, in that how one screening platform scores a company based on their models, can differ markedly versus the scoring of another screening platform.

ANDREW ORR: There needs to be a clear distinction between regulatory and client reporting here. For regulatory reporting clients want to be able to hand over that responsibility and have confidence that it is being delivered as per all the regulatory requirements. Client reports is more complex, and includes a broad range of criteria, not only the content of the reporting, but also such things as, timing, format, analysis, security. On the issue of content, the first priority for CitiTM is to understand the client needs and then make sure that the reporting meets those, the content of these reports must also is easily accessible an transparent, sometimes this involves pre-transition calls to address question on the reporting. As a side note, responsibility for the reporting continues to reside with the TM managers, even where the origin of the reporting might be a third party provider, such as an electronic execution venue or market data provider. Again, we will make sure that the data meets with the client’s needs and is transparent.

PAUL MCGEE: When it comes to interim management and adhering to ESG guidelines, it’s important to remember we are typically short-term carers of a portfolio and asked temporarily to manage the client’s assets against a given index or a given tracking error. As transition managers we have limited discretion and we’re not the stock pickers.

Even in an interim capacity we are to be guided by the client over what index to follow and what stock exclusions we should incorporate. We’re generally not the creators of the mandate and the mandate guidelines, although we can offer an ability to screen for adherence to these.

DAN CONSTANTINE: Our transition management business currently operates outside the EU, so regulatory topics pop up less frequently than they do for some transition providers at this table. On exposure solutions and interim management, we look to subscribe to ESG benchmark indices, manage against those and apply security level screens on portfolios. Then, certainly, ESG-related or ESG-focused ETFs and futures are becoming more popular, so we have the ability to use those as well if they happen to meet the client’s objectives.

DAVID EDGAR: Clients these days are looking to transition managers to apply regulatory rules onto portfolios, particularly within the UCITS or AIFMD environment, so you can see that concept extending quite easily into any other regulatory environments.

ANDREW ORR: With interim management agreements, we at Citi think it is essential to have two things in place before these mandates are on-boarded. Firstly, a very clear understanding what it is the client is seeking from the interim management solution. No longer are we seeing clients who are looking to simply park cash or assets until some later date. So, we are looking at; risk, reporting and duration. Secondly, and what is essential, is a clear interim management agreement which outlines the expectation of both parties from this period of management. This involves many discussions both to understand what the client needs are, but also internally a collaborative discussion between the senior transition manager representative and our own legal team to ensure the contract is, transparent, comprehensive and fit for purpose.

STEVE WEBSTER: Transition managers deal routinely with momentum bias and these are pronounced for ESG transitions. As sustainable mandates become more frequently the target, that tide will constantly be against them because they are selling the stuff that’s not fashionable and buying the stuff that is. Also, I think that their forecasts of market impact will be out. I think the volumes are much more changeable in what we call ‘replacement names’, which typically occur in a lot of target portfolios. Exclusion portfolios tend to use quite small sets of data to determine what the impact will be; we tend to see the volume of these names being quite sporadic. I think there could be a problem being accurate regarding the costs in the ESG portfolios.

HUGO COX: If real or feared interest rates rises increase market volatility, how will transitions be affected?

ANDY GILBERT: Asset owners, such as pension schemes, should also consider what interest rate changes do to liabilities. We also need to think about that and what that means from a liquidity perspective. Volatility is not particularly high now from a historical perspective, although it does change very quickly. Even if it increases, if liquidity is very high then that may be less of a concern than if liquidity is low, in which case I’m facing that volatility for longer. If that’s also causing significant tracking error, whether compared to a target portfolio – against which I’m being measured for implementation shortfall – or a particular fixed income benchmark, then you may have quite wide-ranging outcomes. It becomes harder to predict.

One of the main issues is a change in volatility or liquidity while you’re in flight in a transition. Typically, prior to commencing the trading you will provide your analysis, set expectations around costs, how long it’s going to take to complete and so on. Then, there may be surprises within your trading period for which you may not have accounted – that’s something we need to always keep a watch for. It means updating clients regularly about what’s happening – not just within their transition but within the broader market.

CHRIS ADOLPH: Talking to my traders yesterday they came up with the phrase ‘taper tantrum’. Their view was there’s so much leverage in the system at the moment, that if rates get higher volatility will suddenly shoot up. One thing that we have done, which Zoom has helped with, is to place traders much closer to clients than ever before. Previously, the transition manager may have done the talking. Now we’re pulling traders into that conversation and that brings a lot of information.

If it’s a volatile day, are we slowing down the pace of trading? Are we putting our trades into smaller baskets, getting a greater number of quotes and maybe changing which dealers you’re getting quotes from? The transition manager may be great at pulling resources together, but as an expert on what’s happening at the time, the traders provide a great insight.

CYRIL VIDAL: A key difference since the GFC is the transparency you now have on clearing levels thanks to the continuous pricing provided by credit ETF. On the one hand we have increased volatility, on the other hand, we have a much better way of managing risk and providing pricing transparency. The ‘equitisation of the credit market’ is underway with 15% of the overall investment grade activity in credit ETFs in the US. This proportion goes up to 30% in the high yield space. That’s a fundamental change from 2008.

DAVID EDGAR: I’m a big fan of having a set of ‘go-no-go’ criteria and this should include a market monitor. For bonds it might be a group of bond ETFs – looking at the current price versus 10-day average or versus 30- day average. I completely agree around the Zoom and Teams calls and the wider range of team members on them: we’re getting much more access to team-members who are more removed from those you would normally meet in person. More often now we get the traders on the call: it doesn’t really matter where in the world they are.

The key to good communication is setting the narrative early in the process so that you have this picture of the market environment being built up as you’re heading into the transition, and if you’re seeing signs of increased volatility, you can talk the client through what that means for their transition. Finally, most clients just want to get their transition done, but if liquidity dries up significantly then you have a problem and it might be better to hold back.

HUGO COX: How can clients evaluate the impact of which algos, venues or brokers are used in a transition?

DAN CONSTANTINE: In order to route and execute in a manner that achieves the client’s objectives you must know the strengths and the weaknesses of the available equity strategies – be that liquidity seeking strategy or a strategy aimed at capturing spread or minimising market impact and so on. Our trading desk spends a lot of time speaking with algo providers and our brokers to understand exactly how their strategies work and to facilitate best execution there. And we’ve increasingly been using post-trade analytics and TCA across all asset classes: the feedback that TCA can provide is critical to guiding and directing the execution strategy.

CRAIG BLACKBOURN: The detailed reporting provided by the transition managers is a critical component of our services. Pre-Trade analytics identify key sources of risk and cost, and the implementation strategy defines how the transition manager will mitigate for those risks. Most importantly, the post trade brings everything back together for the client, how has the transition manager performed relative to their cost estimates, with a detailed explanation for any deviation. The transition post-trade reporting should comprise sufficient TCA analysis to inform the client of venues utilised, volumes routed to those venues, spread capture, crossing levels etc. This level of information can help clients ascertain the benefits of using our services.

CYRIL VIDAL: Gaining a full picture of the venues we have access to achieve the best price is not a simple task. For example, Goldman Sachs in Europe is connected to 68 different liquidity streams. For transition clients, hearing about dark venues, MTFs, systematic internalisers and so on, can be confusing. While transition managers have a role to educate clients and clearly state all liquidity options ahead of an event and through pre- and post-trade transparency, consultants can play a role here and provide comfort that the liquidity mix used by the transition manager is aligned to their objectives.

STEVE WEBSTER: I think that venue analysis should be routine for all transitions, and we expect it from all the post-trades we look at. I want to know where trades have taken place, how successful that decision-making has been, and why that choice has been made as well. I expect any transition manager that is using third party or their own algos to have continually tested the success of using them. There are some algos that are very successful in terms of achieving a good quality outcome in terms of shortfall and some that are not.

CHRIS ADOLPH: On the point of being very transparent about venues or dealers it’s a function of managing expectations. If you’ve gone into the transition saying you will maximise the number of different venues then it’s incumbent on you to demonstrate that you have. Now, when we’re talking about algos, we’re principally talking about equity markets. When you’re talking about fixed income it’s about how you select your dealers: how you approach that is different for every transition manager. Remember that the price a dealer offers one day for an instrument may be very different a week later.

Our analysis shows that no dealer has the best price more than 6% of the time, so you need a wide range and a way to evaluate them. Do you have a process where you’re taking in that historical information and assessing who the right dealers are at that particular point in time? That’s a very different skillset on the fixed income side from the equity side. It includes demonstrating in post-trade analysis what dealers you’ve gone out to, how many bids you got and how you chose between them.

ANDREW ORR: I very seldom find the asset owners who we are mandated by have access to statistical information on algos or venues. Instead, clients look to the transition provider as the market expert to guide them on the most appropriate strategy. We continue to see clients who want to understand the strategy and the logic of the strategy depending on asset class and market conditions.

STEVE WEBSTER: If I can’t tell a client why the result is further away from what was estimated, then I’m not doing my job. The difference will only be clear if I can interrogate the strategy that was used and how effectively it was executed. If there is sizeable slippage from what was estimated then either it was subject to some sort of market event, or something else happened. I’m looking to see how the transition manager adapted that strategy to suit the circumstances, and I can only do that by looking at how they used the different sources of liquidity – which algos were used at what time and how the strategy changed.

CHRIS ADOLPH: Have there been many times where it’s come down to a venue selection or an algo choice that has actually impacted the result that much? I find if there’s a big deviation it’s typically more of a macro than a micro issue…

STEVE WEBSTER: The macro affects the micro: the way the transition manager deals with it is evident through the strategy and the way that strategy changes. When we get the source of the execution and see how that execution progresses over time, we can tell how that strategy changed over time, and we can see exactly where the value-add is coming from.

CYRIL VIDAL: I think you have to distinguish the algorithm that provides the optimal trading schedule, at the portfolio level, by optimizing the trade-off between execution risk and market impact, with the lower level liquidity seeking algos that decide where to route an order. Whether it’s done manually or by an optimiser, the transition manager must be able to provide transparency on the scheduling of executions, the rationale behind each decision to prioritise the unwind of a large idiosyncratic risk or conversely, holding back a stock that is a hedger and reduces the overall portfolio risk. Coming up with the right trade schedule is probably what will have the greatest impact on the overall implementation shortfall.

HUGO COX: Where do you see the most complex transitions coming from today and in the future, and what are you doing to mitigate the risks?

CRAIG BLACKBOURN: The use of transition managers continues to grow as investors seek to achieve cost and risk savings when making changes to their investment portfolios. The skills and experience of the community in helping asset owners identify key sources of risk and cost, before adopting implementation strategies and risk mitigation techniques to help manage the necessary market execution. The range of events where institutional and professional investors, including asset managers, engage the services of the community continue to expand in both size and complexity.

DAN CONSTANTINE: Our most complex events are plan mergers, plan conversions or sub-advisor changes. This means a number of funds involved, often in the double digits on the legacy and the target side. We certainly focus on the planning and project management aspects: coordination across multiple parties; record keepers, sometimes multiple custodians, and then multiple fund managers involved. We start planning many months ahead to consider all the operational issues that could come up, to ensure that implementation goes smoothly.

In one of the events we managed in the last year, we used portfolio optimisation tools to evaluate tracking error and optimise the asset mapping between all the different legacy and target funds. Then, once you’ve got the mapping down it’s critical to evaluate whether to use a hedge and really optimise the composition of the hedge if you do. Also, we have seen asset manager clients using ancillary services. In addition to transition management and interim management, there is outsourced trading and currency management as well.

PAUL MCGEE: To mitigate the risks for complex transitions, we get more involved modelling different ways to approach both the transition period and the transition structure for the client. This is done in the lead up to determine when and where best a client should perform their transition. Is it in legacy account structures? Is it in target account structures? Is it in a ring-fenced vehicle? When we’re unwinding pooled funds, transferring assets or crossing between different legal entities within a fund structure; do these actions incur tax or not?

ANDY GILBERT: Whole portfolio transitions are going to become more and more frequent. Rather than changing asset managers or slightly adjusting the strategic asset allocation across equity and fixed income, it is going to be more about “whole” portfolio change. With the rise of the outsourced CIO, mandates will need to be transitioned regardless of what’s in them; we’ll need to think about how assets are correlated, what kind of risk models you’re adopting to deal with the exposure challenge. Then rolling out or ramping up alternative exposures will have to be accommodated within the industry’s toolkit. As for complexity, we should consider unitised platform-based transitions. But the general point is that complexity comes in all shapes and sizes: complex trading strategies, complex exposure management challenges, liquidity challenges, or operational stakeholder management in a significant platform change. Your transition manager must be equipped with the tools and the experience to manage this complexity for our clients; and importantly to evolve and keep pace with these changing complexities.

CYRIL VIDAL: Regarding the trend towards asset managers using our services, there is greater need for automation – for a fully integrated infrastructure, including trading, analysis and execution. In an environment where everybody is under pressure to reduce costs, being able to outsource certain functions to a transition manager is great, especially for complex transitions. Recently, we have assisted an asset manager during a complex fund merger, where the client was facing various challenges to determine the optimal transition plan to minimise portfolio turnover and adhere to a strict timeline. Working in partnership with us helped the portfolio managers and their operation teams to answer these questions without too much distraction from their day-to-day activity.  

This article is part of the Transitional Management Guide 2022, and if you want to download the full guide click here.