Transition manages can provide a full service or certain components on a flexible basis to match the needs and sophistication of the client, finds Paul Golden
Transition management can be broken down into three distinct functions – project management, risk management and trading/execution. While the latter function is often considered to be central to a transition it may actually only contribute 20%-30% of the value added and the other functions can be provided independently.
In this context it is increasingly essential that transition managers have robust cross-functional capabilities. The importance of each function will depend on specific transition complexities as well as the capabilities and preferences of each client.
For example, defined contribution (DC) pension scheme mergers often have fewer trading requirements than sub-advisor changes, but require intense project management often spanning three to six months prior to the effective date.
By contrast, one-to-one sub-advisor changes can require light project management. Here, the focus shifts to strategy design, such as investment risk management and trading to minimise market impact and preserve value for participants.
While the importance of trading, project management and operations is dynamic, reporting and compliance are
The value added by transition managers has never been greater, according to Justine Anderson, global co-head of transition management at BlackRock. Good transition managers are now trade strategy advisers, ETF specialists, portfolio managers, dealing specialists and risk analytics specialists, which is why the list of transition providers is not very long, she said. “In order to be all of these things you need the right resources and skills.”
Peter Weiner, senior managing director, head of transition management Americas and head of global sales at State Street Global Markets, said: “We have found that the variety of transition exercises is widening and success is determined by an increasingly nuanced set of challenges. Therefore, we believe a multi-functional and dynamic transition manager is the chief component in preserving value for plan participants.”
When evaluating a transition, it could be found in certain circumstances that it is optimal for the asset owner or manager to complete the trading or provide cash. Weiner said that in cases where some or all trading is completed in-house, or by a third-party asset manager, the transition manager can add value through strategy development, project management and post-trade evaluation.
In effect, all of the transition manager’s services (except trading and reconciliation) could be made available to the client through a project-based transition agreement. “Such an arrangement would allow customers to leverage our tools to manage risk, increase in-kinds, prioritise trading or select optimal transition dates,” said Weiner. “Asset owners would also have access to experienced transition managers capable of coordinating a multi-faceted project.”
It is still important to recognise that transitions managed in a hybrid fashion can be more difficult than those managed completely by a transition manager. Typically, a transition manager will maximise in-kinds and crossing while managing a risk plan across all aspects of the trade, according to Weiner.
Any “blind spots” created by bifurcation of responsibilities can create risk, he said. “Examples include changes to trade strategy, miscommunication of positions during trading and settlement issues. These risks are only mitigated with ongoing manager engagement with transition managers in all phases of an event.”
Clients want to be confident that their transition management provider is able to provide a full range best-practice solution but there is also recognition that the process has become more unbundled, suggests David Goodman, division director at Macquarie Group.
“As a transition manager, we work closely with asset managers and they get a feel for the sort of analytics and reporting we are able to do,” he adds. Those asset managers may be in a situation where their own clients want to fund them with cash – but they want to show that they have access to sophisticated reporting or risk management tools and funding directly from another portfolio is an option. “They may ask a transition manager to white label their pre-trades or post-trades or help them with an execution strategy,” he adds.
He observes that large assets owners increasingly want to become part of the transition process and that in some cases they may only need an execution partner.
Most of the work done in the industry is full service transition management – which are episodic events – but these clients may also be engaging with counterparties on overlays, liquidity management and other risk strategies that are more frequent, said Goodman.
He stresses the importance of offering flexibility and the need for transition managers to deliver the plan that is most appropriate for each client – an approach that is not always compatible with a transition manager’s legacy processes.
Internal investment capabilities
Client sophistication has increased significantly with the build-out of internal investment management capabilities and the operations and services that go along with that, including transition management.
Artour Samsonov, head of transition management Emea at Citi, notes that consolidation projects, such as LGPS pooling, mean asset managers that were investing externally may create a framework for developing internal investment capabilities.
“Operational and transition management functions tend to flow from this,” he explains.
There is a sharper focus on costs and greater emphasis on the asset owner taking ownership of the decision-making process, whether it is a sovereign wealth fund or a public pension fund, adds Samsonov. Regarding asset management, “we see consistent support for the transition management service, driven recently by M&A activity”.
This has led to fragmentation of the transition management service, in the sense that clients are not always looking for the full-service offering where the provider takes over the custody account and does all the restructuring.
“Some clients will have their own dealing desks and develop their own links to interact with the brokers and we are seeing an increased volume of this kind of separate demand,” said Samsonov. “However, there will always be clients who prefer to delegate all aspects of the process and there is still strong demand for pre-transition analysis and reporting associated with the trading as well as some of the project management in terms of managing the trading.”
“We want our clients to be engaged in the process,” he continues. “We have the same objective as the client – to achieve the restructuring through tight risk and execution management while keeping control on cost – and they end up with a greater appreciation of the amount of work involved.”
Transition brokers and transition managers
A distinction is made between transition managers and transition brokers. In the latter, legacy and target managers typically interact directly with a single broker, bypassing the needs of transferring assets to a transition account, while maintaining the benefits of project coordination and achieve the cost efficiency for the assets to transfer in-kind (assets in common between legacy and target managers).
Cyril Vidal, co-head of portfolio transition solutions at Goldman Sachs, said “hiring a transition manager can be operationally and legally onerous, transition brokers can, in certain instances, provide a turn-key solution for implementing a transition swiftly”.
Certain users of transition management services have morphed into fully fledged asset managers. These clients often go back to a transition broker to assist them for certain aspects of their projects, including trading/execution for high volumes or complex transactions.
“Transition brokers have global cross-asset execution capabilities that can complement in-house trading teams” said Vidal. Post-trade reporting is also an element that can entice clients to use a particular counterparty. “Client’s dealing desks may use a single executing (transition) broker, knowing they can receive a comprehensive post-trade report after the event”, he adds.
BlackRock’s Anderson said that the expanded range of expertise of transition managers has helped them address the trend for some sophisticated asset owners and managers to carry out part of their transition events in-house.
“Because we are able to break down a transition assignment into the different individual elements we can work with clients’ in-house teams, which take care of certain elements of the project,” she said. “This allows all parties to be more scalable and to integrate more easily. However, the key factor in making this work is having specialists and the right technology.”
In the main, Anderson said that in her experience clients who prefer to handle some elements of the event in-house have the necessary skills and expertise, and understand where the transition manager’s offering compliments their skills. He believes that dialogue and trust are the key factors in ensuring clients who bring elements of the event in-house understand how this might affect the outcome.
“We start talking to clients long before they start down the implementation route, taking account of not just transaction cost analysis but also operational and liquidity considerations and feasibility studies,” she adds. This means that expectations are aligned when it comes to the transition point and each side knows exactly what is expected from them, backed up by service level agreements that clarify each of these aspects.
Anderson observes that the role of the transition manager has changed over the last decade from that of a transaction partner to more of a trusted adviser, involved in the very earliest stages of event planning. She said this is likely to lead to an increase in strategic partnerships and fewer managers being chosen through the panel process, with clients working with no more than one or two managers on all their events.
“The events that clients are undertaking are becoming more complex, with a wider range of instruments and a greater variety of strategies required to achieve their objectives,” concludes Anderson.
Strategic approach led to success
Good planning was an essential component for State Street to deliver a DC pension plan a transition on time and below the estimated cost
A defined contribution (DC) pension plan offering more than 180 fund options wanted to restructure $4.1bn in assets across seven sub-plans and included both equity and fixed income options. The plans also utilised multiple record keepers and custodians, adding to the operational complexity of the event.
The strategic theme of the transition was consolidation. The plan sponsor sought to merge plans and record-keepers, while streamlining and enhancing investment options. Recognising the operational and investment complexity of this event, the pension plan sought a transition manager with a proven track record in complex, multi-asset DC transitions.
State Street was appointed the transition manager for the event. The pension scheme had already had a series of successful previous engagements with the provider and was aware of its expertise in complex, project-heavy transitions.
State Street was responsible for coordinating operations, mitigating portfolio risk, executing trades efficiently and providing clear post-transition cost analysis.
State Street worked closely with the DC plan and other counterparties to organise and complete the transition. The foundational component of the transition was the creation and management of a shared project plan and timeline for use by the client’s custodians, record keepers and other counterparties to the transition.
During the planning phase, transition account structure was optimised to maximise overlap between target and legacy securities for each sub-event and reduce costs. Where residual macro risks remained post-mapping, hedging strategies were employed.
Finally, where available hedging instruments were not effective (for example, in managing idiosyncratic risk), an optimised trading schedule was designed and deployed to minimise costs and manage risk. State Street’s trading strategy prioritised the completion of securities that contribute most to risk.
The transition took many months to plan and approximately three weeks to complete the trading. The client’s expectations for both operational efficiency and transition results were exceeded and the project plan was closely followed with on time completion.
The total cost of the transition came in below the estimated cost due to in-kind retention (28% of legacy value) and reductions in spread and market impact from trade crossing ($800m). The futures hedging positions were effective in managing portfolio risk.
This type of transition highlights the importance of both project management and planning. While this event was a large planning exercise, its lessons are valuable even for less complex transitions. A successful event blends all aspects of transition management from planning to trading, according to the plan manager.