ROUNDTABLE PANEL
Lachlan French, head of transition management, State Street 
Tom van Eijndhoven, manager securities administration, PME (Metalektro) 
Tim Wilkinson, global head of transition management, Citigroup 
Michael Robarts, senior consultant, Hewitt Associates 
Penny Green, chief executive, Superannuation Arrangements of the University of London 
John Minderides, head of transition management, JP Morgan 
Mark Jaffray, investment consultant, Hymans Robertson 
Paul Kessell, investment manager, London Pensions Fund Authority
Moderator Paula Garrido, FT Mandate
Paula Garrido: The number of institutional investors hiring the services of transition managers has grown considerably over the recent past. In your opinion, what are the main drivers behind this growth?
Lachlan French: I think the drivers are pretty straightforward. There has been considerable industry focus on maximising fund performance, so people are looking at all aspects of the investment process; efficiency and cost savings in the implementation of new investment strategies is obviously one part of that. There has been significant change to investment management approaches over the last five or six years; with the move from balanced to specialist mandates, the adoption of unconstrained mandates, and most recently the use of LDI, hedge funds and private equity. Also there appears to be a transition management virtuous circle with the more transitions we do for clients, the more we prove that they can be completed efficiently and cost effectively.
Tom Van Eijndhoven: Increasing risk awareness on the institutional side is, in my opinion, probably one of the more important drivers. Pension funds want to be more in control of their risk, but moving from a balanced mandate to a specialist mandate, firing one manager and hiring another, or changing asset allocation can be very risky. If that period is long, the risk increases. Managing that and mitigating risks are very important things.
Tim Wilkinson: We are also seeing meaningful restructuring activity driven by regulatory changes. Increased fiduciary duties are being imposed upon trustees, and are accompanied by more prescriptive legislation such as the pension protection levy introduced under FRS 17. One of the ways to tackle defined benefit liability shortfall is to reallocate the assets. Also clients are responding to the era of low inflation by tackling unsustainably high fixed-cost bases. Some have re-engineered the entire investment structure towards a core/satellite strategy, replacing the traditional asset manager line up with 80 per cent of total assets being run as under low cost index –beta -structures, and the other 20 per cent being farmed out to absolute return –alpha- managers. Total fixed costs fall dramatically, but the quid pro quo is that 20 per cent of the assets are expected to generate the entire alpha for the fund.
Michael Robarts: I would say that the main driver is changes in asset allocation and fund management structures, of which there is a lot going on at the moment. Despite the growth in transition management, we as a consulting firm don’t actually automatically assume that every time you make a change, you need to appoint a transition manager. There are other ways of dealing with the risk.
Penny Green: A lot of it is driven by trustees understanding that moving from one complex strategy to a different but more complex investment strategy does incur costs that previously had been hidden. However, now when we have a low return environment and people need as much as they can get because of the pressure on assets and liabilities, trustees are becoming much more aware that transition managers in a lot of cases – and I would agree with Michael that it is not in every case – can actually save money. That becomes a very important part of the equation. You then add to that a lot of peer group pressure: the more people like me and Tom say we are using transition managers, the more other trustees think perhaps they ought to think about it, too.
Mark Jaffray: There is a recognition that transition managers can do a good job of taking away a lot of operational risk away from those entities. That has been a strong driver. Consultants have also been in the middle taking some of that operational risk, but they are less willing to do so now.
John Minderides: All these comments around reducing risks and costs and helping with admin are absolutely correct, but this has actually produced a feedback mechanism in that the recognition of the quality that transition management brings is actually showing that the traditional fund manager can’t do the job, so there is a need for a specialist of some kind to carry out the transition events. That has gone hand in hand with the need to put something in between the pension fund trustee and the traditional executing broker in order to actually carry out that work - hence the transition manager becomes more desirable the more you understand what is involved in transitions. You have to put something in the middle to help trustees out. That is where transition management has grown a lot.
Also transition management has actually given trustees more choice because it gives them the ability to make changes in their scheme assets in which they wouldn’t have necessarily engaged in the past. This is a positive development. As providers of transition services, we are almost becoming a new kind of broker, in that sense, as opposed to a traditional broker or a fund manager.
Paula Garrido: Penny, from a pension fund point of view, do you put as much time and effort in choosing a transition manager as you would do when selecting a fund manager? In your opinion, what questions should a pension fund ask when hiring the right transition management provider?
Penny Green: We certainly put as much effort into appointing a contingent transition manager as we would into choosing an actual investment manager. We were going through a strategy adjustment and recognised that at the end of that there could well be one, two or several complex manoeuvrings of assets. Having recognised that, we felt it was important we got a transition manager to help us in some of those moves. We started the process quite early on and used a consultant to help us, but we spent as much time and effort in finding a partner who could work with us and who was right for us. It’s about satisfying yourself about the capabilities of the transition manager in terms of delivery on the change in assets, having access to the right sort of training opportunities and the right skill sets, and being comfortable that there is complete security, particularly if you are using an investment bank, so that there is no leakage of the information given to the transition manager to other parts of the firm. It is also about being comfortable that, at that end of the process, you are going to get all of the reporting that you need at the accuracy levels you want and at the time you need it. So you can account to your members accurately as to what has gone on so that the trustees can genuinely account for their proper stewardship of the assets. On top of that, you actually have to like the people.
Paul Kessell: The Pensions Fund Authority undertook a significant transition in the last quarter of 2005, moving from a traditional bond and equities portfolio to an unconstrained approach, investing across derivatives and other types of products and strategies with which LPFA had not invested in previously. For us, the key was that the assets could be transitioned between the existing and new managers efficiently and smoothly, and we had to be confident the manager could achieve that outcome for us. That was probably more important than the actual cost of the transition in selecting the transition manager.
Beyond that, there is the need for a strong relationship with the people within the transition management organisation. You also need to ensure they are able to explain what they are doing and how they are doing it, how costs are being managed, and how the transition is measured and monitored.
Tom Van Eijndhoven: We have a set panel of two transition managers who we selected based on our judgment of their trading skills, as well as their project management abilities, which are very important. How efficiently can your transition manager guide your custodian and legacy managers, as well as your target managers, through the entire transition process? They also have to have the ability to explain how the manager sees the trading pattern, or what they expect of how they will implement the transition, what risks they see, how to mitigate them, and how to report on that pre, during and post the transition.
Michael Robarts: In many occasions transition clients actually decide on their investment managers before they give any thought to how they are going to do the transition. In other words, they don’t think of the question of costs of transition early enough in the piece. For example, picking a manager who only operates using pooled funds can make a huge difference to costs. Will that fund manager operate pooled funds or do an in specie transfer? If he won’t, you may find yourself with some extra costs. The other aspect is this question of audit trail. I think that most of our clients probably wouldn’t think of the issue of having a bullet-proof audit trail until after the event, although that is at least as important, if not more important, to most of our clients. That hardly gets discussed in most transition manager’s presentations. But, it is so important.
Penny Green: Before they appoint transition managers, pension funds need to be clear in their own mind about what they want to achieve: do they want to do it quickly, or do they want to do it cheaply? If you can do both, that’s great, but don’t expect they can do both because, normally, if you can do one, it’s at the cost of the other. They’re different skill sets, so you need to determine what skill set you want first before you go and make the appointment. Or, are you prepared to compromise?
Tom Van Eijndhoven: I would like to disagree. If we assign a transition or if our managers pitch for a transition, I never weigh the cheapest against the quickest. They should be as optimal as possible in all respects.
Penny Green: But there is a compromise inherent in that decision which you have already made, which is, ‘okay, that’s fine’; that’s the decision that you’ve taken.
Tim Wilkinson: We need to be flexible in accommodating Tom’s preference for transition manager input here versus Penny’s preference that the trustees determine this, based upon input from the managers. We always outline our central recommendation, but respect that different clients want varying levels of input.
Lachlan French: Users are looking to the transition managers’ advice and want to get them in the process early so that they can help them with it
Lachlan French: That is one of our roles – we have to understand what our client’s objectives are. All three users here have talked about looking to the transition managers’ advice and getting them in the process early so that they can help them with it. I would adopt a very different risk management approach to a client’s transition if they tell me they are doing this because there is a significant mismatch between their assets and liabilities rather than a more simple change in fund manager. Risk tolerances and the whole issue of timing becomes very important.
John Minderides: We’ve never knowingly won a transition because a previous transition manager’s costs were too high, but we have won transitions where the previous manager’s administration and settlement procedures had failed. That is a major focus.
Paula Garrido: How can pension funds measure whether their relationship with a transition manager and the transition itself has been successful? What are the key issues they have to look at?
Tom van Eijndhoven: When you start such a process, you have an idea of what the implementation shortfall may be given the liquidity of the legacy and the targets and the asset classes. The transition manager must also manage expectations as to how the implementation actually took place against what he expected. If his pre-trade indicates an implementation shortfall of 50 basis points and he reports in the end 120, he has something to explain. That is bad news for a transition manager because he has not managed my expectations well. It might be easily explainable, and if he can explain it very well, then it’s simple.
Michael Robarts: We have a rule of thumb approach that before the transition manager ever gives a pre-trade estimate to the client, we like to give the client some clue as to what we think the structural change is going to involve. We have some ideas about what spread costs are in different asset classes, so you can work out a figure which gives the client some context to judge the figure in the pre-trade analysis. I am cynical enough to believe that the transition management industry has to be very careful not to give an exaggerated idea of what they can achieve in terms of keeping costs down. It just so happens that most implementation shortfalls seem to come in when the market has been close to a pre-trade estimate, and usually slightly better than that.
Tim Wilkinson: The industry is now over ten years old, and one would surely expect any serious provider to demonstrate an established track record and also a robust process. A competent provider should also be able and willing to clarify the confidence interval of hitting its estimated impact cost range. Not being able to do that would presumably be off putting to potential clients. I think it’s important for clients to keep this in the forefront of their minds and to demand of providers that they demonstrate their overall track record and their results versus expectations by asset class. Equally, I think it is incumbent upon providers to maintain a proper track record and deploy this as demonstrable proof of its capabilities and as a factor of clear differentiation.
Paula Garrido: However, there seems to be new players trying to break into this market. How are they managing to attract business without having those track records?
John Minderides: There are two misconceptions. One is that there are too many transition managers, but I do not think there are. The second is that there are lots of new players trying to get into the market, but there are not, really.
Tim Wilkinson: One or two custodians are understood to be looking at it, but have yet to make a move. At this stage of the game, it’s a real challenge. If you haven’t already got the necessary infrastructure and an experienced team in place, and you haven’t built a track record, one suspects that it’s going to be extremely difficult to win favour with clients and their advisers.
Michael Robarts: It’s very difficult for a consultant to recommend a transition manager they’ve never worked with before.
Penny Green: We don’t mind using an investment manager that our consultant hasn’t heard of, but there’s no way I’d touch a transition manager that the consultant hadn't heard of.
PART TWO
