Paul Kessell: If we’re comfortable with the management fee charged and the cost of implementing the transition, then we can say we are happy with it. How much of the management fee goes to the bottom line for the transition managers, is not really our concern. Even though there are a limited number of transition managers, it’s an extremely competitive market. It’s our role to get the best price we can, not forgetting the transition manager is running a business.
In terms of investment banks coming into the market, they will remain as long as they see a potential profit, but clearly if they’re able to take on a transition and achieve the outcomes we’re looking for, then I can’t see that as an issue.
John Minderides: Again, there are a lot of misconceptions here. Investment banks have been in this business for a long time; it’s not new. They’ve been doing it since they decided portfolio trading could be sold to be something a bit more than portfolio trading, which goes back to the mid-1990s. It’s new perhaps in terms of how they are structured internally but it’s coupled with changing conflicts of interests in other providers where the nature of fund management has changed dramatically to be more focused on concentrated portfolios and hedge fund management. What’s going on in those houses is very different to what it was when they were just running pooled index funds. However, the profit margins are not high at all. This is a low-margin business.
John Minderides: Why can’t we ask the question a different way and talk about the issues of using a fund manager? Is a fund manager the right choice?
The reason we are in this business is not just for the bottom line, but obviously we do want to make a profit because we have to pay our teams and our shareholders. However, we’re in this business because as a large integrated financial institution, we’re also expected to serve clients in multiple dimensions, and transition management is one of those. We have to be in this business because we touch clients in many different ways, and if we don’t have that piece, it looks like a gap.
Tim Wilkinson: Given the legacy of poor transparency and high profitability, investment banks probably still need to demonstrate more than other providers that this is clear separation of the transition model. Our transition management business is housed in a completely different part of the bank from all the different trading activities.
There is absolutely no engagement in pre-hedging or price adjustment and we provide as much transparency as possible into every aspect of our business. Clients are thus clear as to our profitability as well as our total charges to them. The legacy of having spawned from a broker-dealer model is that, for new clients at least, we will continue to have to clearly demonstrate the impartiality of our model and our operating structure. Existing clients on the other hand are very familiar and equally comfortable with our model.
Michael Robarts: It is fairly clear to me that investment banks are in the business because they actually want to generate as much order flow as possible so they are trading on their prices as opposed to going out to the market to trade on someone else’s prices. Anyone who has ever run a book will tell you that you make your money by dealing on your own price, not on the market price. The crucial question is: is the inherent conflict of interest being controlled properly?
Lachlan French: We talked about the nature of the investment management business changing; I think that the nature of investment banking has also changed over the last five years. You look at the main profit drivers within the investment banking firms, and there is a significantly greater contribution from proprietary trading than there was four or five years ago, and so I do think the world is changing. The situation you have to avoid at all costs is that this doesn’t adversely impact a transition client’s portfolio. This should be the primary focus of any transition process.
Paula Garrido: Mark, from a consultant point of view, do you think institutional investors do worry about the background of their transition manager? Is there any model that you favour?
Mark Jaffray: We don’t favour one model over another across the board. If a client was looking to warehouse their money in an index manager, then typically the index manager would be replaced for the transition, but there isn’t one specific model. We tend to put forward a number of models to clients and have discussions with them about the merits of different models, and then let them decide which one they favour. We’ve used asset managers and investment banks, and there are different aspects of the business models and there are different conflicts in each of them that we have to make clients aware of.
Michael Robarts: When they pitch for business, the investment bank tends to come five-strong to the pitch. I have often seen that put trustees and pension schemes off.
Tim Wilkinson: I’ve actuall had the reverse experience. I have turned up for a pitch on my own whilst the other providers all turned up with a whole team of people. It was made clear that under-representation was a significant disadvantage. Thus it is very much on a client-by-client basis.
Paul Kessell: The issue with investment banks seems to revolve around a marketing and positioning issue as anything else. From a client perspective, there are risks and conflicts with each different model. Our awareness of those and our ability to mitigate the risks are important. I agree that a five-strong team coming in front of us at a presentation is going to be too much, but that is something they have to come to terms with. Knowing how to deal with pension funds and their trustees as opposed to dealing with an institutional client is critical to their success. Pension funds are generally more cautious and want some comfort level through having control over the process. Otherwise, I don’t see that as a significant issue for us.
John Minderides: Why can’t we ask the question a different way and talk about the issues of using a fund manager? Is a fund manager the right choice?
Tom Van Eijndhoven: I believe that the way an asset manager structures his processes can mean he is not capable of implementing a transition quickly.
John Minderides: One of the things I was thinking of was compliance. Where an investment bank, broker or trader in theory clears his books at the end of the day, a fund manager could have an overhang of stocks he was trying to sell or buy for months. There are very different compliance problems.
Tim Wilkinson: An asset manager may be acting for other [non-transition] clients for whom he wants to execute trades the opposite side of the transition activity and that asset manager might determine to hold up the transition execution for a day or so in order to cross the orders. Is that cross in the best interests of the transition client? I very much doubt it.
Tim Wilkinson: There are changing demands on transition managers, and changes in the way that people are approaching the investment management process
Lachlan French: Our business model is that of a dedicated transition manager always acting as agent for our client. There have been some comments in terms of trade allocation; these are issues that should be, and regularly are, addressed by a transition manager’s compliance procedures and monitoring process. If I was an asset manager, I would keep the transition management business separate from my asset management business so I wouldn’t have the sort of issues that you’re talking about. I don’t think there’s any truth in the argument that the compliance function within a broking entity is more appropriate to transition management than it is to an asset management entity. Going on to the discussion of whether a broking model is more consistent with transition management or not, I think the important distinction here is that it is about managing conflicts of interest and the major conflict of interest is obviously between the trading book and the client. The important aspect of any asset management structure is that they can adopt more of a fiduciary role in the process.
Paula Garrido: What is your definition of ‘fiduciary’ in relation to transition management services?
Lachlan French: My definition of ‘fiduciary’ is that you employ someone who is acting in your best interests, and solely in your best interests. It is defined considerably more accurately in the US than in the UK or in Europe. So, a fiduciary transition manager acts in the clients’ best interest and has a responsibility of loyalty solely to that client.
Paula Garrido: I would like to hear from the pension funds sitting at this table whether they think their transition managers are doing their job properly, efficiently and in a cost-effective way. Tom, would you like to start?
Tom Van Eijndhoven: As our main reason for hiring a transition manager is mitigation and management of risk during a transition period, I’d say I’m pleased by managers. They report in a transparent way pre, during and after the transition, and that’s our requirement. During a transition, I want to see on a day-by-day basis how risk was effectively reduced.
Paula Garrido: As sophisticated institutional investors, how much information do you need about exactly what the do and the strategies they use?
Tom Van Eijndhoven: I want to know what his trading strategy would be and what his expected period of transition would be. I want to know what his proposals are for risk mitigation. During the transition, I don’t need it online, as we’re not that close to the actual trading. On a daily basis, I want a report that tells me how my risk was reduced, what my remaining risk is, what he traded and what was projected, and what he needs to do for the remaining period. A few days after the transition, I want a full post-trade report that compares what he expected pre-trade with the actual outcome.
Penny Green, SAUL
Penny Green: I think the question that you ask is a very good question that all trustees should look at because, actually, in many ways it’s not just appropriate to transition managers; it’s appropriate to all advisers. A transition manager, or any other adviser, will only do the job they are able to do given the information they are given by the trustee. If a trustee doesn’t manage the relationship effectively, then they’ve got no idea whether the job done at the end of the day is good or bad, and therefore there can be no evaluation of the efficacy of that expense. When it comes down to it, I want the same thing that Tom wants. It is about watching that process going through it and having the difference between what was expected and what was actually delivered in a way that I can then report back to the trustees.
Paul Kessell: Are we happy with the way the transition management industry has developed and the service that we are getting? In short, yes. More importantly, I think it’s about getting trustees comfortable with the process, the expected outcomes and assurances that any issues arising will be resolved promptly. And as the person managing the relationship for the pension fund, were you happy with how the transition was managed? If it is managed within the constraints that we have set, if the transition manager communicates with me, of there were any issues to be resolved, and if the transition has been successfully completed, then I’m happy.
Tom Van Eijndhoven: There is one concern that I have. I have been offered to have transitions done for free. I don’t understand that. I want to understand how that happens. I understand there’s increasing competition and it’s important to get flow.
Michael Robarts: They want the first transition.
Paula Garrido: Michael, is what Paul and Tom have just described what you see from your clients when you talk to them?
Michael Robarts: I think it is. The only thing I would add is the audit trail afterward. It is so important. You can have all the risk mitigation and all the post-trade reporting in the world, but if 15 months later the auditors come and cannot make the cash add up, you’re in trouble. You’ll never find out in 15 months time what happened to that.
Paul Kessell: That’s part of the process.
Michael Robarts: It so often isn’t, in my experience. I find myself as a consultant after a transition sweeping up after the transition manager and producing a cash reconciliation.
Lachlan French: Over the last few years we have significantly enhanced our service to clients in many areas, in particulary in reducing transition costs. We spend a lot of time looking at the risk characteristics of a portfolio and managing that risk process. Basically, on an absolute and a risk-adjusted basis, the cost of restructuring portfolios has fallen.
On the project management side the transitions we handle are becoming more sophisticated, more complex and more immediate. I’m absolutely convinced that transition management services have improved over the last five years and will continue to improve over the next five years.
Tim Wilkinson: There are changing demands on transition managers, and changes in the way that people are approaching the investment management process. You ask an investment manager the top five asset classes over the next five years, they don’t talk about global equities; they talk about liability-driven investments. That is what we are currently seeing, so the demands on the transition manager are increasingly complex. I think it’s important to have those kinds of capabilities integrated into your process so that you can offer them opaquely but seamlessly. You can say that you have an experience in offering synthetic solutions, simple futures overlays or more complex ways to swap, and we can show you that these aren’t perfect and will have tracking error. This comes back to Penny’s point that we have to give comfort in explaining what we can and can’t achieve. If we don’t outline the limitations of our or anyone else’s abilities, then we do mislead and perhaps over-egg the expectation.
Paula Garrido: As investment strategies become more complex, do you think transition managers will be able to continue adding value to investors? What are the most important developments that will impact the work of transition managers and their ability to deliver?
Michael Robarts: One thing we are seeing is that structures which are non-traditional tend to involve a lot of bonds, a lot of alternatives, often in the form of pooled funds, concentrated portfolios, and managers who are not very familiar with the concept of in specie transfers. That is actually working against the traditional transition management model where you take a block of heritage assets and stick up a portfolio of target assets. You are going to end up with funds that need cash and have a reinvestment cost attached to them. I’m not convinced that the transition management industry really has any meaningful answer for dealing with that last leg. It’s a problem that clients aren’t focusing on at the time they make the decision to go down that route because consultants like us fail to point it out early enough. The decision is made without all of the consequences of the decision being considered. I think it’s a pity.
Penny Green: I actually think the biggest challenge for transition managers is not in what asset managers are talking about, because there is a lot of hot air around absolute return, portable alpha and that sort of thing, but how many funds are moving significantly into that space is a good question. I think the biggest challenge that faces them is the move from DB to DC because the mindset changes completely, and nobody has gotten to grips with that.
Mark Jaffray: The DB/DC thing is obviously a trend that is happening, and DC schemes now are getting quite big. You’re at the point where you think if it is worth getting a transition manager into a £40m DC scheme. My guess is that transition managers will start to get involved in services in that area – perhaps not in £40m but £100m-ish, where it might be worthwhile.
Penny Green: If that happens, I think transition managers will no longer have just a trustee and an employer to deal with; they will actually have members who are going to see real-life costs incurred. They are going to go, ‘What the hell happened there’. That might go from member to trustee, but there is no way the trustee is going to take that one on the chin; it’s going to go straight back up the line. That’s a completely different communication dynamic to the one where you are just dealing with the trustee.
Lachlan French: It goes back to the point I made earlier about the increasing complexity of what people are asking us to do. There is significant responsibility on the trustee of a pooled fund to make sure that you mitigate the costs of a portfolio restructuring, similar to the responsibility of the pensions manager of a segregated pension fund. However the pooled nature of the fund means there are more operational issues such as: insuring accurate unit pricing and that all fund holders are treated fairly.
Paul Kessell: I see a very positive outlook for transition management. I expect it to become the standard approach to moving assets within an investment strategy. Obvioulsy, it’s a very very competitive standard market with profit margins quite low, and there may be other business areas the transition managers may look to expand into similar to what custodians are doing these days. Whether that means they take their focus away from the pure transition management model on which they are currently focused, is something they will have to deal with. From our perspective there will always be a need for efficient, cost-effective, transparent and bespoke transition solutions, and it’s incumbent upon the transition managers to meet that challenge.
John Minderides: Transition managers have got better and costs have come down, but part of that are low volatile markets. Volatility going up – is that more or less difficult for a transition manager? Actually, it cuts both ways. Volatility going up means there is an inherent increase in the expected cost that will be incurred. Whilst that may be higher than it is currently, there is also a need to manage that cost. Transitions will cost more, potentially, but we are also going to help mitigate those increasing costs.
