The transition management industry has until recently resembled the market for cosmetic surgery. When clients needed dramatic and often costly one-off changes to their portfolios, they went to their transition manager. But as the underlying economics of the business are changed by technological advances, and the demands of clients become ever more complex, transition management is evolving into a process more like personal training – a constant, consultative process that improves the overall health of the client’s portfolio.
“What we have seen is that over the last couple of years, or certainly in the last year, is that the relationship between asset owners and transition managers has shifted from a one off event-driven relationship to a continuous relationship,” says Kal Bassily, global head of BNY Global Transition Management.
“Whereas in the past you would see a pension fund either have a transition manager when they have a significant asset reallocation event, right now we help them with portfolio rebalancing, we help them with rebalancing back to their target asset allocation… all of these tweaks that take place every month, every two months, every three months,” he adds.
According to a recent Tabb Group report, “The Optimal Transition: Mitigating Risk and Minimising Market Impact,” pension funds’ move to liability-driven investing, coupled with an increased understanding of the transition management process, has seen pension funds worldwide transition $3400bn (€2170bn) – just over 10 per cent of total global pension fund assets – per year. Around 45 per cent of those transitions are currently handled by transition managers. A combination of better understanding of risk management at the asset owners, and the fact that complex, multi-asset class transitions are now more commonplace, means that this proportion is likely to change in favour of third party transition managers, the report predicts.
Recent volatile market conditions have also served to aggravate asset allocation drift – the relative shift between asset classes – and poor performance and constrained liquidity in traditional equities and fixed income instruments are also prompting more aggressive rebalancing and reallocation.
“That is not to say that this [continuous relationship] is the case with every asset owner. The vast majority of asset owners still deal with transition managers on an on-and-off basis, but our prediction is that the trend will spread to other asset owners of different sizes.” As with many trends, Mr Bassily says, the larger, more sophisticated funds are the first to negotiate these kinds of relationships. They are also best able to understand the benefits, as they generally have more access to the analytics and expertise needed to assess the transition costs.
Falling cost
And those costs have fallen, according to Lachlan French, head of transition management at Barclays Global Investors (BGI), despite the increasing complexity of the clients’ investments and the trading infrastructure. “If you look at a five to ten year view, the overall cost of transitions has fallen,” he says. Technology is a key driver behind this, as electronic trading becomes more commoditised and algorithmic execution techniques improve and reduce market impact costs. The Tabb Group report pointed to the availability of block trading and dark liquidity venues which, used properly, can dramatically reduce the risk of transitions.
BGI has also witnessed the shift towards a longer term, more consultative process. “I definitely see the way we interact with clients developing into a more continuous relationship, in that clients continue to want swifter response, they continue to want us to manage more complex situations. And both of those require an ongoing relationship to be most effective,” Mr French says.
Liability driven investing (LDI) and the growth of defined contribution platforms have led pension funds into more complex asset classes that require a new approach to transition management. For example, Mr French says, the use of multi-manager platforms by defined contribution pension schemes creates an unusual challenge.
“In [multi-manager] environments they have a range of funds which are daily priced and they have daily cashflows in and out of those funds. So from our point of view as a transition manager, we are likely to be transitioning in ten, twenty different pots, all of which we have to meet deadlines in terms of transaction reporting and unit pricing and we may have cashflows in and out of all those different accounts,” he says.
“Obviously, that is a different type of operational challenge than a single account where we have no particular intra-day trading requirements.” In this environment, Mr French notes, the impact of the transitions costs are more evident to the client.
“You have a unit price, and that unit price is impacted by the structuring activities, so it’s an area where managers take the overall cost of managing transitions very seriously,” he says. “It would have a more visible impact on a unit price than maybe on a segregated portfolio.
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