The floodgates are open, flung wide by an avalanche of newly arrived transition managers descending on the marketplace in all different forms and guises. Suddenly, it seems that every type of financial institution that has anything to do with the investment process now has a transition management capability. What does all this mean for the future, where is it leading us, and whichcategory of providers, if any, will win out in the fight for supremacy?
The transition process flow chart below reveals the potential parties to a transition and how they might typically interact with each other during the transition phase.
Consider for a moment that every different financial entity represented in this chart (the client excepted) is now offering its own version of transition management services. Given that the vast majority of transition managers – including the more independently positioned providers – are derivatives of one or other of these various financial entities, it is hardly surprising, in a world driven by the commercial imperative, that each one now considers itself qualified to provide transition management services.
It begs the question: how well qualified and suitably equipped are some of these providers, and is there not an element of opportunism at work as each seeks to generate yet another revenue stream for its ultimate parent?
From the client’s perspective it amounts to a myriad of different providers – some well known to the client and others not so – each peddling their wares and each telling a different story as to what really matters and where the client’s focus should be in seeking the optimal transition solution. The challenge for the client should not be underestimated. They face a variety of issues including how to distinguish between providers, who to believe and where to begin.
Perhaps the best starting point is for the client to ask: “What exactly am I trying to achieve?”
More often than not the answer will be that the goal is to implement the board’s decision in the most cost-effective, risk-free and time-efficient manner possible, while having regard for all the factors.
Recently, there have been numerous arguments touted in favour of a more patient strategy, based on the premise that the board decision took weeks or months to reach. These are entirely unfathomable and misguided. History reveals that decisive execution of Ulysses’ remarkable initiative ended 10 years of Trojan conflict in just two days. While not all board decisions can be expected to have quite that impact, the decision should be implemented without avoidable delay.
With the primary objective established, the client then needs to determine who is best placed to implement the proposed changes. This requires a further decomposition of the types of risk, both generic and specific, that attach to the transition; and also an appraisal of the distinguishing characteristics of the transition managers.
Investors should be aware that transition risk is singularly unique. This is the result of it being an aggregation of all the various different types of risk that present at each and every stage of the investment process. Namely operational, opportunity cost, exposure, execution and administrative risk – all amalgamated into the one process.
While each component of risk will carry a different weight according to the individual transition circumstances, all of the client’s efforts should be centred on identifying which specialist provider is best equipped with the necessary tools and experience to manage every facet of risk that presents at each stage of the process.
Assuming the client is unwilling to break every rule of portfolio diversification theory, it is also peculiar to the transition phase that the fundamental decision as to which assets to hold going forward and which not to, does not rest with the transition manager. The existing portfolios are inherited from the terminated managers; the target model portfolios are the wish lists of the newly appointed managers. The transition manager only facilitates the most cost-effective change from one to the other.
Creating a bridge
It is for this reason that transition management is most often, and quite correctly, identified as being a largely short-term process. Essentially, it is the bridge between the old structure and the new.
In evaluating the relative merits of the various different providers, it is helpful to begin with an assessment of not so much how they differ, but what most of them have in common with each other. Notwithstanding that some providers are more independent than others, all transition managers have potential conflicts of interest of one kind or another to address.
The price of true independence is the ever-growing dilemma of an inevitably high cost base in the face of ever-shrinking margins. It is up to each provider to clearly articulate how it proposes to manage any potential conflict and to do so to the full satisfaction of the client. All transition managers agree that confidentiality is critical (although some models inescapably compromise this in their choice of execution methodology).
All are agreed that powerful access to liquidity is essential to minimise impact cost, but some liquidity is less readily accessible than the client is led to believe, and other types of liquidity result in the client becoming a “price taker”.
Perhaps the biggest buzzwords of all, however, are “project management”. In this regard, no one should be under any illusion that project management and effective management of transition risk are mutually exclusive propositions. If this appears to state the blindingly obvious, consider for a moment the relative positioning of each provider within the transition process chart and work through each one’s corresponding ability to effectively manage each and every aspect of risk. To reiterate the primary risks: the operational process; the opportunity cost risk; maintaining interim portfolio exposures; minimising execution risk and effectively addressing the administrative burden of the transition.
Transitional oversight
As a first observation, it occurs that no single entity is richly endowed with all the requisite skills. This gives way to the acknowledgement that a successfully implemented transition is not just about the performance of any one party to the transition (the transition manager included). A critical part of the transition manager’s role, therefore, is to establish itself as the epicentre of clear and effective communication between all parties to the process.
The next thing to observe it that, while each component of risk is the more natural domain of one or other type of financial entity, fund management firms and investment banks – simply by virtue of their daily responsibilities –are more regularly exposed to, and called on, to deal with the full range of risks presented. It is also intuitive that other categories are unlikely to have some of the necessary risk management expertise and market experience; it is incumbent on those entities to convince potential clientsotherwise.
Further weight can be added to this proposition by prioritising the magnitude of each type of risk. Without underplaying the critical importance of strong operational controls and a soundly based administrative process, it is opportunity cost, exposure risk and execution risk thatpresent the greatest scope for performance slippage, and it is experience here that is critical.
The current frenzy will inevitably abate eventually. The most independent providers are unlikely to disappear as there will always be those clients prepared to pay the middleman price to resolve the potential for conflict.
Broader domination of the transition space, however, will likely come down to the most committed and well resourced of the fund management and investment bank providers. Neither need necessarily prevail over the other, as different circumstances demand different transition structures and accompanying skill-sets. In the meantime, clients can look forward to an increasingly competitive environment in which explicit margins – and consequently explicit costs to the client – remain under pressure.
The challenge for the clients is to see through these murky waters in their selection of transition manager and thereby avoid the rocks that can so effortlessly smash the hull of fund performance.
Tim Wilkinson is managing director, global transition management at Citigroup. For more information, please email timothy.wilkinson@citigroup.com or Tel: +44 (0) 207 986 4533
