The past few years have seen the development of transition management services to control the market risk exposure of funds changing manager. Frances Maguire examines the latest offerings.
Is a transition manager a fund manager or a trader? In essence, portfolio restructuring is likely to be carried out by a team, headed by a project manager, and to be comprised of traders, risk managers and operations staff to ensure the smooth transition of a portfolio from an outgoing to an incoming fund manager or an efficient rebalancing to reflect a new allocation strategy.
Traditionally, the teams came from the large fund management houses, which were first to offer transition services. Today, sell-side banks are just as likely to be offering their trading expertise for portfolio restructuring services.
Focus
The focus is moving away from managing the fund towards using trading expertise to make the changes at lowest cost and market impact. Increasingly, this is just as likely to be done at Goldman Sachs – or more recently, Dresdner Kleinwort Wasserstein – as it is at State Street or Barclays Global Investors.
That said, State Street’s transition management team restructured $250bn of assets last year. Lachlan French, head of transition management at State Street in Europe, says: “Now that the measurement of transaction costs has been put firmly in the spotlight, the techniques that grew up in transition management are likely to be used more widely within the industry as a whole.”
Having seen several new entrants to the transition management sector in the past three years, Mr French predicts this will whittle down again.
“We have witnessed a significant growth in transition management over the past few years; certainly, we are finding that success breeds success and our growth has exceeded that of the market,” he says.
“I expect the bulk of the business will be concentrated with just five or six global players.”
Internal liquidity
Mr French claims that the key factor attracting restructuring funds to State Street is the fact that its investment management arm, SsgA, has substantial internal liquidity – in excess of $901m in assets – which is always the first port of call for any major restructuring. Added to this, he says State Street differentiates itself from programme trading operations by managing the total risk of the transition for its clients.
Daniel Wiener, managing director at State Street in Europe, points out that any major restructuring of a fund is driven by the search for “the natural buyer or seller”. Furthermore, Mr Wiener stresses that careful handling of information flow is critical in securing minimum market impact for the restructuring.
“In an ideal world, traders would be able to execute all their order flow without having to show their own orders,” he says. Much of this can be achieved at State Street, in that around 40% of the transition is usually crossed internally. “But rarely can we trade everything through internal crossing and for the balance we need to ensure that trading costs and in particular market impact is minimised. That is where crossing networks [or alternative trading systems] can play a big part.”
‘If you put all your order flow into a crossing network, the portfolio could suffer from adverse stock selection’Daniel Wiener
State Street has its own intelligent order routing and crossing system, Lattice, which is part of its Global Link platform and is used to control client trading costs.
“Lattice lowers trading costs by searching out liquidity and intelligently slicing order flow into the market in order to reduce the effects of market impact and spread,” says Mr Wiener.
However, exclusive use of crossing is not necessarily the best option. Mr Wiener explains: “If you put all your order flow into a crossing network, there is a chance that the portfolio will suffer from adverse stock selection and this can have an impact on the portfolio and introduce risk.
“For instance, if you are looking to buy a broad cross section of the market, but end up only crossing a single sector, the portfolio will become skewed. We ensure all our trading is managed in a highly intelligent and risk-controlled way.”
Legacy portfolio
Barclays Global Investors (BGI) argues that the use of crossing networks brings lower costs and speed of execution when moving from a legacy portfolio to one defined by a new fund manager. Paul Samuel, head of transition management at BGI, says: “Where the portfolio restructuring is using the same asset class, say from UK to US equities, crossing networks can reduce the cost of execution. Furthermore, the liquid US markets usually enable allocations to be filled within a single day of trading, leaving us to get on with the more illiquid markets.”
‘A lot of trading is a multi-day event to transform the overall portfolio cheaply and efficiently’Paul Samuel
Where an institution’s wish list incorporates less liquid foreign equities or corporate bonds, trading the transition can take days to complete, according to Mr Samuel. “A lot of trading is a multi-day event to transform the overall portfolio cheaply and efficiently, and provide a detailed performance against a benchmark,” he says.
By analysing the preferred portfolio, crossing internally then pricing trading strategies, putting futures hedges in place for the transition, and trading and preparing the results, BGI aims to return the completed overhaul to the institution within two to four weeks.
The predicted increased growth of transition management is more than a gut feeling by those players aligning their businesses to cater for it – much of it is spurred by incoming regulation. The Financial Reporting Standards are forging ahead with a requirement that pension funds report annual charges and, following the Myners Report, it is clear that the UK regulator, the Financial Services Authority, will also soon require commissions paid for execution to be unbundled from the research packages provided to fund managers by brokers.
Earlier this year, Dresdner Kleinwort Wasserstein (DrKW) invested heavily in building up its global portfolio trading team with six high-profile appointments reporting to Tim Clorite, global head of portfolio trading.
Diane Garnick, head of US portfolio strategy at DrKW, says: “Dresdner has been in the portfolio trading and transition business for many years. However, similar to many other brokers, we found that experience in this niche market can make a big difference. As a result, Dresdner has made a concerted effort to attract and hire investment professionals with many years’ experience.
“Today the global portfolio trading team at Dresdner has over one hundred years’ experience, with individuals having joined from the largest brokers around the world.”
‘We have fully integrated our global portfolio team with our single stock trading team’Diane Garnick
Client-facing technology
Ms Garnick adds that the broker has now developed its own client-facing technology. “We believe the two most important factors that are necessary for successful portfolio trading are education and pre/post trade analytics. We now have a research series, entitled Portfolio Professor, and offer an internet-based portfolio analytics package, PalNet, to all of our clients.”
Like State Street Europe, DrKW is experiencing a growing interest in transition management. “Increasing numbers of investors have been focused on transaction costs, which has led to the growth of portfolio trading. While we see portfolio trading as the centrepiece for efficient trading, we simultaneously recognise the need for individuals who specialise in single stocks. As a result, we have fully integrated our global portfolio team with our single stock trading team,” Ms Garnick says.
Already the availability of transition management services is having an impact. Fund managers are also passing portfolios over when there is no change in manager, just a desire to change the assets held – or the style of management – from high to low risk.
Mr Samuel says while the norm is years between restructuring, a large, actively managed fund may restructure as many as three times in one year. Certainly, at this rate, fund management costs will become more fully disclosed and the fund manager will move closer to being a manager of transitions.
