Leading transition managers and consultants came together in London in July 2019 to discuss the major themes shaping the transition management industry, from ESG and emerging technologies through to liquidity constraints and the evolution of transparency.
- Chris Adolph, director, Implementation Services, EMEA at Russell Investments.
- Craig Blackbourn, senior vice president, head of transition management EMEA, capital markets at Northern Trust.
- Graham Dixon, director, transitions at Inalytics.
- Andy Gilbert, EMEA head of transition client strategy at BlackRock.
- David Goodman, managing director, portfolio solutions at Macquarie Group.
- Daniel Morgan, senior managing director, head of agency trading and transition management, Americas at State Street.
- Artour Samsonov, head of transition management EMEA at Citi.
- Cyril Vidal, head of portfolio transition solutions at Goldman Sachs International.
- Steve Webster, senior adviser at MJ Hudson Allenbridge.
- Chair: Louise Fordham, special reports editor at Global Investor.
CHAIR: The finance and investment sector has recently taken a number of steps to enhance transparency, from MiFID II to the Cost Transparency Initiative (CTI) for pension schemes; how far has the transition management industry come in terms of transparency and how has that positioned the industry to evolve?
CRAIG BLACKBOURN: The implementation of MiFID II in January 2018 really put the wholesale market under greater scrutiny in terms of providing greater transparency to clients. Personally, I think the transition industry was already the vast majority of the way there on the back of the transition management thematic review the FCA conducted in 2014. Through the comprehensive reporting suites offered, the transition management industry was already providing clients with the level of granularity in terms of reporting and the transparency now required of the wider wholesale market under MiFID II.
CYRIL VIDAL: Transition managers were ahead of the game in terms of providing transparency on cost. For me, transparency goes a bit further than cost and remuneration. It goes towards providing analytical tools to clients to help them to evaluate risks and see how they can execute their rebalancing in the most efficient way.
STEVE WEBSTER: The CTI is a real sea change as to how clients are able to access information about expense and I think it has really helped to open the door on the sorts of things that transition managers have been looking at for years. The CTI talks about the costs of a mandate, but it’s important that we don’t lose track of what the expense is between terminating one mandate and getting to the other. If the CTI can actually provide that, this will be an excellent move forward. If it can’t, then maybe asset owners should remain wary of the slippage they are paying.
ARTOUR SAMSONOV: When I think of transparency I think of it not only as data analytics but also as an alignment with clients’ interests. What the regulation and the focus on transparency are trying to address is: where are your interests versus your client’s interests, and are you aligning with those interests? I am pleased to see that MiFID II is aligning the financial industry’s obligations concretely through legislation along with those of the client. That’s an incredible step forward in support of the transition management industry because when we act as a transition manager for the client we act as an agent on their behalf.
ANDY GILBERT: MiFID II has also created an environment where the suitability of what you are proposing is also something that needs to be considered. That extends to balancing the benefits of a strategy with the risks that may go with that strategy. The transition management industry has been at the forefront of this debate and MiFID II enshrines it in regulation, which is a good thing.
GRAHAM DIXON: Perhaps an interesting question to consider is why did the transition management industry offer this level of transparency before others? I think it’s because we all settled on implementation shortfall as being the appropriate benchmark for performance measurement. The best thing about this benchmark is that it cannot be influenced by the transition manager; every cost that we run up, whether it’s an explicit cost or an implicit cost, is captured in that metric. Transition managers provide attribution analysis of the implementation shortfall so clients can understand what factors drove the outcome.
CHRIS ADOLPH: As liquidity has become more challenging, strategies have evolved and increasingly with more liquidity being available on the close you do see more instances of clients being advised market on close (MOC) trades. There are very good reasons for this, but it does lead potentially to a lack of transparency, as by definition if you participate in something you will influence it. Furthermore, if the motivation is just to show a reduced market impact cost (thus a lower cost relative to other providers), that would not be comparable to another provider using an implementation shortfall (IS) methodology. One of the reasons the transition management industry came together was to enable comparison between providers. How clients compare us was a key part of that. If we go back to a situation where it’s difficult to compare because everyone is adopting different strategies, that doesn’t help clients, unless a T Standard IS analysis is also always provided.
DANIEL MORGAN: It is important to realise that clients don’t do this every day, so we need to deliver explanations that are easily consumed and allow for a fair comparison between providers. That means clear explanations and transparency around the pros and cons of each strategy.
DAVID GOODMAN: The provision of independent third-party reports on transitions, sharing of underlying fill data with clients and/or their consultants and robust supervision and validation by firm compliance of client reporting, in particular the transition management firm’s total remuneration (and all sources of remuneration), are all base level requirements for appropriate transparency for a transition event.
CHAIR: How is technology currently being employed to provide operational efficiencies and mitigate risk? And how do you expect the role of technology in transition management to develop over the next 10 years?
MORGAN: Technology is currently one of the biggest expenses in this space, and that is going to continue. I anticipate advances in reconciliation technology as well as the way we gather information from clients. We currently get information from clients in a relatively low-tech way via spreadsheets, which is a very operationally-intense workflow. I see advances in the ability for clients to communicate with us electronically so that there is not an opportunity for an operational mistake on the front end.
ADOLPH: If we are talking in terms of where we spend our budgets, if it’s on systems then it is on data and data management. But it’s not just about the front end and execution systems, which are always going to advance. Where things have improved a lot, and where I think a lot of resources are going, is on the operational side. How can we make that process easier and more transparent? Operations is vitally important, for us and for our relationships with our clients, and it is the operational side that will make a big leap.
WEBSTER: The temptation is to talk about all the ‘sophisticated’ value add, but getting the basics right has got to be key. There has to be a certain amount of budget that’s still spent on ensuring that the basics are done well and in a uniform way in every single transition event. Even today we don’t see these basics being managed at the same level, so let’s hope technology will play a part in raising standards.
VIDAL: Technology and data come together and, so far, we’ve been using a lot of data for measuring liquidity. Where the shift is happening is that we also now use data for risk management. Most transitions are a two-sided event where you want to go from one portfolio to another incurring the least amount of tracking error and you need to take into account the correlation between the assets you’re trading for achieving an optimal outcome. The transition manager usually looks at the overall performance of one portfolio versus another and not the performance of the individual assets.
GILBERT: Ultimately, technology is an enabler. Transitions are on the whole becoming more complex, they have more nuances, and technology can help us overcome some of those challenges and create the right outcome for a client. But while the technology you have may be fit for purpose today, you have to be able to evolve it for tomorrow. For example, as alternative asset classes are becoming part of portfolio construction, how does technology think about that? How do risk management tools think about private equity? These are things that may not be there immediately, but I am sure you are going to see that coming through.
DIXON: Technology is the most important thing that we look at in due diligence and it is one of the dimensions where you can really differentiate between providers. Some of the projects that we get involved in are really complex, for example, 350 separate funds that you have to consider as a whole, produce cost estimates for, and report on. Having an infrastructure that can handle projects of that size is really important.
SAMSONOV: Transition managers have developed dedicated transition management systems over many years in the industry and have cutting-edge tools to provide services to clients. Therefore, we not only bring transition management expertise but also the technology along with it, and the commitment to continue to develop this technology.
GOODMAN: Transition platforms at leading providers have evolved into real-time STP platforms that allow transition managers to continually have access to accurate data on all aspects of a transition’s status. This promotes both better risk control and enhances operational efficiencies. Going forward we would expect to see transition managers increase their investments in trading and risk management technologies, potentially, for certain types of transitions, solutions analogous to DMA execution platforms for investors.
CHAIR: How is the transition management industry navigating liquidity constraints and volatility?
ADOLPH: As volatility is changing, liquidity is changing. Understanding how a transition manager is accessing that liquidity is key for clients. It is becoming more and more challenging and that points towards the need to be able to access multiple different sources of liquidity. In terms of keeping costs down, being able to access liquidity at the right times, on the right venues and at the right cost is fundamental.
DIXON: This is not a new problem; it’s something that transition managers always address in their planning. Volatility, in itself, is not a problem, although it can be a leading indicator of illiquidity. To deal with volatility during a transition, the transition manager uses careful risk management to make sure that, if the right course of action is to step away from dealing, the client has the correct market exposure. Illiquidity is the real enemy of a transition, and the only answer to that is patience.
WEBSTER: We can access more prices in more securities in more places than ever before but, as we’ve recently seen, if that suddenly stops or markets become restricted, then access to liquidity becomes a key differentiator between transition managers. If there are market dislocations then I think we will see differences between the sorts of services and the value add that transition managers provide in these markets.
VIDAL: Liquidity is not a one-dimensional problem; you have to take into account various factors and turn these into simple liquidity metrics. A key skill of transition managers is to be able to summarise all the information available and simply answer the question: ‘What is the liquidity of my portfolio?’ Fixed income has traditionally been more challenging given the lack of information available. The good news is that 18 months after the introduction of MiFID II, we now have an improved historical data set, both in quantity and quality, we can establish an aggregated view of the volumes and more reliable indicators of liquidity.
GILBERT: What might be perceived as a liquid market or a liquid set of assets today can change overnight. When we think about access to liquidity - different venues, different counterparts - we need to continually assess them because a great source of liquidity today evolves and changes. A continual eye on the gauge when it comes to both volatility and liquidity is an absolute must.
SAMSONOV: More recently we have seen volatility primarily being driven by the news headlines. As a transition manager, you have to stay patient through volatility events and manage clients’ expectations through the turbulence. You have to be a guiding light through those volatile events, instil confidence and trust, and at the same time have the capabilities to manage the transition strategy dynamically. For example, take advantage of opportunities when liquidity is available, and have the discipline to hold back when market conditions are unfavourable during the trading day.
BLACKBOURN: As transition managers, we have access to market-leading modelling tools and technology which truly help us evaluate and quantify risk. Volatility is frequently coming from the macroeconomic environment, and as transition managers, clients are looking to us to look holistically at the bigger picture. When you’re looking at timing, it’s about understanding all the data points around the time when the client is looking to transact, for example, are there Central Bank announcements, corporate earnings or GDP data which could easily contribute to volatility within an event? It’s the role of transition managers to be able to consume all of the critical information and present this back to the client, allowing for an informed decision to be taken.
MORGAN: The transition process starts off months, sometimes even years before the actual event occurs. Many times, the client is flexible in terms of timing, and to the extent that we can provide information that allows them to transact in a quieter market environment, I think that’s certainly a benefit for them. When it comes to managing expectations, we have a responsibility to make sure that the client understands that we may need to apply the brakes for all or a portion of the transition due to a particular situation and because of liquidity constraints in the market.
GOODMAN: Transition managers need to ensure that they move ever closer to the point of execution in their decision making. Transition managers should not be overly rigid or wedded to one approach to execution and be capable of accessing venues and client types that can provide liquidity in good form for a transition. Volatility can have a number of effects on a transition, it can drive increased opportunity and trading costs, it can also encourage some liquidity into the market that can be accessed to help complete the transition. Transition managers need to plan their execution strategies such that they are resilient to intra-day volatility, managing progress on their trading in a risk-aware manner.
CHAIR: As ESG (environmental, social, governance) continues to rise up the agenda for a number of asset managers/ owners, how can transition managers best support clients transitioning to ESG-led investment strategies?
GILBERT: Clients need to consider what ESG means for them first because ESG is not one size fits all. It may be that you want to have a low carbon bias, it might be that you’re looking at pure sustainability, it might be a ban on certain weapons manufacturers. As a client, you need to think about how ESG manifests itself in your portfolio construction. Are you going to use an MSCI Index that is ESG compliant? Are you going to use a regular index and put your own screens on top of that? What kind of products are out there?
Where transition management can help is to provide that assessment of what the cost and risk profiles are for those different scenarios. If you think about different indices, such as going from MSCI World to an MSCI ESG focus, there is around 53% retention index to index. If you take the same legacy index and go to MSCI Low Carbon, it’s 83% retention. So, different interpretations of ESG have got very different impacts on the cost, the risk, the trading, and therefore the transition. Helping clients understand what that looks like and what that means is where the transition management industry can really benefit clients.
WEBSTER: The danger is it becomes a crowded trade in ESG names, and that means transition managers are all chasing exactly the same illiquid name in order to rebalance the same ideas across E, S or G. That could effectively increase the cost of making those changes, and would a client have necessarily wanted to make those type of changes if they’d know of the additional expense that would have been incurred in moving to that type of index? Transition managers can help with that strategic thinking about this kind of implementation.
BLACKBOURN: ESG is an investment style, and as transition managers, we are acting in a non-discretionary capacity - it’s about managing execution cost and risk whilst observing the client’s ESG restrictions. The client has already employed managers to apply their discretion to the ESG tilt of their portfolio. We’ve been answering clients’ questions around not just ESG, but also sharia-compliant approaches to transition management.
MORGAN: I think many of our respective customers are drawing on other parts of our firms to help them formulate data points that come up with these ESG policies. Many of us have the opportunity to partner with other sides of our firms to offer a combined solution, from advice on setting policy to different forms of implementation.
SAMSONOV: As financial institutions we sit at the crossroads of multiple clients and we get the benefit of multiple perspectives and feedback, whereas clients may not always have an all-market view. For us, it’s a matter of having access to that information, absorbing it and thinking about the best ways to apply it. As an example, today I learnt that MSCI ESG futures are soon to be launched. Maybe not every client is aware of that, so it is up to us to inform them and to use all the tools that are available to add value to their investment process.
CHAIR: What does increased consolidation, such as asset manager M&A activity and LGPS pooling, mean for the transition management industry in the long term? Will this result in changes to transition managers’ value propositions and focus areas?
GOODMAN: Both events you have highlighted are very much front loaded in terms of activity; trade planning, structuring, advisory and other pre-trade activities are quite complex in these assignments and areas where transition managers can add significantly to the value. However, as the goals of these events are often either to simplify investment structures or to
increase organisational scale or both, the organisation(s) on the other side of the transitions are likely to have different needs of their transition managers that could increase their focus more on sophisticated trading and risk management solutions.
BLACKBOURN: The types of clients transition managers were traditionally servicing included corporate pension funds, public pension funds, sovereign wealth funds (SWFs) and government agencies. However, over recent years we have seen consolidation among the public schemes, not to mention greater use of fiduciary platforms and outsourced chief investment officer (OCIO) offerings. As such we’re dealing less and less with the underlying investors themselves and we’re dealing more with entities that are becoming almost asset manager like. We’re seeing far more use of transition managers by asset managers, and that’s not just through the consolidation; I believe the asset management community as a whole has realised when they look at large value/large volume trading activity across their portfolios, and trying to save cost is of paramount importance, the use of transition management services can be a true value add.
DIXON: Consolidation activity means larger, longer duration, and more complex transitions. Taking the LGPS pooling initiative as an example, the transition manager has not only the LGPS Group as a client but also each Partner Fund with their own requirements. So, they could be acting for eight or nine clients, and then there’s the platform provider who is very important in this as well, and you’ve probably got a transition adviser that also needs information. In practical terms, this means the transition manager has to have much greater project management resources than for a typical transition. For really complex assignments, you can be in the planning phase for six months because a lot of things need to be completed before you can start moving the assets.
GILBERT: When there is an extended planning period of that kind, the transition manager is probably going to devote quite a lot of resource on managing those stakeholders, whether they’re the individual pool or the underlying stakeholders, and that is quite a different skillset. It’s not all about the trade, there is also a deep project management requirement.
VIDAL: At one end of the spectrum you have clients who have grown so much that they have sufficient scale for developing in-house transition management capabilities. That’s an interesting dynamic for our industry and an opportunity for the broker model given these clients will continue to require our execution capabilities.
SAMSONOV: Different types of transition managers will benefit through different phases of client growth. Longer term, I expect these pooled entities to become fully-fledged asset managers and to interact with banks directly, without the use of intermediaries. It is down to transition managers, with all of our different business models, to guide clients through their evolution process, contribute through their different phases, and find ways to evolve with them. We do have value to add now and we will have value to add in the future, it’s just that the capacity in which we do that will change.
WEBSTER: There are unique skillsets that transition managers bring to a consolidation or reorganisation, whether it’s a pension pool or an asset manager. Many of these events require some form of independence because of the nature of the clients involved, and the need to ensure they are being treated fairly. Typically, transition advice is not only important because of the lack of specialist resource or knowledge, but also because of the lack of independence in balancing client and manager interests.
MORGAN: Active asset managers are cutting their fees, they’re looking to take on less risk, they’re looking to outsource anything that’s non-core. Implementation in many forms is non-core to these asset managers, it doesn’t produce alpha. Meanwhile, transition managers have spent years and significant investment on constructing multiple sources of liquidity and various technology stacks which can be utilised by different parts of the asset management community effectively.
CHAIR: Is the market ripe for disruption? Where could innovation and the evolution of services deliver the greatest benefits to clients?
VIDAL: Disruption in some other industries is synonymous with the idea of being replaced by technology. Some aspects of transition management can be made more efficient through technology, such as pre-trade analysis, executions, post-trade analysis, and that can free up time and resources. However, what is at the core of transition management is experience and project management and that cannot be replaced by technology.
DIXON: Transition management has been around for 25-30 years and during that period rather than disruption, we have seen gradual innovation and improvement. Can we replace transition managers with robots? I don’t see that because transition management, particularly for the largest exercises, is a craft and the expertise resides in a small group of highly expert and experienced individuals. Having said that, where major breakthroughs and developments in execution are made, you can bet your bottom dollar that transition managers will be the early adopters.
SAMSONOV: Disruption is probably not the right word to use in the transition management context. We are in the business of risk management, and disruption requires some degree of risk taking. Therefore, the biggest changes for our industry are coming from the clients themselves who are pushing the industry to change, while our responsibility is to address their needs.
BLACKBOURN: If you look at the financial institutions which we all represent, there’s no doubt technology is a key part of everything that we do. There is going to be further disruption, whether that’s around blockchain, liquidity, clearing agents… I think we’re in a fortunate position where we as individuals can add something a little bit different because the very nature of what our clients are doing is so unique from event to event. Continuing to stay at the cutting edge and investing in technology as transition specialists is of paramount importance for our industry.
CHAIR: Looking forward, what do you consider to be the greatest opportunities and challenges for the industry?
GOODMAN: Continuing to move forward into implementation and portfolio construction advisory and trading services will not only be an opportunity but a necessary requirement for transition managers to stay relevant to their customers.
ADOLPH: We’re seeing the contraction of the DB (defined benefit) market. As the DC (defined contribution) market starts maturing more, and as platforms change, there is an opportunity there. Those types of transition are not as easy to manage as, say, for your typical DB scheme. You have to re-think how you are approaching it. We typically approach any event based on risk mitigation and managing costs, but those might not be preeminent in DC, where operational and minimising blackout periods might be more important considerations. While you are still adding value and managing those costs, you are facilitating change in a slightly different way.
DIXON: Normally in a transition project, if you want to go faster or you want to go slower or you want to change the strategy, then you go to the transition manager and it happens, whereas in a DC transition the platform provider is king. Once the transition starts, the train leaves the station and it’s not going to stop. This means you have got to have a really good plan, and that plan has to be robust and it has to contain all the contingencies and mitigations.
MORGAN: We see opportunities in the DC space expanding. I would describe a DC transition event as an ‘all hands on deck’ exercise, and not just because you have additional parties in the mix. There are quite a few additional complexities that you just don’t see in a DB transition. You cannot mitigate that risk with technology; it’s all about the people, so it comes back to the strength and depth of teams to deal with a large-scale DC event.
CHAIR: If there was one issue you would like asset owners, asset managers and other industry stakeholders to be aware of or better understand about transition management, what would it be?
BLACKBOURN: My message to investors would be: you have taken a decision to make a change to your investment portfolio and there are an infinite number of ways in which you can get from your start point to your end point. Some are still of the view that they would rather their legacy manager or their target manager manage that change, and some clients do not want to see the explicit costs involved with making those changes. I would urge them to go back and think about that. The whole point of using the transition manager is to help put a better-defined cost basis and governance process around making the change; and specialist transition managers are well-placed to help clients manage those changes.
VIDAL: Whenever they have to choose a transition provider for a specific event, I would advise clients to go for a realistic cost estimate supported by data. Clients could be tempted by the lowest overall cost estimate, which would not necessarily result in the optimal outcome. Ask for the quantitative analysis that supports the cost estimate.
WEBSTER: If you want to understand long-term performance, make sure you count the gaps. The gaps (or transition) between mandates can make a significant difference in long-term performance. Ignoring proper planning, management and measurement of transition is an acceptance of unmanaged risk and cost.
SAMSONOV: As an industry we are here to help. Ultimately, when a transition management client comes to us, they are receiving professional help and there is value in that. Although it does cost something it is money well spent because in most instances savings from a transition being managed to a high standard will be greater than the cost of our service.
GILBERT: If you are planning a change, don’t leave it until the last minute to think about how you are going to do it. Early engagement is important because you can then start to understand how your transition manager can help you. This may well be in the risk management, in the trading capabilities or in some heavy project management lifting, but there could also be some other things a transition manager can assist you with that you may not have even thought about, such as managing assets on an interim basis, for example.
DIXON: Implementation shortfall is brilliant but it is focused on the transition managers so we can monitor and evaluate what they do, it’s not particularly helpful to clients. Usually their questions are: ‘Did I make the right decision to move?’ or ‘How long is it going to take to pay back the transition cost with the additional performance that I’ll get for making the changes?’ Implementation shortfall is not useful for answering those questions. So, my plea is for a better understanding of implementation shortfall; what it tells you and what it doesn’t tell you.
ADOLPH: We are not trying to introduce complexity or manufacture costs. Our role is to try and help clients with transitions and to provide clarity where there’s obscurity. We are there to offer a service that tries to reduce complexity and minimise those costs, working in their best interests, not against them.
GOODMAN: A substantial amount of discussion time with respect to transition management usually centres on trading and risk management processes and technologies during the “live” stage of a transition. More time should be given over to understanding the value add that an experienced transition manager can add during the planning and design phase of the transition where decisions can be made that can greatly affect the potential outcome of the change event.
MORGAN: We all put an immense amount of resources forward in order to help maximise fund value and protect the returns for asset owners and asset managers. We make the investment into our businesses for one reason: to protect clients and their shareholders. There are many implementation options available, and they may be available even for the simplest transaction. However, I believe it’s incumbent upon our customers to challenge all of us to develop and present different strategies that will help accomplish various goals.
This roundtable features in the Transition Management Guide 2019. Download the full guide here.