Corporate toolbox / transition management
The need for greater transparency and clearer profits is pushing pension funds to look for specialists to handle the delicate work of managing a shift of assets.
Pension funds face a changing world. With greater scrutiny driving the need for more transparent processes, and potential shortfalls demanding higher profit margins, increasing numbers of funds are looking to adjust their investment strategies. But for handling the nitty-gritty details of shifting assets, they increasingly turn to the expertise of a transition manager.
There are a number of strategic issues—from solvency to accounting and visibility to simply making a profit—that are prompting pension funds to review their assets and liabilities and to initiate significant changes to their strategies. From an economic standpoint one big driver for changing plan allocation and switching managers is the potential shortfall within a pension fund.
In addition, many new regulations are coming into effect that require greater visibility. So trustees are making structural changes to their funds to address these concerns, and many funds are looking to transition managers to gain that visibility.
John Minderides, managing director and global head of transition management at JPMorgan, says: “Trustees and plan sponsors everywhere are under enormous pressure to deliver profitable positive results for assets under their watch. They are increasingly looking for professional advice and agents to carry out work for them.”
But each shift in asset allocation involves a complex transition process, and funds are realizing more each day that it pays to have someone with experience to manage the transition process. Michael Gardner, head of transition management at Bear Stearns, says: “For a single asset transition to a single target manager, then maybe they can do it themselves, but add one more target manager or more assets, and it becomes increasingly complex. Then they may want a transition manager to coordinate.”
Steve Webster, head of the transition management group at ABN AMRO, says the biggest driver is the pressure on funds to have much greater visibility in the way they do things. “The great thing about a transition manager is that they are independent to all parties, and they can be objective about the event and provide greater visibility in how changes have happened within the funds,” he says. “That helps the trustees in measuring performance see the difference in performance of managers versus the cost of change. Transition managers can offer a quick and effective solution to meet changing requirements.”
Keeping It All Together
Funds require a transition manager that can handle the advisory, risk management, project management, execution and performance reporting—a single counterparty that is held accountable for all aspects of the transition mandate, explains Bill Stush, North American head of transition management at Merrill Lynch. “Plan sponsors are under pressure to minimize costs and generate returns that exceed their liabilities. This combination creates the demand for a transition manager that can handle the increasingly complex transitions required by liability-driven as well as absolute-return investments, and the requisite ability to coordinate and manage fixed income, futures and currency overlays and alternatives,” he adds. Indeed, one area that transition managers are seeing much growth in is new asset classes, such as alternative investments. “Pension plans, endowments and foundations still don’t use a transition manager for fixed income and alternative assets, but we see more and more each year looking to do so,” says Gardner.
Funds are looking at a number of different avenues, including portable alpha, according to Jamie Cashman, director of marketing for Mellon Transition Management Services. “They can get alpha from smart managers, but there is no guarantee that they will have persistence in generating alpha,” he says. “They can get investment returns through the market, but that is unpredictable. As a result, they are more focused on the implementation cost for changes, and using a transition manager can allow them to get the best value for money.”
The role and requirements of a transition manager vary, however, by region. Minderides at JPMorgan says that in the United Kingdom a lot of this revolves around solvency and accounting. “As a result, many are now using liability-driven investment mandates [LDIs],” he says. “Indeed, many pension funds in the UK are restructuring assets more in line with how they are looking at liabilities.” He adds, “In the US one big theme in the market is fiduciary mandates.” It is increasingly becoming required for transition providers to act as a fiduciary. “Public mandates almost exclusively will require a fiduciary provider, but it really doesn’t make any difference to what the service is about,” he says.
Transition providers have upped their game, says Minderides: “They are growing continuously, and what they are delivering is increasingly more efficient, more robust and more cost-effective proposals for plan sponsors. As a result, trustees are growing more comfortable with using a third party to carry out transitions.”
Pension Funds Get Choosier
As the use of transition management is now widely accepted, pension funds are looking for ways to evaluate the various providers, says Stush. “Plan sponsors are gradually migrating to a request-for-proposal [RFP] process before inviting transition managers to present their capabilities and before conducting on-site visits,” he says.
One big issue that has drawn much press in recent years is the development of codes of practice for transition managers. In the UK, market participants have been working on such a code, the T-Charter, for the past two years. Notes one market participant: “It is near completion but not quite there yet. The aims of it are to ensure that clients get a service offering that is transparent, fair and in the interest of clients. In its current form it pretty much does that, but there are still some adjustments that need to be made to ensure it reflects all possible business models for transition managers.”
US market participants have also begun preliminary discussions on setting up a code of practice, but it is in very early stages. In addition there is the T-Standard—a performance measure for transition management to provide clarity on how transition managers execute.
With much growth over the past few years, there is inevitable talk in the market about competition and consolidation. Some transition managers feel it is just that—talk. But others say there will come a time in the not-too-distant future when market growth stalls and transition managers start to feel the squeeze. Says one market participant: “There is a lot of jockeying for position. But at the end of the day, clients are looking for expertise, capability and someone they can trust.”
Webster comments: “Competition is growing within this market. I am not sure how much space there is, but certainly we are seeing a lot more competition. This will be a healthy thing for us all as long as standards can be maintained within it. Once you start to fragment the industry, you hope that the standards and the general mechanisms that are recognized for transition management are maintained, that the quality is upheld.”