Whenever a large institutional investor or asset owner needs to move assets between investing mandates, they need a transition manager to do that effectively, says Travis Bagley, director, transition management-Americas at Russell Investments.
Simply put, according to Kevin Byrne, head of the transition management group at Fidelity, transition management services might be needed when there are investments in flight. Perhaps a manager is being terminated and others are being hired.
“Turning to an experienced transition manager can minimize the cost and the risk, in order to gain a better performance outcome,” Bagley says. A transition manager knows strategies for minimizing the time assets are out of the market and are often able to perform transactions at a lower cost than the plan sponsors can themselves. It’s equally relevant to defined contribution (DC) and defined benefit (DB) plans, he notes: Both plans are sensitive to risk and want to manage investment risk.
But not every single move of assets requires these services, Byrne points out. “We would love to transact every opportunity that comes our way,” he says. “But we try to understand what the client is trying to achieve. And in a number of plans moving assets, some need transition services and some don’t.”
Byrne recalls a DC plan with a sizable interest—north of 20%—in a mutual fund. The plan was told it would receive a distribution of securities that would have meant finding another place to park the asset. After Fidelity’s analysis of the plan’s needs, which considered various options, a cash allocation was negotiated with the fund sponsor—a preferable scenario, since the plan was not in a position to take the distribution in securities. With global assets, the time to open up the appropriate accounts would have delayed the timing of the transition.
DC plans may have a small amount to transition, Bagley says, such as a $20 million change from a U.S. S&P 500 mandate to funding that $20 million in an EAFE mandate (the MSCI EAFE Index). An amount of $200 million is considered substantial, but he points out, “Smaller movements don’t face the same challenges.”
The size of the position can obviate the need for transition services, Bagley says, or the need for services can hinge on the investment strategy of the mandates the plan is funding, or the liquidity of the assets. Heavy use of over-the-counter (OTC) derivatives, for example, which are not as transferable or as fungible as securities, would not require the services of a transition manager. In fact, as the contracts of these instruments have been individually negotiated with counterparties they would need to be unwound or funded by the underlying manager, according to Bagley.
When the instruments are not easily transferable or between investment managers, the value add of the transition manager is diminished, Bagley says, but that applies to a small minority of the mandates that exist. “In nearly all cases, a transition manager for a larger institutional client will add value in the transition process.”
Significant structural changes to a plan, such as moving to DC from DB, can mean benefits from transition management that go beyond the investment benefits, Bagley says. “The project management in a transition is very valuable to the plan sponsor,” he says, “because of the number of different vendors involved: the recordkeeper, the custodian; different managers; possibly a consultant. All need to be managed and coordinated to deliver a successful outcome in those big DC overhauls.”
Transition managers coordinate with all parties, design and implement trading strategies based on pre-trade analysis, and produce post-trade reports that include actual performance relative to predicted costs.
The plan’s investment committee is going to be very involved in the decision, Byrne says, from the decision to use the service to choosing the provider. “Depending on the sophistication level of the plan sponsor, investment committee members are very involved with the selection of the investment manager and with asset allocation.”
As transitions tend to be a somewhat episodic event over a span of time, the transition manager should be someone the plan sponsor can bounce a question off, according to Byrne, and have a disciplined process in place that the plan sponsor feels comfortable with, that will plan for any event that might occur during the transition.
It is critical to understand the business model under which the transition manager operates, advises Bagley, and the model should be focused on transparency of cost. It can be a tough question, but Bagley feels the plan sponsor should ask, “How does your firm make money in those transitions?” A clear answer about how fees are negotiated, agreed on and set forth in a contract is the desirable answer, he says.
If the provider is acting in a principal capacity, Bagley says, the revenue the firm makes is generally not transparent. In cases like this, the plan sponsor is selling the asset and the transition manager is also the purchaser of the asset. Fees are embedded in the price of the execution. According to Bagley, this situation arises in currency markets, in which the transition manager is also a principal trading firm.
More and more plans are employing the due diligence process around transition manager selection that they do around investment managers: the background of the people they’re working with and their level of seniority, according to Byrne. “Plan sponsors will want to work with a trusted adviser,” he says. “It comes down to people, process, and philosophy.”