The process of selecting a transition manager has never been more complicated or heavily scrutinised. Some clients are primarily concerned with global execution and some with a specific location or asset class, while others may be driven by maximising accountability or complying with regulation.

There is considerable disparity in the range of business models employed by transition managers. Asset owner or manager clients usually sign an agreement with their provider that specifies the cost of the project and gives the client recourse in the event of the provider failing to disclose the actual amount that it earned.

According to Ben Jenkins, senior vice president, global head of Northern Trust’s transition management business, the criteria for assessing and selecting a transition manager will vary depending on the client’s experience. “Generally, clients more accustomed to transition management know the questions that matter most to them and quickly focus on those touchpoints. Less experienced clients tend to want to cover all elements as they are trying to both select the best provider and build experience.”

He describes transition management as a multi-disciplinary activity that requires deep expertise in a number of fields and service offerings. “A transition manager could be the best trader in the world, but if they can’t settle assets or manage the project – or even report on their success – it is a moot point. We suggest that clients look for managers that have a broad bench of experienced staff and are focused on the business.”

The role of consultants

The value of engaging a consultant to help a client through the process depends upon a number of factors. If the client has an ongoing relationship with a consultant – and therefore understands its priorities – input from that consultant should be helpful. If the client doesn’t have any standing transition management relationships, or even has not had any experience of transitions, an outside opinion may be even more valuable. However, if the client already has experience of transition management and doesn’t have an intimate consultant relationship, merely securing an ad-hoc opinion from a consultant may not be particularly useful.

The most common source of project failure comes down to expectations not being reasonably set between the transition manager and the client. “There are a number of areas where problems can arise in transition management events,” observes Jenkins, noting that these include account/ country setup; fund trade timing/pre-notifications; expected and unexpected macro events; and trade performance/fails. “It is crucial that a transition manager establishes a robust and extensive project plan to review all elements of the event.”

The asset classes involved in a transition will also determine which provider is the most appropriate, explains Thomas Schoenbeck, senior consultant at Aon Hewitt. “There is a difference between providers and the quality of their services across asset classes. Some managers are well suited to execute a global equity transition but less appropriate for a bond transition, or vice versa, whereas others are capable in all areas and would be appropriate for a multi-asset class transition.”

Business models

The business model employed by transition managers predominantly depends on the parent company, whether that is a broker model, an asset manager model or something in-between. Transition managers can execute trades on either a principal or agency basis and the fee structure can also vary – for example, a flat fee or basis points on trades completed. Certain transition managers can also provide temporary custody solutions for clients without a custodial relationship.

Michael Gardner, senior managing director & global head of portfolio solutions at Cantor Fitzgerald suggests that an insurance company or sophisticated sovereign fund might be more likely to go with a brokerage model due to sensitivities around execution and direct market experience: “Those with considerable internal resources that deal directly with the markets may go with a brokerage model.” He adds that a pension fund is more likely to be keen to have a cofiduciary in the process.

A common thread across transition management projects is cost and transparency but, as a rule of thumb, when costs fall to a certain level there will inevitably be a decline in transparency, according to Gardner. “We have seen this happen in the past and there are people leaving the industry still as a result of these past failings.”

However, Schoenbeck is confident that transition managers have done enough to ensure lessons have been learned from past failures. “We have seen a number of transition managers increase the level of compliance monitoring in order to reduce risks and conflicts of interest and we have also seen improved client servicing and transparency across the transition management area with more providers following the T-Charter.”

“Where we have seen deviations from a transition plan this has usually been as a result of an operational issue such as overdrafts,” says Schoenbeck. “When a client manages a transition independently, this can result in financial losses due to out-of-market exposure, expensive pooled fund spreads that could be avoided via an in specie transfer or a lengthy transition period, delays from decision point to execution point, due to clients not having the resource to complete a transition in a timely manner.”

Pre and post-trade reports have also been developed so that they are easier to follow. “We believe that this is an area that will need continued development across all providers to improve reputation and ensure that providers are continuing to self-monitor and provide transparency,” he adds.

Risk management is critical to the success of any transition and evaluating the risk strategy is important when selecting a manager. In many cases a major element of the risk strategy will be utilising the risk diversifying characteristics of the target and legacy portfolios and associated trade scheduling.

However, where this is insufficient to manage the risk to acceptable levels, a derivatives strategy will be introduced, explains Mark Dwyer, head of portfolio solutions EMEA at Macquarie. “In these instances the client should be presented with the cost benefit analysis of such hedges. Where appropriate, transition managers should provide alternative risk strategies and the reasons for recommending a particular approach.”

If there are difficult securities to sell or buy, transition managers should ensure that the client knows the issue and the proposed solution, he continues. “If there is a significant risk to manage, we need to make sure the client knows the risk and the hedging strategy proposed.”

According to Dwyer, communication prior to the transition should always be the top priority. “The objective is to provide detailed analysis of any associated costs or risks. The transition manager should secure not only the client’s approval but also their understanding before proceeding with the transaction.”

Selection process

The process of selecting a transition manager will be different for every client and event. However, a recent transition for a large US retirement plan provider implemented by Cantor Fitzgerald illustrates the process from the provider’s perspective. The client was making a change in its sub-advisor network, swapping out certain managers in its US small cap equity mandate, and has been a regular user of its transition management services in the past.

“We were invited to bid for this business through a competitive tender and selected in July 2016. As part of the selection process, we had to complete a comprehensive compliance questionnaire and a due diligence visit that focused heavily on our connection to the firm’s policies, procedures and risk management oversight,” explains Filip Skala, managing director US head of portfolio solutions at Cantor Fitzgerald.

Although the size of the transition was not large by industry standards, small cap equity transitions can be challenging from a liquidity perspective. In addition, because the assets are part of retirement portfolios it operates in a daily valuation environment and large flows in and out of the sub-advised funds can happen on a daily basis (this type of transition usually occurs without a blackout period).

“The challenge was to undertake the transition as quickly and efficiently as possible because you don’t want the fund to be in a state of flux between managers for an extended period when you have participants making changes behind the scenes that could affect the valuations of the portfolios,” says Skala. “The longer the transition takes, the more potential there is for massive outflows or inflows of funds that the transition manager has to adjust on the fly.”

Skala says he is observing a trend for insurance companies and manager-of-manager-type products to undertake more extensive due diligence for their transition managers than in the past. “This client undertook a significant amount of on-site due diligence with us, with a great deal of focus on our connection with compliance and operations as part of the bidding process.”