The transition management industry model in the US has solidified over the last 12-18 months, with providers acting in an agency capacity to provide best execution to clients. Demand for transition management is strong from both defined benefit (DB) and defined contribution (DC) pension funds.
Public DB plans have been particularly active in the last few years, according to Paul Francis, head of transition management US at BlackRock. There have also been some large DC events, helping plan sponsors to combine platforms or effect wholesale changes in their investment portfolios.
Francis said that there has been increasing recognition among providers and clients that this is a skilled business and that scale is required to effectively service clients and generate enough revenue to reinvest in the platform.
Francis said there is a particularly high sensitivity to transparency and best execution among US clients, which results in providers being asked to operate as a true fiduciary and to execute all transactions as an agent.
“As an asset management provider we cover every type of asset class and investment vehicle, which helps us access liquidity across multiple asset classes,” he said. “We always contract as a Fiduciary with our clients – not just those that are ERISA-regulated – which provides all of our US clients with assurance that we are acting in their best interest.”
The US market has moved away almost completely from transition managers having the ability to execute with their own book, said Francis. He also said: “Clients in this market also expect transitions to be prepared and implemented extremely quickly, which is partly due to our clients’ heavy involvement in the transition management process and their experience with such events.”
William Cobbett, head of transition management Americas at Citi TM, describes the market for transition management in the US as strong, referring to a large number of events from a wide range of clients. Unlike other markets, he said the US has not experienced any significant changes in the competitive landscape over the last five years.
“We have helped clients build up their internal capabilities and some of these clients are now more programme trading than transition management clients,” he explains. “However, they will still come to us in special situations where they feel that either the operational aspect is too much or their trading desk is too busy.”
Expanding user base
Virtually every type of institutional asset owner, as well as many family offices, have made use of the services of transition managers. At the same time the number of investment managers involved in transitions has increased, reflecting a natural growth in complexity of their businesses.
Ben Jenkins, senior vice president and global head of Northern Trust Transition Management, said public fund and corporate asset owners are the most frequent users of transition management, adding that these clients tend to have historically had the most experience with transition management and have consistently seen value in its services.
Jenkins said the types of clients it works with have expanded since 2011, a time period over which he said his business volume increased by 41%. He said the common themes driving interest among all client groups are robust project management oversight and strong trade execution. “We are seeing increases in the use of transition management by a range of client segments, notably fund managers and insurance companies.”
The US institutional client base has adopted ETFs to a greater extent than elsewhere in the world and, in line with this, BlackRock’s Francis said that many transitions handled by Blackrock involve ETFs.
ETFs can also play a key role in fixed income creation and redemption. “It is not necessarily plain vanilla asset restructuring – we might be brought in to work with an asset owner that thinks the liquidity that fixed income ETFs bring can be useful,” adds Citi TM’s Cobbett.
“Our analytical tools allow us to help clients look at different ETFs that their portfolio might go in and out of and see if there are opportunities to add value. ETFs have been used in transition management for a long time – we are now talking to clients about using them outside of transition management.”
Francis adds that he is also seeing the impact of other recent investment trends. “We see clients continue to execute multi-asset type transitions and see the potential for expansion in the DC space. We have colleagues who understand the sensitivities involved in effecting transitions for DC clients and we partner with other business units in the firm.”
Keys to success
The key features of a transition management services for US clients, according to Jenkins, are threefold.
Firstly, project and risk management; as transitions become more complex, clients rely upon a transition manager’s ability to create an implementation strategy. This includes management of all aspects of the restructure and detailed timelines for each transition.
Secondly, trade execution and performance, and more specifically global execution as an agent for equity and fixed income. And thirdly, the reporting suite including cost estimates and performance analysis at all stages of the transition. This includes the pre-trade and post-trade reports, which details the actual costs against estimates and transaction level transparency.
In addition, DC plan clients, which are a large set of Northern Trust’s US client base, require further operations. “These entities require additional support and structure given the addition of a record keeper and our preference to not operate a transition in a ‘blackout’, which adds to complexity but ensures DC participants do not lose investment choice.”
The large US DC market requires a higher level of process and risk management, but beyond that Jenkins suggests there are no best practice elements unique to the local market.
“Transition management is a global business in every sense and we are seeing an increase in clients using our services in multiple regions, such as regional pension plans for global corporate clients,” he said. “A consistent and normalised service, especially around best practices, ensures an optimal process and transparency for clients.”
Jenkins adds that the US market provides opportunities to expand transition management services. “We are working with clients on expanding the traditional role of transition management to include more project management and execution services. Within the US market, this is especially for our insurance and fund manager clients, who have very specific needs as it relates to their asset allocation decisions.”
One area of particular growth in the US market is involvement with insurance M&A activity, where the acquiring firm wants to restructure the target firm’s balance sheet. This is similar to a traditional transition management event except that the buyer of the service (the acquiring insurance company) is not normally a transition management client.
Foreign exchange risk
According to Citi TM’s Cobbett, one of the interesting features of the market is that most US pension plans don’t hedge their foreign exchange exposure. This contrasts with their international counterparts in France and Australia in particular, which almost always put on an FX overlay to separate the foreign exchange from the equity component. This can be attributed to the fact that over the very long term the US dollar has slowly weakened, increasing the value of foreign holdings.
Following the US presidential election there were a number of de-risking transitions. Equity prices were strong and interest rates picked up a little so the funding status improved for plans – some of which were on an automatic glide-path, said Cobbett. “We have also seen activity where a portion or all of the pension is sold into an insurance company and the insurance company assumes the liability.”
In some cases there are open bonds that need to be bought to satisfy the insurance company’s asset allocation, but many of these are happening in cash. “We continue to see outsourced managers take on significant assets,” he concludes. “We have done a record number of $1bn-plus onboardings of corporate pension plans this year.”
Case Study: Customised approach yields healthy outcome
A complex event covering multiple plans was an opportunity for Northern Trust to demonstrate the value of holistic project management
A large healthcare system, based in Pennsylvania, wanted assistance with the restructuring of its multiple investment plans. It wanted to transition from its existing outsourced CIO (OCIO) provider to its new provider. In addition to the interactions with the OCIO providers, there was also an array of underlying investment managers that were part of the transition.
Northern Trust was chosen to carry out the transition. In total, there were four underlying plans, each of which had their own unique manager mix and allocation structure. The healthcare system instructed the transition manager to ensure that all plans were treated equitably, with a focus on reducing both cost and risk throughout the event.
Due to the varying sizes of the plans, the treatment of the vehicle types within each plan had to be customised. The small plan, holding commingled funds, would redeem/subscribe using cash, whereas the larger plan was subject to receipt/delivery of in-kind securities.
Cash transactions, which may appear to be straightforward, present the predominant driver of risk through a transition event. In addition to ensuring settlement dates are aligned, cash has a zero correlation with the majority of other investment assets and can detrimentally impact the opportunity cost of the transition.
Significant planning took place both within Northern Trust and by the other key stakeholders to the event – the custodian, the OCIO providers and the underlying investment managers. The healthcare system also undertook its own planning.
Although the underlying liquidity of the assets was reasonable, the implementation, trade execution, settlement and delivery of assets to the new managers took a calendar month to complete.
The event consisted of 106 different funds and accounts with total value of approximately $5bn. The restructuring activity was across multiple asset classes: US equity, non-US equity, emerging market equity, fixed income, real estate and commodities. All aspects of the event were completed on schedule and within the pre-trade cost estimate provided.
Although transition size is a commonly used metric to assess the proficiency of a transition manager, this can be misleading. The complexity of the event – the varying asset classes, the number of managers and the vehicle types – is what differentiates one event from the next. This complex event warranted the expertise of transition manager where the focus is on risk containment and holistic project management.
It is expected that type of activity will become more prevalent over the next number of years, with the maturation of the OCIO offering and initial relationships testing the market for potential new providers.