Access to technology, particularly electronic trading tools, has shaken the transition management landscape. In the technology-intensive business, global custodians and index managers now are vying with broker-dealers to help pension clients realign their portfolios.
Pension sponsors - as well as foundations and endowments - need transition managers when they switch investment managers because of poor performance, change their asset allocations or look to diversify their businesses. While the major buy-side players in transition management continue to be global custodians and index fund managers - including State Street, Northern Trust, Mellon, Barclays Global Investors and Russell Investment Group - sell-side broker-dealers entered the market a few years ago, building off their trading-skills strengths. "If you're using a broker-dealer, the advantage is perceived to be higher trading acumen," says Gavin Little-Gill, research director, investment management and retail brokerage, at Needham, Mass.-based TowerGroup.
But now that trading venues, such as ECNs and crossing networks, and algorithmic strategies - once exclusive to broker-dealers - are readily accessible, buy-side providers say that trading technology has helped re-level the transition management playing field. "We're talking about some serious firms with serious technology budgets," says Little-Gill.
And the size of the playing field is huge. Little-Gill estimates that on an annual basis, between 15 percent and 20 percent of institutional assets, or $1.9 trillion, passes through the hands of transition managers.
What Is Transition Management?
In transition management's simplest form, a pension client hires a transition manager to migrate fund assets from Portfolio A to Portfolio B. Typically, the transition lasts anywhere from three days to two weeks. But, transition management can get complicated, cautions David Rothenberg, director, business development, Russell Implementation Services, a division of Russell Investment Group (Tacoma, Wash.). "Very infrequently is it a simple move from a single asset manager to a single asset manager," he says. Often, the move involves multiple asset managers, currencies and asset classes, Rothenberg notes.
Technology is used throughout the process - to capture data from each manager, factor in corporate actions and stock splits, analyze the risk of portfolios, and estimate the cost of the transition, explains Kevin Hardy, global head of transition management at Chicago-based Northern Trust. But where technology really is moving the business forward is on the trading end.
"If you go back five years, much of the technology that was out there really existed in the big Wall Street powerhouses that had the ability to access sources of liquidity, ECN aggregators, and DOT trading and algorithmic trading strategies," says Ross McLellan, managing director and head of North American transition management for Boston-based State Street Corp. But the buy side now has access to the same tools and liquidity as the sell side, McLellan contends. "Firms that you don't think are trading powerhouses basically have the same technology that the largest broker-dealer investment banks have."
As enabling technology becomes a commodity, some transition management providers are seeking to differentiate themselves by focusing on other attributes - such as whether or not they play a fiduciary role or how they manage the transition risk, relates McLellan. Custodians like State Street and Northern Trust that also are index fund managers point to operational expertise in data capture, and in clearance and settlement as differentiators.
In order to hold trading costs down, large institutional index fund managers can cross the transition portfolios against their index clients' order flow - without charging a commission. This may give buy-side providers an upper hand over their sell-side counterparts.
McLellan says his firm - which manages $500 billion in index portfolios - is well known for using its internal crossing capabilities in transitions. However, fund managers may be able to cross only a certain percentage of the transition portfolio internally, and they may need to tap external sources, including exchanges, brokers and third-party crossing networks, which runs the risk of leaking information.
According to Hari Achuthan, head of sales and strategy for transition management at Credit Suisse First Boston, zero-commission index crossing is a myth because the internal crosses as promised by indexers only work if the stocks being transitioned are in a passive S&P 500 index portfolio, which is different than an actively managed portfolio concentrated in a short list of small cap names. If the transition manager can't cross the stocks with internal flow, he has to go to outside sources of liquidity, and there is a danger of information leakage. "That means you are giving up information," Achuthan contends. "That means you are showing your hand."
Further, Lance Vegna, head of transition management at CSFB, says index managers tend to run these crosses only two times a month on specific funding dates, so the crosses can lengthen the transition period, which can impact a portfolio's returns. Conversely, CSFB has access to natural liquidity from asset managers - what Vegna terms "unsolicited agency executions" - since clients are sending orders into its Advanced Execution Services (AES) algorithmic trading strategies. "We enter the transition orders and we automatically find crossing opportunities in the system due to our natural flow - benefiting both customers," Vegna says.
However, State Street's McClellan says his firm uses all sources of liquidity in the market. And Russell Investment Group has built a multibroker platform to access every liquidity pool on the Street, notes the firm's Rothenberg.
Similarly, Hardy says Northern also utilizes a number of independent, third-party ECNs. "One of the benefits is they provide an anonymous, low-cost source of liquidity," he notes. Meanwhile, Northern simultaneously uses direct-market-access tools as well as program trading and algorithmic trading. Plus, it uses FIX connectivity via its order management system to post indications of interest to various electronic outlets, Hardy adds.
Going forward, both buy-side and sell-side providers will continue to evolve their systems to estimate transaction costs, control trading costs and track risk exposures. Since the '90s, the cost of transition management has fallen from around 200 basis points to 50 basis points, largely due to technology advances, according to industry sources.
"Because of the increased competition, multiple asset classes, currencies, multiple derivative products that are out there, it forces you to look at your technology," says John Sacks, manager of quantitative research at Russell Implementation Services. Russell developed PARMS - Portfolio Attribution and Risk Management System - a Microsoft .NET SQL environment that wraps pre-trade analysis, risk management and historical performance into one package.
At CSFB, the firm's trading and transition management technology enables it to monitor risk in real time, according to the firm's Vegna. "We know that we can re-optimize in real time as opposed to waiting for an end-of-day plan," he says.
However, there still is an ongoing debate about the role of a fiduciary. "Most plan sponsors engage a manager as a fiduciary," says John Webster, managing director at Greenwich Associates. "The reason is, you're sort of bound to act in the best interests of the plan." But brokers cannot be a fiduciary if they trade as principal, since this raises concerns as to whether the provider's interests are aligned with the client's. Some sell-side firms, however, feel that the investment managers are using the fiduciary issue as a marketing tactic, to scare the pension sponsors into thinking they are getting ripped off.
"The rise of competitors has raised the bar on people disclosing how they actually get paid," including disclosing if they are "doing crosses and stock borrows and currency [trades]," Webster says. "As the competitive landscape gets more parties involved, you're throwing more light on what was an opaque business."
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Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio