Issue: September/October 2005
Assets on the move?
Why specialist transition management makes good sense for trustees
The unique fiduciary responsibilities of a pension fund trustee
demands specific knowledge of a wide range of investment
and legal issues. The aim of this article is to introduce the
fairly new notion of “transition management” to trustees.
Trustees often have to make decisions regarding the movement of assets. For example –
Much like a relay race – you may have excellent runners, but if the transitioning process of changing the baton is not efficient, the change-over process can result in a fund paying dearly in performance – with little or no risk control during the change. Little wonder that specialist transition management is becoming a necessity in the pension fund arena worldwide – over $3.6 trillion having been transitioned by 17 large professional transition managers in the US during 2004 alone (source PlanSponsor.com).
What exactly is transition management and why is it still in its infancy in South Africa?
Essentially transition management is the professional management of the entire process of trading out of initial portfolios and into target portfolios, while controlling for the important risks during the process, the timeliness of the trades, and upfront and hidden costs – including all the legal and administrative requirements.
This important service is still in its infancy in South Africa because the specialist skills required by a transition management team are indeed substantial and diverse – and up until recently these collective skills have not found themselves under one roof in South Africa. Amongst other skills, a transition management team requires:
Understandably a transition management team has a specialist role. The relationship with the client starts when a customised transition plan is developed. This plan can be as simple as liquidating an equity portfolio, or as complex as hedging the entire pension fund and restructuring it. The latter being necessary when a fund needs to convert from a de- fi ned benefi t to a defi ned contribution scheme.
When implementing the transition plan, the ability to make quick and minimal cost transfers at low risk and the capability of transacting in multiple markets are imperative for a good transition management team. However, the hallmark of a good transition is the ability to integrate skilled trading with the science of risk management, quantitative trading techniques and custom-made derivative-based hedging to protect fund value if needed.
The transition management team’s primary objective is to minimize total costs and risks for the client during the transition. Visible costs such as commissions and taxes are usually easy to identify (Figure 1), but hidden costs are harder to quantify and the transition specialist is especially skilled in this area. The main hidden costs are market impact, bid-ask spread differences, liquidity, and opportunity costs (the cost of prolonging the execution of the trade). Figure 1 illustrates that a managed approach can substantially reduce hidden costs.
Figure 1: Visible and invisible costs
for managed and unmanaged transitions
Demystifying transition management
The actual steps taken in a transition management process might be unknown territory to pension fund trustees. The role of the transition manager in this regard is to lead the trustees through this potentially complex process. The project management role of the transition management team is also central.
Transition management stages:
The changing of fund managers can benefit from using a transition management team
Perhaps the most common mini-transition management situation is that of changing fund managers. In the local equity market, when moving assets from one equity manager to the next, our research has shown that on average 43% of the fund is common to the both initial and the target portfolio. This means that 57% of the fund is typically sold and a new 57% bought. Clearly, with such a high turnover (114%), a professionally executed transition is imperative.
Importantly traditional approaches of either selling all assets and handing over the cash to the new manager, or simply giving the new manager the old fund are somewhat archaic and expensive processes for a manager change.
A far superior approach is to use a transition management team to transition the old portfolio to the mandated benchmark – and hand the benchmark to the new fund manager.
This strategy is superior from both a cost saving viewpoint as well as from the viewpoint of monitoring the active risk of the new manager. Furthermore, far less overall trading would be required as the benchmark is typically “close” to the final portfolio. The new fund manager would thus need to do a relatively small quantity of initial trading from the benchmark to the new portfolio. Thus handing a new fund manager the mandated benchmark is by far the best strategy when changing managers.
An unmanaged transition can easily become a haphazard affair where different parties are not properly communicating and the important issues of risk control and minimization of cost is ignored in the process. Instead, a disciplined, integrated approach by a specialist transition management team can add substantial value to a fund when there is a planned shift in the assets managed. Trustees should be aware of the circumstances where a professional transition management team should be used – so that the baton change is efficient.
Importantly the specialist risk management and cost saving potential of professionally managed transitions are likely to make them an important part of the pension fund arena in South Africa in the future.
Contact: +27 21 657 8500 • www.cadiz.co.za
Dr Jaco Maritz • firstname.lastname@example.org • +27 21 657 8356
Prof Dave Bradfield • email@example.com • +27 21 657 8351
SPECIALISTS IN: risk management • quantitative modeling • dealing • derivatives engineering • administrative and legal aspects of transitions