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Magazine Issues » December 2010

TRANSITION MANAGEMENT: all change please

railway_pointsPortfolio changes prompted by the market environment have taken place as the number of specialists who execute transitions has shrunk. Nick Fitzpatrick looks at who is in and who is out of transition management and why certain approaches have faltered

If institutional investors are in step with fund manager marketing trends then the past two years would have seen them switch money into an array of assets that are only broadly familiar to them if not wholly unrecognisable.

High-yield debt, emerging market equities, local and hard currency emerging market sovereign bonds – sometimes with a currency overlay around the edges – would have been sought-after assets since the economic downturn. Meanwhile, the more user-friendly European equities were left behind in flames.

The demand for these assets put the ability of transition management specialists in the spotlight again. But it did so at a time when a number of providers had pulled out of the market following the financial crisis.

UBS and RBS closed down their European transition management operations, as did – for obvious reasons – Lehman Brothers, which before the crisis had a highly visible team. Citi and Credit Suisse closed their European branches but are now rebuilding them. Meanwhile, BNY Mellon, which brought in transition specialists from Citi’s closed European operation, has seen most of them leave.

BlackRock’s acquisition of Barclays Global Investors will have added to the shrinkage too, as both fund managers ran transition businesses.

But the main shakeout, clearly, has been in the investment banking sector. Why?

“It is a function of how the transition management businesses are aligned,” says Michael Gardner, Emea head of transition management at JP Morgan Worldwide Securities Services (JPM WSS).

“Most brokerage models have transition management on their equity trading desks, yet transition revenues don’t just come from equities, but also from fixed income. This means that the equity desk only sees a proportion of the return and is therefore subsidising the transition business.”

In a tough period when a bank has to cut headcount, the equity desk may well close down transition management, which is labour intensive compared to other trading businesses. “It’s a serendipity moment,” says Gardner, adding: “It’s not that the banks did not like transition management. They had to make tough choices.”

JP Morgan’s transition business was realigned three years ago and placed within the custody banking unit of JPM WSS where the client base – the asset owners – also sits.

Culture clash
Transition management businesses run by investment banks compete heavily with those offered by custody banks, and a clash of cultures between the two mindsets that each model produces may have been behind the exodus at BNY Mellon. In March 2009, BNY Mellon announced it had expanded its global team to 50 with the addition of seven people from Citi, including Tim Wilkinson who was appointed as head of Emea. He has since left, as have other former Citi colleagues.

“This relationship did not work out,” says Ben Gunnee, European director of Mercer Sentinel Group, a unit within Mercer Investment Consulting that gives operational advice to investors. “I would describe it as a clash of philosophies between an investment banking team from Citi, and BNY Mellon, a custody business.”

Since then BNY Mellon has added people to its European team from its San Francisco office, Gunnee notes.

The cultural differences are reflected in Citi’s hiring of former BlackRock transition executive, Steve Dalzell, who is rebuilding Citi’s European operation.

“[Citi transition management’s] previous reporting line was into equities, but it is now very much a global markets initiative,” says Dalzell, who influenced the reorganisation.  He adds: “ I want to be very neutral on which asset class I take on.”

For a time after the closure of its European business, Citi ran European clients from offices in North America and Australia. Inevitably, the closures by the banks affected clients.

“Some clients were caught by this and were not best pleased,” says Chris Adolph, head of transition management at Russell Investments and formerly a transition business head at UBS. “It will take time to win back the trust of consultants,” he adds.

Being one of the consultants in question, what does Gunnee, of Mercers, think?

“Pre-crisis there were arguably too many transition management teams,” he says. “The market was too small to accommodate all the players, of which some were not credible. We were concerned by the scramble for business, and although there was quite a lot of flow, it was all fairly captive.”

He says the closures were a “knee-jerk” reaction and “it has not helped those that are now trying to rebuild their business. Clients need to feel comfortable that providers are committed”.

“And on top of all this, clients have been changing what they were previously doing, too.”

Three years ago the business would have been all about equities with a little fixed income trading. But now it is much more focused on fixed income, such as emerging market debt and high-yield bonds, says Gunnee.

“Before the crisis, when portfolios centred on large caps and the world was a very benign place, it was easier to carry out transition management, which is one reason why there were so many players. Now, though, assets are less transparent, more expensive to execute, and less liquid.” He adds: “Nobody really had a track record in these asset classes so transition managers have had to build them over the last couple of years. There will be times when people want a new asset class and the transition manager has to learn how to transition it, to learn the nuances of a market.”

New model
The chance to build reputations in these sectors that are, for many investors, new, may be a help for those rebuilding their businesses. For Mercer, transparency and price are important, which brings up a familiar question in transition management – that of execution models, or the principal versus agent debate.

Gunnee says: “For us, in the fixed income sector, we focus on transparency and price, and so our preference is to look at providers with multi-dealer, multi-price coverage, rather than those that trade with themselves on a principle basis.

“This view is new. Before we might have used both, but we feel that in these new sectors the risk premium is too high.”

At Russell, Adolph says: “The problem with sell-side firms is that although they can do agency dealing, quite often they report to the head of portfolio trading who reports to the bank as whole. This leads to a conflict of interest that has to be managed.”

Gunnee acknowledges that each transition manager will have different strengths.

“We have a number of ratings factors, including execution quality in fixed income and equities, project management, risk controls and technology.

“Depending on what the client needs, we might weight the providers differently, meaning a provider with good execution skills could still be selected despite not having the best project management skills as long as this is suitable for the client.”

Dalzell highlights Citi’s capability in interim portfolio management, which is a result of being involved earlier on by clients in the asset allocation process. Gardner highlights JPMorgan’s capability in complex transactions. And Russell recently highlighted its transparency by making data for five years of global transitions available through the Inalytics TIPS database.

Meanwhile BNY Mellon says it will announce new appointments shortly and believes it has one of the strongest regional teams with experience in every region.

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