Pension funds and other institutional investors increasingly are using portfolio transition management services provided by larger consultants and money managers to save money and ease the shift of assets among allocations and between money managers.
It's hard to find official estimates of the total volume of assets going through transition management, but H. Paul Reynolds, president and chief executive officer of Tacoma, Wash.-based Frank Russell Securities Inc., estimates it to be more than $1 trillion per year. And growing.
That's based on Russell's own numbers, which in 1999 and 2000 averaged about $60 billion per year, and numbers reported by other firms. This year, Mr. Reynolds said he expects Russell's volume to more than double to $150 billion.
At State Street Global Advisors in Boston, the amount of money the firm handled through portfolio transition management jumped $130 billion between 1997 and 2000, said Ross McLellan, vice president of transition management. In 1997, SSgA handled the transitions of $30 billion in assets. Last year, it transferred $160 billion. Already in the first quarter of this year, the firm has handled $50 billion in transitions and is on pace to handle $200 billion by the end of the year.
The story is the same at Barclays Global Investors in San Francisco. In 1996, the firm handled transitions totaling $16.2 billion in 115 assignments, according to company statistics. In 2000, BGI handled $175 billion in 435 assignments.
"The marketplace has exploded," Mr. Reynolds said. But, he cautioned, arriving at a total volume can be tricky. That's because some firms include money from program trades and other sources beyond third-party asset transitions in their figures. Russell, he said, includes only money it managed during transitions for third-party clients.
And as more money seeks out portfolio transition management services, the number of firms willing to help has grown, also, according to an informal Russell survey. Mr. Reynolds said five years ago, Russell found three or four competitors offering transition management in their marketing materials. By 1997, that number had grown to seven competitors. Last year, Russell found 25 companies offering transition management.
"Pension funds have realized this is something they need help with and the providers see an opportunity to come in and help the pension funds," Mr. Reynolds said.
Changes that prompt the use of a portfolio transition manager include asset allocation shifts, style shifts and manager shifts. In all cases, funds want to maintain their exposure to the asset class, minimize trading and other costs, figure out the best time to make the transition and decide on a benchmark against which to measure the transition.
Too big to be efficient
Among the challenges: the value of the securities to be sold and bought as part of the transition can be too large for quick, efficient trades through the markets; and unexpected economic shifts can negatively affect the value of assets being moved.
Experts say the market for transition management will only grow. According to figures from BGI, nearly half of the assets for which plan sponsors used BGI's transition management in 2000 were from public pension funds. Eighty-one percent of the money was from defined benefit plans. Overwhelmingly, the assets were part of domestic equity portfolios, although the amount of international equity assets going through the transition process rose to $46.4 billion in 2000 from $5.5 billion in 1997.
As more foreign equities become subject to transition, more plan sponsors are seeking out portfolio transition managers to assist in what can be a complex process.
"It's certainly becoming more prevalent in the industry," Mr. McLellan said. "Five or seven years ago, people were skeptical. It (portfolio transition management) was a new product. When you fired a manger and hired a new one, you just gave them the assets and said `do your best to get it into the new portfolio."'
That doesn't always work out for the best. Last year, the Teachers' Retirement System of the State of Illinois, Springfield, sued Ark Asset Management Co. Inc., New York, after Ark allegedly sold $579 million in equities on the day the then $21.5 billion system terminated the firm. The pension fund has sued in Cook County Circuit Court in Chicago charging breach of contract, breach of fiduciary duty and violation of the state pension code.
Illinois Teachers said in its lawsuit that selling so many securities at once hurt the price of those securities and kept the retirement system from using them in a transition plan that was to be part of a major restructuring of the fund's investment portfolio.
Ark, however, maintained it followed the instructions in the system's termination letter and sold the stocks to take advantage of high market volume and good prices.
The retirement system's consultant, Michael Beasley, managing director of Strategic Investment Solutions Inc., San Francisco, at the time said Ark wasn't supposed to do anything with the securities. He also said under normal circumstances when a manager is terminated, the owner of the securities, in this case Illinois Teachers, would assume control over them.
In a recent interview, Mr. Beasley said using portfolio transition management makes sense. Simply leaving the assets with the old manager until the new manager takes over is the worst thing to do.
"(The old) manager, other than professional pride, doesn't have any incentive to do a good job," he said. "You've lost confidence in that manager, so why would you have confidence they'd transition the money? That's a poor choice."
Strategic Investment Solutions prefers to play the major Wall Street trading firms off one another to get the best transition deal, Mr. Beasley said. SIS uses its own software to analyze the portfolio assets that will be moved, determine the tracking error to the benchmarks and then group and block the securities to make bidding easier and less expensive.
Determining the tracking error to the benchmark allows the Wall Street firms to hedge their exposure to the securities they're moving, he said.
Most of the transitions Mr. Beasley and his firm handle are for clients with at least $500 million in total assets. But portfolio transition management is gaining popularity with plan sponsors of all sizes, said SSgA's Mr. McLellan.
In 2000, State Street handled transitions for clients with anywhere from $1 million to $11 billion in assets.
Clear picture of costs
Craig A. Husting, chief investment officer at the $22 billion Public School Retirement System of Missouri, Jefferson City, said portfolio transition management saves the fund money and gives it a clear picture of what transitions cost. Missouri uses Strategic Investment Solutions as its consultant.
"We think it's important to minimize cost and, from a fiduciary standpoint, to determine exactly what the cost of the transition was. Any transition manager will give you a detailed report that estimates the total cost of the transition," he said.
Missouri last used SSgA's portfolio transition management services in February 2000 when it transferred money from an active large-cap value manager to a passive Russell 1000 stock index portfolio run by SSgA.
The most important thing a portfolio transition manager can provide is liquidity, said Charles Shaffer, director and product manager for Deutsche Banc Alex. Brown global transition management team.
"There are hundreds of moving parts in any transition, and a good transition manager will be responsible for making sure all of them work together," he said. "What separates a good transition manager from one that's not so good is the ability (of the manager) to allow access to multiple sources of liquidity."
Typically, Deutsche Bank sees transitions where a plan sponsor is replacing two or three managers with the same number of new managers, Mr. Shaffer said. Deutsche Bank first works with the custodial bank to freeze the assets under control of the manager being terminated. Then the custodial bank gives Deutsche Bank a list of assets to be sold in the transition. The new manager, or "destination manager," provides a list of the securities it wants to own after the transition is finished.
Deutsche bank crosses these lists with each other. The new manager picks up the securities that will be held in the transition. Any other assets that won't be held, as well as the leftover assets that remain to be bought, are then crossed at no commission against Deutsche Bank's global program trading network, Mr. Shaffer said. Whatever is left is sold as a program trade.
Some use in-house
Stephen Malinowski, managing director of equity link products at Merrill Lynch & Co. Inc., New York, which includes transition management and portfolio trading, said while some larger consulting firms offer in-house transition management, many refer inquiries to outside sources. He said smaller pension funds that don't often change their managers or asset allocations can benefit from consultants who use outside firms for transition management. But larger funds that change managers more often may prefer a consultant that does its own transition management.
Shauna Lambright, president of Capital Resource Financial Services LLC, Chicago, which does third-party transition management, said whether consultants offer such services isn't as important as whether they understand the benefits of transition management.