The Road Ahead in Transition Management
Clients are demanding a more transparent, agency-only approach to trading and sourcing of liquidity, as well as deeper discussions around venue analytics to better understand the reasoning behind order routing preferences.
By Michael Mollemans, Head of Global Market Structure & Analytics, and Sharif Shukr, Project Manager, Transition Management, Pavilion Global Markets
(This article first appeared in Global Trading magazine.)
As risk-adjusted performance requirements continue to drive investment allocation decisions among institutional investors, transition management services play a key role in optimizing the portfolio restructuring process by striving to minimize the inherent transaction costs, as well as controlling the potential drift in performance. Pension plan future obligations provoke asset liability reviews as underfunded pension liabilities remain a constant burden. This has motivated clients to increasingly insist on transparent cost structures from their investment partners, as they look to improve the overall performance of their assets. Clients are demanding the same transparent service model from their transition managers. Single-party accountability, risk management, fiduciary oversight and operational efficiencies across the entire trade lifecycle are all essential elements of the process. Going forward, client feedback has shown increased demand for transparency across the entire trading process with a need to better understand the liquidity sourcing preferences.
Transparency is often cited by clients as one of the main qualitative factors considered when making transition manager decisions. Agency-only brokers, by being free of conflicts, are naturally well positioned to earn high marks for transparency within the industry surveys. Venue analysis tools are increasingly being used to help clients recognize when a broker’s own dark pool or systematic internalizer is being preferenced, or if a venue is causing excessive information leakage or reversion costs.
Transparency of order routing logic and smart order routing prioritization settings require informed communication to help clients understand what is happening “under the hood.” Pre- and post-trade analytics can be very helpful in driving informed discussions with clients around implementation shortfall costs at the venue level and help brokers act in the best interests of clients by removing hard-coded venue biases in favor of venues that provide the most opportunity for earning spread capture and speed of execution. Guided conversations around trade cost analytics provides added depth of understanding of a client’s performance goals, which help transition managers fine tune trading strategies across various market conditions.
Over time there has been dramatic shifts in our clients’ asset allocations, as they transition from traditional into alternative investments. The strength of the equity markets, as well as volatility fears, have led many of our pension clients to review their overall risk allocation. Client decisions to de-risk their equity allocation has led to more transition events moving from active to passive strategies, as well as defensive and low-volatility strategies. We have also seen an increased appetite for emerging market (EM) allocation changes, especially as China’s share of the emerging markets indices grows. Clients are either switching investment managers or moving into a passive EM index strategy. Large discrepancies in EM manager performance have led many plans to reallocate their funds to other EM investment managers or a different asset class all together. Liquidity is always a source of frustration, and a few illiquid names in a transition can severely damage overall performance numbers. Access to a breadth of counterparty relationships gained through experience can make all the difference when dealing with liquidity issues.
The liquidity landscape is constantly changing with new and alternative venues springing up all the time. Clients expect the transition and trading teams to stay updated on the market structure changes and consider how best to take advantage of change in new crossing venues and innovations. Experienced traders utilizing their breadth of counterparty relationships, gained over time, can help source block crosses and minimize implementation shortfall. Experience on the trading team can also help to minimize information leakage cost by managing the information flow carefully, rather than over disclosing to the market. Electronic crossing venues can be a good source of liquidity, but care must be taken to make sure they are not generating information leakage or excess reversion costs.
Communication between transition management teams, global trading teams and settlement is key when implementing global multi-asset transitions. Centralized communication across teams is key when working on a customized transition event. Economic or geopolitical news can cause large moves in the markets, which may require sudden trading strategy changes intra-day. Dynamic communication between teams from a centralized location helps manage performance risk. The same is true across the entire trade lifecycle. Smooth settlement requires constant communication between traders and settlements teams, especially with the difficult emerging and frontier market account identifier matching requirements. “Lost in translation” or delayed communication between global trading and settlement desks located in various cities or countries can entail additional costs for late or failed settlements, which in some markets can be very significant. Centralized implementation across the transition management workflow process is ideal when speed of communication and implementation shortfall performance is the goal.
Managing global multi-asset transitions necessitate project management expertise to address the list of requirements across the process including: (1) a thorough pre-transition cost and liquidity analysis, (2) developing and implementing an optimal trading strategy across overlapping markets, (3) global multi-asset cash flow management, (4) global settlements, and (5) a comprehensive post-transition performance analysis.
Customized service partnership
Every transition event is a customized service partnership, with accountability to the project manager for optimal planning and coordination among all the relevant parties in the process. Monitoring and reviewing the transition process with clients requires constant communication and yields a valuable feedback loop used to help produce the best possible performance result.
Reliability of execution is often mentioned as a key qualitative factor when it comes to making transition manager decisions. Clients do not want the burden of responsibility on them to assure they achieve the desired transition outcome. Project managers are expected to form customized service partnerships with clients by providing continual updates and gaining feedback from clients, which builds knowledge of client preferences and helps assure transition strategy goals are reached at the end of the day.
Clients are asking for transparency, liquidity and communication. The transparent, agency-only service model, by being free of conflicts, is naturally well positioned to build trusted partnerships with clients. Access to liquidity, especially in the emerging markets, continues to be a key driver of transition management decisions. Communication with clients, when forming customized transition service partnerships, and centralized communication between transition management, global trading and settlement teams is key when trying to achieve the best possible performance result. With over 20 years of experience managing global multi-billion dollar transitions, Pavilion Global Markets’ value proposition is built on these client values, as they pave the road ahead in transition management.