Transition Management: 2003, 2004 And Beyond
By: Bob Collie
Given the choice of reviewing the past year, or forecasting the future, the fun part is surely looking forward.
But the two tasks are not as different as they appear. Almost all forecasts observe a trend and project it forward. That’s how human beings predict the future. Think of it as The First Law of Forecasting. It means that I’d be willing to guess that in other sections of this edition of Benefits and Pensions Monitor, you’ll find such radical ideas as: ‘Hedge funds and alternative investments will be a bigger part of the institutional investment landscape in future’ and ‘some corporations will question their commitment to Defined Benefit plans.’
It makes sense; there’s more interest in hedge funds today than there was a year ago, so the obvious prediction is that there will be more still a year from now. It’s easy.
Pick any trend, and you can play this game for yourself:
In 1973 there were 17 Elvis impersonators in the world. Today there are 35,000, 3,000 in Las Vegas alone and more than 10,000 in Asia. By mid-2039, everybody on the planet will be an Elvis impersonator. Buy pharmaceutical stocks and gem producers.
Or take the internet (which is apparently identical to railroads, which presumably means it will soon start going on strike in the UK every two years), or biotech, or whatever.
Or consider transition management.
In 2003, the transition management industry continued to mature. In 2004 it will mature further.
This can be seen as part of a wider move towards specialization in the investment industry. When one portfolio manager is being replaced with another, there is an interregnum period during which neither is fully accountable for the portfolio. The old portfolio must be sold and gotten in line with the new manager’s model holdings, while all the time maintaining the integrity of the structure (the biggest no-no in transition management is selling, waiting for the trades to settle, then buying. Loss of market exposure can easily turn out to cost the fund more in a day or two than the old manager lost in years).
This is the reason investors are now turning to transition managers. Transition management requires trading capability, but a trading capability different from that of either a traditional buy-side or a traditional sell-side trading desk.
Transition management requires risk control, portfolio building, and investment management capabilities, but applied in ways different from how they are used to run traditional investment management products.
In short, it is a specialist task. In 2004, investment managers may well move off the sidelines and start to actively encourage the use of transition managers whenever they are appointed to a new mandate. Their traders have enough to do buying and selling the firm’s developing ideas. They don’t want to have to build from scratch a portfolio they’ve already set up for everyone else. They don’t want to divert attention to selling whatever happens to be in the portfolio they inherit. These were stocks that got the previous manager fired, after all.
Like Elvis Impersonators
Recent years have also seen a big increase in the number of firms selling transition management services. Like Elvis impersonators, there are more than ever to choose from. Firms with trading capabilities have seen an opportunity to increase their order flow and hung out a shingle. Custodian banks have seen an opportunity to break out of their traditional fields into a higher growth business area and done the same. Others have noted the explosion in interest and jealously eyed the easy money apparently to be made.
At this point, I’m going to break The First Law of Forecasting. I predict that the number of transition managers (and, indeed Elvis impersonators) will reach a natural limit and stop growing. Calling yourself a transition manager is no more a guarantee of limitless profits than adding .com to your name was in 1999. Some will pull out when they fail to achieve market share or experience unexpected losses from inadequate operational control. Transition management is not easy; some will fail.
The other big trend has been a closer focus on portfolio performance.
Indeed, the single biggest development of 2003 was the production of a standard methodology for calculating performance, known as the ‘T standard.’ I should declare a vested interest here, since I wrote the article in the Winter 2002/2003 edition of the Journal of Performance Measurement that called for such a standard and set the ball rolling. The speed and willingness with which plan sponsors and the industry picked up that challenge was terrific.
The case for a standardized calculation is simple.
For plan sponsors, it makes reporting on transitions clearer and more meaningful. It will lead to better analysis of a transition event. It creates greater confidence in the transition industry and raises the level of discussion beyond what is currently possible.
The standard has been produced after a consultation process involving dozens of interested parties – transition providers, plan sponsors, investment managers, consultants, and others. I expect that, within a short time, just about every transition agreement will specify that performance should be reported on this basis.
This could transform how clients look at transitions.
Once they become accustomed to clearer reporting, clearer expectations can be formed going into an event. Major sources of risk can be identified in advance. After the event, the outcome will be compared to those expectations. If an unexpectedly bad outcome occurs, the client is better placed to understand what caused it.
In the absence of calculation standards, bad outcomes can be disguised by adjusting for factors deemed to be outside the transition manager’s control. The client would never see what really happened.
Looking further out, transition management will lose its ‘new’ status and take its place as just another specialist investment function. The different types of service available to investors will be better understood, along with the performance implications and risks of each. Competition will be based on service and performance and the better firms will flourish.
And, somewhere in Las Vegas, the strains of ‘In The Ghetto’will still be heard floating in the wind…
Bob Collie is director of research at Russell Investment Group.
The views expressed in this article are those of the author, and not necessarily those of Russell Investment Group, especially the bit about Elvis.
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