Transitioning to a new paradigm

Written By: Matthew Craig LAPF Investments

Matthew Craig discusses the role of the transition manager during the pooling process and hears the views of some fund managers who are at the start of the process

Transition management is a largely unseen but vital part of institutional investment, ensuring pension fund assets move safely when a fund decides to make a change to its investment managers. With the Local Government Pension Scheme (LGPS) asset pooling exercise underway, transition management is now in the spotlight, as it will be vital for the smooth transfers of billions of pounds from the underlying local authority pension funds to the new asset pools.

Transition management refers to the process of minimising the costs and risks when moving money from an outgoing asset manager for, say, UK equities, to a newly appointed manager. In the case of the asset pooling exercise, it will be needed when assets are transferred to the new pools to be invested in new sub-funds, or other vehicles used by the pool. As well as controlling the trading costs of buying and selling shares or bonds, the transition manager aims to minimise the risks of being out of the market, and to carry out the transition discreetly so other market participants cannot exploit it.

When a pension fund needs to move assets from one manager to another, it can either appoint a specialist transition manager, or ask one of the asset managers involved to carry out the transition. Nigel Keogh, operation and developments manager, National LGPS frameworks, commented: “It is a very niche activity and very complex. Using specialists to manage the costs and risks involved makes sense – you do need to use a specialist in these areas. They should work with the platform operator and individual funds to make sure that the transition goes through as smoothly as it can.”

Keogh explained how the National LGPS Procurement Frameworks brought transition management within the scope of its services to LGPS members. “We undertook an exercise last year, working with six of the eight asset pools to establish a national LGPS procurement framework for transition management, to assist in their transition activity. We undertook the full OJEU tender process and structured the framework in such a way as to enable the pools to access transition management services quicker, more flexibly and cheaper than through individual procurement.”

As a result of this process, seven transition managers – BlackRock, Citigroup, Goldman Sachs, LGIM, Macquarie, Northern Trust and Russell Investments – have been appointed to the framework in lot one, for transition management and implementation services. The lot one firms, apart from Citigroup, have also been appointed to lot two, for transition execution services, while three consulting firms – Allenbridge, Hymans Robertson and Mercer – have been appointed to lot three for transition management advisory services.

Using the LGPS National Framework will make the process of appointing a transition manager more efficient, as Anthony Parnell, Treasury & Pension Investments Manager at Carmarthenshire County Council, and the host authority for the Wales Pension Partnership (WPP), explained. “The framework will reduce the length of time needed for a tender exercise by many months, as it means that you don’t have to go through the full OJEU appointment process. There are many transition managers on the framework so it definitely makes life easier and just as importantly reduces the costs of the exercise.”

Parnell said that the WPP is to launch to initial global equity sub-funds in the near future: “Once the FCA has approved the prospectus, the funds will be launched, and transitioning from the respective Wales LGPS funds will occur later this year. Our platform operator, Link Fund Solutions, in partnership with the Wales funds will use the LGPS National Framework to appoint a transition manager.” He added that the WPP is likely to select different transition managers depending on the asset class involved. “Transition managers specialise in different asset classes. We will transition bonds and alternatives further down the line so we are unlikely to have the same transition manager for all of the transitions.”

In most cases, the asset pools are likely to use a specialist transition manager, given the complexities of large-scale transition exercises. For the Border to Coast Pensions Partnership, chief executive officer, Rachel Elwell, stated: “We believe it is appropriate to use a specialist transition manager in most situations but will assess this on a case by case basis.”

Elwell explained that Border to Coast is utilising a transition manager, taken from the LGPS framework, and a transition adviser. “For the transitions in 2018 we are working with LGIM and Inalytics, but we will look to assess the best people for the job for each transition, depending on factors such as asset class and geography.” Given that the new asset pools will have tens of billions in assets, moving all of the assets from the current managers will inevitably take time, Elwell explained. “We expect it to take broadly two to three years to transition the assets from our Partner Funds to Border to Coast, and currently expect this to broadly follow the transition plan as outlined in our submission to central government in July 2016,” she commented.

The time needed to transition varies according to a range of factors, but one key element is finding the right approach to control costs and minimise risks. Keogh explained: “In terms of minimising costs, the biggest cost element with a transition will be the opportunity cost of being out of the market for a period, as well as the market costs on a bid-offer spread. The way to minimise both is by working with a transition manager to come up with a transition strategy. It is about striking a happy medium between speed of implementation and cost of doing it.” To do this, a specialist transition manager can map out scenarios and provide pre-trade reporting showing what the transition will look like depending on how it is carried out, Keogh said. “It is about managing the balance between risks and costs. The main risk is always going to be market movements during the transition. You want to be no worse off than at the start of the process. This is where using a transition manager can help you understand the risks.”

For Elwell, very careful planning and the involvement of specialists are vital to managing the risks and controlling the costs. Stopping information leaking about a transition is also important, as this could lead to markets moving against the transition. Elwell added: “It’s important to have good programme management throughout the process (for example, we have daily calls) and involvement of the affected parties, including Partner Funds and their custodians, as well as the asset managers, tax advisers and Border to Coast team. It is important that all are aware of the potential market sensitivity on timing and detailed information about the transition.”

The next couple of years will see some intense transition management activity involving the LGPS sector. It is expected that public, listed assets, such as equities and bonds, will be easiest to transition and will be moved first. Carrying out transitions with illiquid, private market assets will be more challenging and in some cases, these assets may not transition to the new asset pools, as it would not be cost-effective. In these cases, the assets may be held at the individual fund until they are run off. It is also likely the asset pools will need to do more work, with the help of government and the regulator, to make fund structures used in the asset pools, such as the ACS vehicle, suitable for illiquid assets.

In conclusion, transition management is going to be an important part of moving £263 billion in assets from around 90 individual LGPS funds to the eight asset pools. If it goes well, no-one in the outside world will know much about it. By using specialist transition managers, the LGPS funds can minimise the chances of things going wrong, control the costs and manage the risks of their forthcoming migration of assets into the new asset pools.