Moving assets: It pays to hire professional
In a rush to de-risk, many pension schemes are potentially missing out on substantial cost savings.
It pays to hire professionals
Anyone who has ever moved to a new house will tell you it’s one of the most complicated things they’ve ever done. Most end up hiring professionals to broker the property transactions and move the items they want to keep. Few would ever consider selling all of their household possessions as a job lot on Ebay and then replacing everything with new goods. It might make things easier, but they would be squandering tens of thousands of pounds for the sake of convenience and a fresh start. So, is there a risk that many institutional investors might make this mistake when moving between investment managers?
De-risking on the rise
Manager consolidation and pension de-risking have led to a massive wave of manager transitions in recent years. Equity markets have done quite well since the Global Financial Crisis and funding ratios are healthy. It’s no surprise then, that many pension schemes are moving assets into or within fixed income to lock down their liabilities. In fact, according to recent research pension schemes look set to shift hundreds of billions over the next five years1. That’s a lot of money in motion, and if these transitions are not managed wisely, it could end up costing these schemes billions of pounds in potential investment income.
Since the early 1990s, transition managers i.e. firms that specialise is transitioning scheme assets between asset managers, have set out to save institutional investors tens of billions of pounds in portfolio value. Now, transition management is routinely used for the equity portion of many pension scheme portfolios. Yet, the use of transition managers when shifting assets to and within fixed income is still rare.
The shift to long duration
Defined benefit schemes that are de-risking generally implement some style of de-risking glidepath. In most cases this means implementing the conversion of scheme assets to long duration fixed strategies over an extended period of time. Unfortunately, some investors and asset managers have not historically been diligent in the transition of assets to these strategies. This has often taken the form of lost market exposure, i.e. the investor leaves assets uninvested until the new manager can invest the cash into a complete fixed income portfolio. However, this can take a considerable amount of time.
Lost investment income
This uninvested cash means lost investment income – especially when compared to yield-rich long duration credit. And scheme performance can suffer as a result. The yield ‘give-up’ that investors might incur during the transition process would only increase if the yield curve steepens. And we believe it might do just that in the near future. This income loss is even greater for riskier assets like high yield and emerging market debt.
One basis point per day…
Here’s a quick rule of thumb: Every time you give uninvested cash to a fixed income manager, you should assume your scheme loses about one basis point of investment income for every day that the cash remains uninvested. Going back to the moving analogy, this is akin to selling all of your possessions on Ebay in a bid to raise immediate cash, when renting a storage unit and thoughtfully selling them over time would yield fair value.
Assume your scheme loses about one basis point of investment income for every day that the cash remains uninvested.
Most long duration fixed income managers take weeks to complete their portfolio, and the income loss can grow to 15 basis points — or even higher — during the transition period. Multiply this income loss by the hundreds of billions expected to move to and within fixed income in the coming years and this lost income could easily be measured in billions of pounds.
Proper implementation mitigates loss
These losses can be mitigated with proper implementation. Giving the current portfolio or cash to the incoming investment manager doesn’t always align the interests of the manager with the goals of the scheme. New managers are generally not held accountable for portfolio performance during the portfolio transition period. This is commonly referred to as a performance holiday and can often lead to situations where operational convenience dominates the decision-making process, rather than investment outcome.
Avoid performance slippage: Hire a professional
Whether you’re changing investment managers or moving to a new house, it pays to hire professionals to help manage the transition. We believe the best way to avoid this performance slippage is to employ a specialist to manage the transition of assets from current investment mandates to new ones. Transition managers function as partners for investors, creating and executing an implementation strategy to liquidate assets thoughtfully with an eye toward minimising the performance impact of the transition and saving valuable investment income.
A sea change in defined-benefit scheme management is currently underway. Corporate treasury departments are focusing more on managing their defined benefit scheme costs and risks. And the de-risking process should be a priority. The industry will be watching to see if a new era of pension investors — focused on costs and performance outcomes — give birth to a higher standard for implementation.
1Mercer (2018) “European Asset Allocation Survey Report”.
Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.