Transition Management – Case Study 2

External Transition Management

Key elements of the planned transition

  • Restructuring of an existing passive equity portfolio
  • Shift of the regional focus (from EuroStoxx to global equities/excl. Europe)
  • No asset manager switch

Brief: An institutional investor is mainly invested in Europe and plans to reallocate a 200-million-euro segment of his master fund from a passively-managed EuroStoxx manadate to a passive global mandate excluding Europe. A switch of asset managers is not planned. The investor therefore has the choice of either carrying out the transition through the asset manager or involving a transition manager.

The advantage of using the asset manager would be that apart from changing investment guidelines, no further steps would be required. A performance break is often agreed for the restructuring phase. An asset manager usually trades using the benchmark closing prices of the relevant markets. This makes sense for the asset manager as liquidity is particularly high at this point because he/she is trading close to benchmark prices and thereby generating as low a tracking error as is possible.

However, this approach, carried out by an asset manager who is not incentivised during the transition phase, raises questions that can be identified and analysed by an objective transition manager. For example: How does the intraday risk profile look?

Different global trading times zones need to be taken into account:

  • Asia-Pacific: Trading in Japan and Australia closes before European exchanges open, at about 7:00 and 6:00 (German time), respectively. Singapore and Hong Kong coincide with the opening until 10:00 and 9:00, respectively.
  • Europe: Trading on the key European exchanges closes at 17:30.
  • North America: The US and Canada trade until 22:00 German time.

The intraday profile of trades at closing prices (see Chart 1) is as follows: 120% over-investment after trading closes in Asia and Australia as the Asian-Pacific trade has been executed while the European equities have not yet been sold. By 17:30 the European equities have been sold and the fund is 20% invested. Stock bought in the US and Canada is traded at 22:00 and the fund is now invested at the 100% target. The trading was well executed from the point of view of benchmark pricing but it carried substantial intraday risks given the volatility.

Source: Portfolio Management Universal-Investment-Luxembourg S.A., Branch Frankfurt am Main

Transition management has the potential to reduce risks considerably by improving the intraday profile (see Chart 2) and guaranteeing consistent risk optimisation. Australia and Japan are also bought at the close of trading. This results in overinvestment of 110% at the opening of trade in Europe. 20% of European stock is sold after taking sector risks into account, while at the same time, buy orders are executed in the remaining Asian markets of Hong Kong and Singapore. About half an hour after the opening of trade in Europe, the fund is once again 100% invested. Parallel to this, transition managers keep an eye on possible risks to the remaining European equities in order to ensure the smallest possible risk deviation from the target portfolio. American stock is bought at the start of US trading, while the remaining European stock is sold in tandem. The fund is 100% invested throughout.

Result: Optimisation by the transition management ensures that there are only very slight fluctuations in the investment quota. The liquidity and risks involved in the stock traded are taken into account. Comprehensive transition management that has been planned well in advance substantially reduces risks and is vital to ensure a smooth and secure restructuring of both equity and bond-based portfolios.

What kind of portfolio restructuring are you planning? Let’s talk. We look forward to sharing our ideas with you.