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April 16, 2007

Risky Business

Transitioning Large Portfolios and the Cost of Leakage

By Michael Scotti and Gregory Bresiger

Pension funds realize firing a money manager or a group of them can be expensive. They know there are plenty of trading costs and operational risks that accompany the implementation of new investment strategies, moving assets between investment managers. But no pension fund likes to get taken for a ride and overpay. Yet that is exactly what some pension funds feel has been happening-and some transition management pros agree. "We believe in our firm that the transition management community has not provided the solutions for plan sponsors," says Hari Achuthan, head of strategy and sales for transition management at Credit Suisse.

Indeed, the Illinois Teachers' Retirement System gave the transition management community failing grades three times in 2006. The $37 billion public fund then joined a growing list of pension funds that have stopped releasing information about the firing and hiring of managers.

The public only learns of a manager hire after the new portfolio is in place or successfully transitioned. So why would public pension plans shift from their long-held belief in transparency to total secrecy? The answer is the bane of any institutional trader, regardless of the size of the order: leakage.

Illinois Teachers' declined to comment for this story, but a spokesperson for the plan confirmed Pensions & Investments' reports of its leakage allegations: Traders in the marketplace were shooting against its sell and buy orders, particularly in the small-cap area. That helped to double the fund's expected costs in three transitions last year worth $1.5 billion. Other plans also declined to comment or did not respond to Traders Magazine's inquiries.

Like Wildfire

But one sellside trader describes what could easily be an axiom for the transition management business: "The more people who know about the trade, the greater the risk is that word will leak out that there is a big trade in the marketplace-and that will have an adverse affect on your transition." Lance Vegna, head of transition management for the Americas for Credit Suisse, seconds that opinion: "Information can spread like wildfire."

Transition managers are hired by pension funds to work on the funds' behalf in the movement of assets between money management firms. They sell the fired managers' portfolios and buy portfolios for the new managers. The goal is to transfer these assets efficiently and to trade the securities in the marketplace as inexpensively as possible. Transition managers are typically brokerage firms, ranging from bulge bracket shops like Goldman Sachs and Merrill Lynch to niche brokers; custodian banks such as State Street and Mellon; and big index players like Barclays and Northern Trust.

Transition management is big business. U.S. corporate and public funds oversee about $4 trillion in assets. Based on a typical range of asset allocation models, from 50 to 60 percent of that amount is invested in equities, or between $2 trillion and $2.4 trillion.

Big Trades

David Rothenberg, managing director of Russell Investment Services, a division of the Russell Investment Group, insists that many pension funds require their transition managers to act as fiduciaries. With a tremendous amount of assets involved in an individual transition-anywhere from $20 million to $500 million-pension funds want to ensure that their interests always come before those of the transition manager. A fiduciary will sometimes act as an investment adviser and invest a client's assets.