Out of the (Transition) Frying Pan, Into the Fire

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“It takes many good deeds to build a good reputation, and only one bad one to lose it.”

Since Benjamin Franklin uttered these words, there have been innumerable less-wise men wishing they had paid attention—none more so than those in the transition management and asset servicing business who have had financial regulators come down hard on their activities and made them pay for their mistakes.

In December, the US Securities and Exchange Commission (SEC) slapped a $150 million fine on ConvergEx for overcharging clients. (“The mark-ups and mark-downs caused many customers to unknowingly pay more than double what they understood they were paying to have their orders executed,” the SEC said in its ruling.) In February, the UK’s Financial Conduct Authority (FCA) made State Street cough up £23 million for similar offences. (“State Street UK breached a position of trust… caused a significant risk that financial crime would be facilitated.”)

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Both companies admitted there had been “irregularities” and said that these were “legacy” issues, but the affair is not over yet. Tantalizingly, the SEC mentioned an “unaffiliated company” party to ConvergEx’s activity, but has not yet named it. The agency even worked with the Federal Bureau of Investigation on the case—the regulator means business.

On the other side of the Atlantic, the FCA has undertaken a full-scale review of the transition management industry. Few working within the sector avoided an interrogation, and all had been waiting many months for the final analysis, published early February.

It has been a tough and tawdry couple of years for asset servicing. Aside from reputations getting slammed, the landscape has altered dramatically. JP Morgan decided transitions were just not worth the effort—despite the company managing some of the largest asset moves for the biggest clients—while Credit Suisse also threw in the towel on most markets.

Of the 17 companies that signed up to the T-Charter—the industry’s voluntary code of practice—in 2007, just 10 are still standing as independent entities, and only a handful of these are doing any sort of meaningful business. The T-Charter itself has been largely forgotten, and few seem interested in reviving it.

One head of transitions based in the UK said the document had been useful, but only as an educational tool—for suppliers and customers alike—as, without it, the “irregularities” that had been uncovered over the last few years may have remained hidden.

So as 2014 starts, where does the industry find itself? Investors are still moving money, and as unfathomable as it seems to some, the companies implicated in the (well-documented) scandals are still the ones they choose to have do it for them. Regulators have stepped up to reassure investors, and the world continues to turn.

It is not business as usual, however.

New players have thrown their hats into the ring: In September, Australia’s Macquarie bank appointed Credit Suisse veterans Fred Fogg and Lance Vegna to its portfolio solutions group, while insurer Legal & General’s investment arm has been quietly ramping up transitions work using its passively managed portfolios.

The “original” companies that weathered the storm have found it necessary to adapt, according to Lachlan French, global head of transition management at BlackRock.

Investors have become more demanding, not just about transparency of pricing and measuring the end result against estimates, but for what they expect their transition managers to be able to do. “We have expanded our product range,” says French. “We have gone from transitioning just core assets to illiquid securities and dealing with a larger range of alternative investment managers.” He also notes that increasing investor sophistication has required boutique asset managers to rapidly learn the transition management ropes. Geographical diversification of portfolios, increased volatility in markets—and the fear of a counterparty going “pop”—has also led transition managers to expand their trading partner pool, French says.

Investors are more able to keep an eye on what is going on, too. The advent of CIOs having real-time access to data has meant providers have had to keep pace and upgrade their own systems.

And let’s not forget defined contribution (DC). Transition managers’ parent companies—be they investment banks, asset managers, or custodians—have finally embraced the notion that DC pensions are the future. Transition managers, although not immediately a natural fit for the sector, are realizing that they must adapt to this “new normal,” too. Pooled funds, platforms, and unit-holding investors might not be a native hunting ground for transitions teams, but like the rest of their industry, they will have to get used to the idea and run with it.

Therein lies the irony: What a shame it would be for the industry to survive a raft of reputation-damaging scandals only to be killed off by a failure to evolve.

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While South Africa is struggling with its commodity and foreign development-led economy stalling, an unexpected story is emerging: Sub-Saharan Africa is starting to attract institutional money.

As with many new institutional investment ideas, it’s the Danish leading the way. Old Mutual Asset Management, one of the key players in this space, told journalists that the Danes were supportive of African funds because they are more sophisticated in how they treat illiquidity premia.

They are also less reliant on consultants—typically a big stumbling block for African fund managers seeking investment from institutions.

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Danish pension Danica is one of several funds investing in listed equity funds. CIO Peter Lindegaard tells aiCIO it is early days for his fund, and the size of his stake is still small.

Small stakes are not uncommon. Another Danish CIO, who asks to remain anonymous, says his fund had made a limited number of commitments to African managers in the past, and that it is unusual for funds to raise more than $500 million at a time, limiting some of the bigger players’ involvement in the region.

Where the Danes lead, the UK and the US are beginning to follow. aiCIO discovered one of the largest corporate pension funds in the UK has been using an African equity manager “for a few years.”

Again asking to remain anonymous, an investment chief at the fund says he currently has a watching brief on private equity in Africa, but laments the difficulty of negotiating deals to take majority ownership of African companies.

“There are problems around liquidity outside the major markets in Africa, and the Arab Spring has created issues in further reducing the size of the potential universe,” he says. “Because of liquidity issues, public equity managers may be permitted to hold private/pre-IPO issues. On the private side, there are a few managers with track records, but they tend to be in the major markets, such as South Africa and Nigeria.”

Another major UK pension fund, the Pension Protection Fund, is currently investigating African investments for the first time.

CIO Barry Kenneth has met with several managers, and discussions are being held internally about how best to get money into Africa.

“Frontiers are an asset class that I’m not convinced we invest in in the best way at the moment,” he says. “We’ve seen a couple of people about it, but there are no conclusions yet. We need to think about the asset allocation as it evolves over the next 15 years or so. You can’t ignore the frontier area—people need to spend more time understanding these areas.”

As for the US, having traditionally been a region that has remained cold to African investment—scared of the impact of political risk, illiquidity, and corruption potential—now endowments and foundations are beginning to take managers’ calls.

Walé Adeosun, a former CIO for the Rensselaer Polytechnic Institute in Albany, is the founder and CIO of Kuramo Capital in New York. He says endowments are attracted to the “excellent risk-adjusted returns offered by capturing the tremendous sub-Saharan Africa growth opportunity.”

Risk perception is still the biggest stumbling block for investors, Adeosun continues, but with more education on the region, this could subside.