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Boston-based McLellan has found himself near the center of transition management’s recent turmoil. For the first time, having recently started Harbor Analytics, a transaction costs analysis and transition consulting business, he speaks with the media about the business’ past, present, and future.
“The problems in the transition management industry all stem from one thing: disclosure. Or a lack of it, I should say.
There is no common way to present transition results. The bid process is flawed. The post-trade process is flawed. I’ve lived in this industry for so long, it’s sometimes hard to see it—but I think it’s fair to say that the whole model is flawed.
Look, commissions have been so compressed in this industry. It is difficult to survive charging one or two basis points on international equities, or half a cent a share on US equities, without making money somewhere else. Whether it’s FX, sales trading, or something else, that’s the business—but it should be disclosed. Pension plans should understand what they are getting themselves into. I started in this industry in 1997. It is probably better now than it was then, or even 10 years ago. There was an extremely large transition executed about a decade ago—Paul Ballard and Steve Glass, two industry veterans, wrote a paper on it called ‘Prudent Transition Management, or Sneaking an Elephant Across a Putting Green’—and seeing the potential for huge profits, many firms increased their focus on transition management.
It’s not that things are necessarily worse now than then, but recent events—of which I’ve been a part, of course—have caused clients to take a harder look at the industry.
What am I going to do now? I’ve started a consulting firm. The goal of the firm, on the transition side, is to become a central clearinghouse for all data in the industry. Many providers have resisted any sort of central reporting in transition management, but it seems that now is the time. Transparency, after all, is good for the best providers. It should be no different than going to a consultant and saying, ‘I want a large-cap growth manager that fits into these ten criteria.’ We want to provide the same ability on transitions. I want to calculate what goes into the league tables and not rely on data submitted from the managers themselves.
Graham Dixon and Inalytics are doing something similar, although they are taking a different approach—what we want to do is empower consultants and clients to make better decisions. And we know the industry pretty well. To be quite honest, pension funds don’t know what to believe. My advice to them is this: Pre-trade planning might be the most important part of the process. You need a project manager, someone who understands hedging, who understands derivatives. Then comes the trading. For the trade, the first thing to be asked is, ‘what should this trade cost?’ A trade costs X, but what a transition manager bids on it—that’s important.
The lowest bidder often wins so pre-trade estimates are not always worth that much. Clients should also understand their trading methodology and how orders get into the market. What I try to do is say what it should have cost, and then look at what it did cost. That difference is at the heart of any problems in this industry.
From there, you can peel back the onion and see how the portfolio did during the trading. You can test it in a variety of ways: Look at 20 days before and after the trade to see if there are any anomalies, compare the target and legacy portfolios, and run simulations on what a transition would have cost on different days.
Of course, most transitions miss when measured against a target portfolio because there are costs associated with it. But were those costs reasonable? Were there any aberrations? Did the provider cost that out? All of these tests and questions help answer the most basic of questions in this industry in 2013: ‘Was this normal?’