Transition Management – Case Study 3

Interim Management with Internal Transition Management

Key elements of the transition

  • US corporate portfolio (volume 500 million euros)
  • switch of asset manager
  • restructuring of the portfolio

Brief: The investor planned to restructure a US corporate portfolio to form a passive US equity portfolio. At first glance the transition appeared to be a straight-forward switch from bonds to equities with a simultaneous change of asset manager. A closer look, however, revealed complex structures with diverse risk factors that could impact both portfolios.

Key points identified in the pre-trade analysis:

  • US dollars: currency risk
  • Sector risk in individual industries
  • Corporate risks
  • Liquidity
  • Integration of overlay management

Calculations by the transition management team at the time showed that without transition management, a classical restructuring with an uncoordinated, simultaneous sale of bonds by Asset Manager A and building-up of equities by Asset Manager B would lead to a tracking error of 14.06 % p.a. or 3.7 million euros in the transition period. By using a transition manager during the transition, the tracking error was reduced to 2.79% p.a. or 0.8 million euros in the transition period. Trading of equities is more liquid than that of bonds. For this reason, the equity exposure was established right at the start of the transition using an S&P-500 future. Opportunity costs could therefore be greatly reduced. The duration risks of the bonds could furthermore be hedged using US interest rate futures.

What essentially remained was the credit risk of the bonds. The derivative exposure was reduced accordingly during the cash-neutral and optimal liquidity-based trading of the physical securities. The advantage of this approach was that trading could be spread over the day in order to keep market impact costs as low as possible. Risks were managed with derivatives and trading of the securities basket took sector and corporate risks into account. Trading in sectors that were under- or overvalued was given precedence. The risk profile of the target portfolio was thus quickly established.

Further advantages:

  • The use of transition management avoided converion of US-dollar cash into the fund currency euro (cross).
  • The overlay manager was able to make adjustments in consultation with the transition manger. Therefore there was no time lapse between trading and the regular adjustment period.

Result: The estimated trading costs were reduced. Total costs (the implementation shortfall) of the overall restructuring came to about 700,000 euros and thus corresponded almost exactly to the estimates for an optimised implementation with transition management. The use of transition management saved the investor approx. 3 million euros.

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