Investment transitions: How to ensure a smooth changeover

Overall, it is important to strike a balance between speed and managing costs and risk.

It is important to be wary of changeable market conditions and to have the flexibility to divert from the original plan

Timing is crucial

Speed is important to get the benefits from the new strategy. When a decision has been made to move the portfolio, achieving this sooner rather than later is beneficial. 

However, moving too quickly can have a detrimental impact on the costs incurred and the risks associated with moving the assets.

There may also be liquidity terms to consider. If one of the investments being sold or bought deals less frequently than the rest of the portfolio this will have a large bearing on the timing.

In general terms, an efficient transition will be phased over multiple dealing dates depending on the size of assets being moved and the risks and costs associated with dealing.

The larger and more complex the transition, the more likely a diverse dealing schedule will support in mitigating those risks. To put it into context, a small equity to equity transition may only take one stage, but with a full portfolio transition there could be five or six stages.

Controlling costs

Controlling transaction costs is a key consideration within a transition. The main tools here are crossing trades and in-specie transfers. 

A crossing trade means that you are selling units in a fund at a price matched with a buyer (or vice versa) so both parties gain a transaction cost saving. For certain assets classes, such as property, this can have a material impact. The difference between buying and selling price can be as much as 7 per cent.

In-specie transfers involve the transfer of actual assets, receiving a slice of the holdings (equities/bonds) from the legacy fund. 

This can be beneficial if the target portfolio has a similar – but not identical – holding. Once the holdings are transferred, the specific securities can be repositioned rather than selling the fund to cash then buying new holdings – some of which had previously been held – duplicating costs. 

This phasing also helps with managing costs as there are more trade dates to look for opportunities and each trade will be smaller, potentially avoiding other costs such as anti-dilution levies and swing pricing. These costs are sometimes applied depending on the net amount of selling/buying activity on a fund at a specific trade date.

Ensure a full understanding of settlement dates

The risks associated with a transition are less obvious. Two important risks to consider are ‘out of market’ risk and operational/settlement risks.

Out of market risk is the term for any difference in timing between when the economic benefit of the sold holding stops and when that of the purchased holding starts.

When moving out of an asset class this is less of a risk as you are wanting to remove the exposure, however when changing within an asset class this is critical to avoid the market moving against you. 

There are certain circumstances where some out of market risk is inevitable. For example, if the fund being sold has a close of business dealing point and the fund being purchased has a noon dealing point. Phasing helps mitigate any unavoidable risk as the size of each trade is reduced.

To manage operational and settlement risks, careful planning of each trade, a full understanding of settlement dates, deadlines and instruction requirements for all parties is essential.

Matching up settlement dates can mitigate settlement risk. This can look impossible, as most funds have different settlement periods, but good transition teams are able to negotiate some flexibility in the standard terms, enabling these to be perfectly matched up.

To ensure that the right balance between speed and managing costs and risk is struck, it is important to be wary of changeable market conditions and to have the flexibility to divert from the original plan.

Matthew Simms is director at consultancy P-Solve