Traditional Service Providers : Going Contemporary
As a result of the above factors some funds which have built out internal capabilities are moving to models that allow some form of control over the underlying trading of external managers. Emulation funds, either as trackers or harvesters of optimised portfolios out of underlying manager sets, is one asset owner solution. Some part of the relationship between investment manager and client becomes Intellectual Propertybased rather than manufacturing based. Similarly another market based solution is for the creation of a centralised dealing desk within an asset owner where most fund orders are passed through on a daily basis. Emulation fund structures and centralised dealing desks also need to manage the payment of research based commissions to brokers who have provided input into the decision making process at their managers. Asset owners who adopt these types of processes need to be aware that potential implementation slippage can occur if the structure creates a timing delay between when the manager could have implemented and when the new structure does implement.
The growth of asset managers with internal trading desks and portfolio management capabilities is also creating great change in the transition management process. Much debate has existed about the merits of the competing buy side versus sell side provider models at a time when many of the largest clients are quietly moving on past this issue. We are seeing an evolution somewhat akin to the growth of portfolio trading and DMA usage at investment managers. Asset owner desks are working with technologies provided by traditional transition managers and others with risk management system providers to directly access the most efficient execution venues in order to implement underlying portfolio changes. For the transition manager the traditional transition client will continue to exist, in some markets purely for regulatory reasons. It is, however, likely that by value the largest asset owners will continue to move to a more internalised model.
As discussed above, one impact of the GFC has been a drive for some funds to hold assets closer to themselves, in order to manage more effectively the operational risk of some aspects of investing in financial markets. Prior to the GFC, but far from forgotten, was the performance of a number of quant related funds during 2007. Large asset owners have reacted to this by either investing in risk management models or utilising risk advisory services provided by parties such as custodians and transition managers. Having acquired the information and married with the internal trading capability, some funds are seeking to manage identified risks through the use of derivatives such as swaps that target reducing risks that are above a fund’s comfort level. The increased complexity and breadth of the ETF market globally is also allowing funds another efficient mechanism to manage risks within their portfolios. For many funds, this activity is just an extension of previously internalised processes such as asset rebalancing using very similar instruments.
A final and potentially most important implication of this trend for service providers, in particular brokers, is that a client class is re-emerging. Many years ago most pension savings were held in entities or invested in entities that operated as balanced fund managers. Services and research were provided to these clients that allowed them to make decisions across asset classes. Over a number of years industry best practice turned to one where asset owners chose to outsource their asset management to asset class specialists and managed asset allocation themselves or on the advice of another party. In this world the main financial relationship between funds and brokers was through specialised asset class managers and internal transition teams on an episodic basis. In order to service the asset managers, brokers themselves adopted similar specialisation. The internalisation process we are seeing now is in some ways a re-birth of parts of the old balanced managers. As these balanced managers will, by their nature, be making cross asset class decisions and, when implementing them, broker service providers will need to ensure their internal structures are in place to provide research input and execution services across asset classes.