Many sovereign wealth funds and other official institutional investors in Asia are mandated to, among other things, stabilise local capital markets and currencies. During the financial crisis (especially in the wake of the collapse of Lehman Brothers), this meant selling a lot of global positions in order to buy local ones.
But now, having absorbed a tremendous amount of volatility by buttressing home markets, many such funds are keen to meet their other commitments -- that is, lock in a positive return by diversifying their exposures. They are, however, hampered by the fact that they can't simply sell their domestic currency or other assets, for fear of causing market instability, which they are mandated to prevent.
Transition managers such as Credit Suisse are stepping into the breach by structuring ways to help big institutions reduce built up exposures to the home market, without disrupting asset prices.
Charlie Shaffer, managing director, and global co-head of Credit Suisse Transition Management based in New York, says his firm completed a record number of transitions in 2008. A significant number of those transitions involved helping investors get out of distressed situations and go to cash -- as opposed to the traditional TM business of moving a portfolio from Manager A to Manager B.
This year it's more about helping investors implement new asset-allocation strategies, including structuring deals to ensure that government-affiliated institutions don't upset the local markets they were required to support during the financial crisis.
While such investors can't simply unwind domestic positions, they can package these exposures and divest them. The simplest way for some investors is to do so via derivatives, however for state-owned investors this solution is not desirable, because these types of trades ultimately require the sale of the underlying assets. In addition, derivatives also pose regulatory challenges for some institutions.
While Shaffer declined to comment on any specific client or CSTM transactions, in general, clients/transactions of this nature would generally be structured to bring together strategic investors, usually global long-only fund managers, to buy the underlying assets in size. This provides long-term investors with the ability to implement strategic investment initiatives at cheap prices (Shaffer prefers to say at a "fair" price), although such deals may come with a pre-determined distribution schedule, to ensure the buyers don't sell these assets too quickly or all at once.
Shaffer likens the activity of some of these agencies to the swan in the lake: above the surface, all is serene, but out of view, the swan's legs are churning a huge amount of activity.
He explains that, generally speaking, a transition manager in these situations would act as an agent, not as principal. Were it to use its balance sheet, it would inevitably have to sell the underlying asset -- a no-no, in this case.
In large part, Credit Suisse has moved away from acting as a principal in managing transitions and has leveraged its algorithmic trading tools to provide agency trading solutions to its global client base. In the past, TM was bifurcated among custodians who acted as agents and broker/dealers who often used their balance sheets. But now the division is more about technology and skill in trading and execution, Shaffer argues.
Principal TM has lost its allure now that many US pension plans require their transition managers to serve as fiduciaries. This has pushed out some bulge-bracket players, a trend accelerated by the financial crisis. Shaffer reckons there are now only seven committed TM players with global businesses, down from 15 just two years ago. (This observation has been made to AsianInvestor by other TMs, although by more than seven.)
Now competition is about technology, Shaffer argues. He joined CS earlier this year, after a 16-year career in transition management at players including Morgan Stanley, Deutsche Bank and Merrill Lynch. He liked CS because it was already a leader in algorithms and electronic trading, which the firm is using as its platform to build its TM business.
Ten years ago, technology in TM meant being able to reconcile lists of securities among portfolios. Today performance as a transition manager is largely driven by the tools used to execute a transition strategy. Ten years ago, a TM was often an over-paid project manager who hired a broker/dealer to go execute deals on an exchange. Today, however, execution is far more complex. In the US, for example, there are over 30 execution venues, including 'lit' electronic trading networks and dark pools -- not just the traditional stock exchanges.
"The old model was about buy-side versus sell-side," Shaffer says of the TM industry. "Today the divide is whether you own your own and author your execution technology, or whether you borrow and re-sell someone else's. If you outsource the critical component of execution, then you by definition are asking someone else -- an arm's length third party with no fiduciary duty to the transition client -- to make the strategic intra-day decisions regarding trade sequencing, venue selection and aggression that ultimately drive the success or failure of a transition."
This matters now because of the explosion in trading technology and alternative venues, in which the game is all about finding liquidity and best execution. As a result of the explosion in electronic and algorithmic trading, liquidity no longer begets just liquidity -- as the old saying goes -- but it generates information. The more information you accumulate regarding the trade slippage and execution performance across the numerous market venues, the better you can design a TM strategy. But to get such data requires owning the execution technology, which allows you to dynamically adjust a TM strategy as market conditions change.
Shaffer says this applies even to Asian markets where a single exchange tends to have quasi-monopolistic power. Credit Suisse has designed algorithms to allow traders to minimise signalling risks in such environments. "You're always competing against highly efficient (very aggressive) traders who are out looking for patterns they can jump in front of," Shaffer says.
So if sovereign wealth funds are looking to transition managers to offload domestic exposures without rocking their markets, what do they plan to do with the cash?
This depends on each institution's capabilities and rulebook. But Shaffer says that Asian investors are now expanding their definition of acceptable asset classes. Until recently, many of the investors would have limited themselves to short-term fixed income instruments. However, with the dislocations unleashed by the crisis of 2008 and early 2009, some of the institutions are branching out into credit and equity.