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Optimizing Outcomes for Portfolio Transitions
As portfolio allocations change and market volatility increases, institutional investors benefit from working with the right transition management partner to optimize outcomes.
Amanda Willams, Regional Practice Lead, Transition Management – North America
There are multiple factors today that impact institutional investors and their portfolio allocation decisions. Some of these may drive an organization to make significant changes to their portfolio. For example, a move to Environment, Social and Governance (ESG) investing or a desire to consolidate pension plans in order to reduce costs and gain scale may prompt institutional investors to overhaul their portfolio allocations.
However, in an uncertain environment, time and expertise are crucial components to making significant changes. Working with a transition management partner is key to a successful outcome.
Perhaps one of the most notable investment trends in recent years is the rise of ESG investing. Driven by a heightened awareness of social issues and the global pandemic, asset owners and managers are reinforcing their commitment to ESG investments.
In Europe, institutional investors have long made ESG a focus of their investing strategies. This has stepped up as governments enact new regulations and countries push to meet targets of the Paris Agreement.
In the U.S., ESG investing has gained considerable traction due in large part to investors putting greater emphasis on sustainable investing. And while regulation is not yet driving ESG investing in the U.S., that could change if regulatory bodies in the U.S. decide to put forth formalized ESG policies. The U.S. Securities and Exchange Commission has named ESG as a focus, signaling regulations could emerge in the coming years.
If an institutional investor decides to overhaul a portfolio to align with newly set ESG goals, the transition could be a large-scale undertaking. In this case, asset owners benefit from the expertise of a transition manager. And since adherence to ESG policies is a priority, investors should seek out an organization with the following:
- Focus on transparency and integrity
- Solid track record of risk aversion and ethical behavior
- Commitment to diversity, equity and inclusion
- Strong corporate governance, internal audit and counterparty review
- For clients domiciled in the U.S., seek a provider serving as a co-fiduciary, compliant with ERISA
The trend toward plan consolidation and fund pooling continues to gain traction as public pension plans and healthcare systems around the globe seek ways to reduce costs, gain scale and increase efficiencies.
In Australia, the $2.4 trillion superannuation sector is merging, driven by pressure from the Australian Prudential Regulation Authority. i There were a record 15 mergers in the year to October 2021, with a number of ‘super funds’ building considerable power.
In the UK, the occupational defined contribution (DC) pension market has consolidated by nearly 40% in a decade, according to The Pensions Regulator (TPR). ii On the defined benefit (DB) side, significant consolidation took place in 2018, when local government pension funds pooled their assets. iii iv Over 80 local authority pension funds within the UK Local Government Pension Scheme (LGPS) in England and Wales, which now have combined assets under management of more than £276 billion v, created eight separate pools, and are expected to consolidate even further, reducing from eight to three by 2030. vi
In the Middle East sovereign wealth space, merger announcements include Oman Investment Fund (OIF) and State General Reserve Fund (SGRF), coming together to create fund with expected assets of approximately $18 billion, vii viii Abu Dhabi Investment Council (ADIC) becoming part of the Mubadala group with a combined portfolio worth over $200 billion, ix and Saudi Arabia’s merger of two of its pension and insurance funds to create a new entity with over $250 billion in assets under management. x
For continental Europe, consolidation has been a key trend for some decades. Over the two decades to 2018, the number of pension schemes in the Netherlands decreased by 75% over the period, for example. xi
The trend is also driving change in North America. 72% of Canadian pension funds have said that they’re considering consolidation options that offer greater certainty that they’ll be able to meet their liabilities. xii And in the US, the state of Illinois enacted the Pension Consolidation Act in 2020, designed to consolidate police and fire pension plans to increase investment returns and decrease fees. xiii
And in the U.S. healthcare sector, a recent increase in merger and acquisition activity has led to additional consolidation. From 2016 to 2018, there was a substantial increase in health system consolidation, with 52 target systems collectively consisting of 178 hospitals and 14,533 physicians merged or acquired by 41 acquirers. xiv
Pension funds and healthcare systems that pool or consolidate assets and change investment strategies as a result will find themselves in need of an organized portfolio transition manager to guide the process. There are many advantages to this approach.
- Transition managers add project management expertise, ensuring coordination between legacy and target investment managers, custodians and trade desks, saving the pension fund time and energy.
- Transition managers can act in coordination with the custodian to execute transitions as assets move, to migrate from legacy to target real time.
- Transition managers can also bridge the gap between the previous investment strategy and the new. Options include utilization of ETFs, optimized index replication or futures to maintain market exposure against a benchmark and ensure the portfolio remains invested in the interim.
While certainly not a trend, market volatility is a factor to consider in any portfolio transition. From political unrest, to economic uncertainty and continuing COVID concerns, market volatility can wreak havoc on investment portfolios.
When the COVID Delta variant first appeared in July 2021, the Dow Jones Industrial average closed down 725 points in one day. The S&P 500 lost 1.6% and the Nasdaq Composite declined 1.1%. xv A similar scenario happened when Omicron variant fears caused the Dow Jones to drop more than 433 points in December 2021. The S&P 500 fell 3.01% and the Nasdaq dropped 3.76% over three days during the month of December. xvi
The prospect of a U.S. Fed rate hike in 2022 has created additional stock market volatility, with mere mention of 50-basis point hikes in January enough to send the stock market into upheaval. xvii Rate hikes aren’t limited to the U.S. In early February, the Bank of England imposed back-to-back interest rate hikes, xviii with more shifts in policy a possibility.
In an uncertain environment, particularly when investors need to act quickly due to increased volatility, having a seasoned transition manager at the ready is crucial to be sure that execution is handled in an expert manner and that risk is managed properly.
The portfolio allocation decisions that institutional investors make are always changing, as recent trends show. Some of these decisions may mean major investment strategy shifts. Transition management is a key service to manage the process and the inherent risk of such a big change. An experienced transition specialist can help navigate risk, complexity and market volatility to make the process run more smoothly and effectively.
To learn more about Northern Trust Transition Management, reach out here.
xiv https://www.healthaffairs.org/doi/10.1377/hlthaff.2020.00017, August, 2020
xv https://www.theguardian.com/business/2021/jul/19/us-stock-markets-investors-delta-variant-coronavirus, July 21, 2021
xvi https://www.cnbc.com/2021/12/19/stock-market-futures-open-to-close-news.html; December 19, 2021
xvii https://www.cnbc.com/2022/02/06/what-fear-of-50-basis-point-fed-rate-hike-says-for-market-volatility.html, February 6, 2022
xviii https://www.cnbc.com/2022/02/03/bank-of-england-hikes-rates-in-first-back-to-back-rise-since-2004.html, February 3, 2022
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