Transition Management Forum Asia 2011: Asset owners warned that fixed income transitions require different skill sets

Fixed-income investments are becoming increasingly popular in Asia, but less transparency in secondary fixed-income market trading compared with traditional equities means institutional investors need to pay particular attention to the ability of service providers to secure appropriate execution when restructuring fixed income portfolios.

Asset owners seeking to transition assets out of one portfolio into another pool of fixed-income assets need to be familiar with the particular idiosyncrasies of fixed-income markets to ensure they receive best execution, according to participants on a panel discussion at Asia Risk's Transition Management Forum Asia 2011 in Hong Kong this week.

John Moore, executive director of investment services for Asia-Pacific at Russell Investments based in Japan, said in the fixed-income area, no one execution source is good for every type of bond – and often corporate bonds react very differently from, for example, sovereign bonds, according to different sets of market dynamics. Asset owners and plan sponsors, therefore, need to ensure their transition managers have access to multiple liquidity sources.

"[Investors] should understand duration and interest rate risks, as well as complex instruments such as cross-currency swaps," said Moore, adding that they should also seek to understand how the transition manager closes out these instruments when transitioning the portfolio from an outgoing to an ingoing manager.

Wingee Sin, head of sales for State Street Global Markets in Hong Kong, said the company's transition management team collaborated with traders to look for attractive bids for clients from multiple dealers. "More importantly, we provide exposure management solutions during the transition as the risk profile of the original and new portfolio change significantly. The use of futures to hedge risk during the transition is important," Sin said.

However, Duncan Klein, head of transition management Asia and Japan for JP Morgan based in Singapore, said while the need for a multiple broker-dealer relationship is important, there are times when an asset owner is better off being serviced by one single dealer due to the very sector-specific nature of bonds - that high yield bonds attract a group of investors whose trading strategy differs greatly from those investing in sovereign or double-A rated bonds.

"Fiduciary or not fiduciary, there are some instances where principal trading [is more favourable to] a client; we see some clients buying or selling the whole yield curve on US tips or UK gilts across the entire maturity, which could [exert] a big market impact. So this is an instance where a dealer should be able to step up to provide principal solutions," Klein said.

In another example citing a high yield bondholder, Klein said due to the specific nature of this sector of the bond market – whereby dealers could often be on the same side of the trade – that if the investor tries to sell at this point, and all he or she would get are multiple bids from multiple market-makers, he would end up being forced to sell at the low-side of the spread.

The specific nature of the bond markets require fixed-income transition managers to use a different approach from just securing multiple market-maker relationships, Klein said. He believes one way to mitigate the impact of tracking error resulting from selling illiquid fixed-income securities is to identify them upfront during the pre-trade process. At this stage, the transition manager should discuss with the client whether or not these securities should be segregated from the portfolio in transition and be warehoused for a longer period of time to ensure a more orderly exit according to the prevailing market conditions. This can happen even after the target portfolio transition has been completed.

Different flavours of transition management services are being offered by broker-dealers, global investment management firms and custodian banks. These are broadly categorised into ‘agency' and ‘principal' models. The main difference is that for the principal model, the service provider does not act as a client's fiduciary and thus there are potential conflicts of interest.

But panellists largely agreed that links with multiple broker-dealers on the part of the transition manager is relevant, irrespective of whether that manager acts as the asset owner's fiduciary or not.