Beware the ‘small print’ in transitions, says Moore at Russell Investments

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The absence of a self-regulatory body for transition management practitioners means pension fund sponsors should be mindful of the small print in their contracts when engaging a manager’s service, to avoid potential conflicts of interest that are not illegal but could work against their members.

John Moore, executive director for Asia Pacific of Russell Investment Services, based in Tokyo, believes transition managers today still fall out of the cracks of regulatory oversight. They are governed neither by self-regulatory industry bodies such as the National Association of Securities Dealers, which regulates the Nasdaq stock market in the US, or other statutory agencies such as the Financial Services Authority in the UK, which regulates financial industry practitioners.

Thus fund sponsors need to ask questions and drill down to the fine print of the contracts when engaging the service of transition managers to avoid some of the hidden costs managers could incur – whether intentionally out of the manager’s own greed, or unintentionally due to the firm’s lack of resources.

“Foreign exchange is one asset class where such hidden revenues are common, due to the fact that the majority of forex trades are done over the counter,” said Moore in an interview with Asia Risk in Hong Kong. “For example, a transition management provider executes FX trades through an affiliated treasury desk as its counterparty to the trade, which in turn is marking up the spread as part of their revenue without disclosing that to the client.”

Another example is liquidity tape rebates in equities trades, where a manager would put more trades through a particular market-place throughout the year and after a certain trading volume has been reached, the manager could earn rebates that are not passed back to the asset owners. These rebates often go unreported and generally are not classified as a commission.

Aside from a deliberate hiding of rebates and mark-ups, hidden costs are also accounted for by opportunity costs such as spread costs from inferior executions, or the lack of ability to get multiple bids for a trade due to limited choice of counterparties. “That’s when understanding how the contracts are set up makes all the difference,” Moore said. “Some transition management service providers might exclude their offshore affiliates when it comes to their revenue disclosure obligation to their clients, for example, so these are conflicts of interest that asset owners should be asking questions about.”

Moore said more real-money investors are moving towards a ‘pure agency’ model rather than using a ‘principal’ model. The pure agency approach uses a specialised asset management firm that does not have proprietary trading and often operates on a multi-broker model for finding best execution opportunities. The principal model involves an investment bank, which raises some concerns about a potential conflict of interests

However, since no execution venue has the best liquidity everyday in every position in the portfolio, and no single entity or venue would have best execution in every position or best spread costing model, pure agents need to have full market access by taking advantage of all execution venues, and be able to access many sources of spread data, including both current and historical data.

Washington-headquartered Russell Investments started its asset management business specialising in multi-manager funds, but has diversified into offering other financial services such as equity indexes compilation, transition management and investment consultancy. Moore said his firm is disclosing all direct and indirect revenues in the contract, including those from its affiliates, in a bid to help clients get a fuller picture of their cost structure.

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