A little instability isn't necessarily bad for business.
Record numbers of pension funds, endowments and other investment bodies are expected to change asset managers during the third and fourth quarter, and the industry's largest transition managers — which feed on such upheaval — are predicting a windfall for themselves as a result.
Transition managers are used when institutional investors restructure their investment portfolios. While the investor switches from one investment manager to another, a transition manager oversees the legacy assets and deals with operational issues until the new manager is in place.
In a survey by Greenwich Associates of Stamford, Conn., 75% of public pensions funds said they plan to hire a new manager before the end of the year and 49% said they plan to fire their current manager. (Sometimes investors hire additional managers but keep their current one.)
Transition managers like State Street Corp. and Mellon Transition Management have an opportunity to gather revenue as pension funds change managers, analysts say.
Mark Keleher, the chief executive officer of Mellon Transition Management, a San Francisco unit of Bank of New York Mellon Corp., said many institutional investors were caught by surprise by difficult market conditions in the fourth quarter. After spending the first quarter recovering, companies are "taking a hard look at their portfolios and starting the rebalancing process," he said.
Ross McLellan, the global head of transition management for State Street, said much of the "uncertainty and volatility" in the industry has dissipated over the past three months. At State Street, he said, there has already been "an uptick in the activity that many say that they are expecting the rest of this year."
"Anecdotally, our clients say they have many moves that they have been waiting to make until there is greater certainty in the trading patterns in the market," he said. "A lot of the volatility has subsided, and I think the pension boards and investment staffs have their arms around certain issues and they are ready to make changes to their pension management."
Pension funds are not the only ones considering changing managers, McLellan said. Endowments and foundations are "rethinking their exposure to alternative investments, where some had 70% to 80% of their assets," he said.
Keleher said he expects similar activity in sovereign wealth funds.
"Some managers are going to have a very difficult time retaining business because of their performance and their track record," he said. "I always think that they are better off communicating quickly and often with their clients. This is certainly not a time to leave customers in the dark."
Institutional investors want to reduce risk, which means many will look to invest in passive index managers rather than active managers, Keleher said. The general trend over the last six months has been for institutions to increase their use of indexing and longer-duration bond strategies, he said.
Institutional investors also want to simplify their portfolios, Keleher said. "People want to be able to clearly understand and articulate every investment and every strategy in their portfolio," he said. "I expect that trend will continue for a while."
According to Greenwich Associates, State Street is the largest provider of transition management services, with a 27% share of the market. Mellon Transition Management has the second-largest market share, 12%. Analysts expect the largest providers to continue to add specialists.
Mellon Transition Management has added nine people this year, including seven in London, to give it a staff of 50 at offices in Boston, San Francisco, Montreal, Toronto, London, Hong Kong, Qatar, Sydney, Tokyo and Singapore. It began offering its services in Europe and Asia more than 10 years ago.
Mellon Transition Management said it had 40% more inquiries from potential customers in the first five months of this year than in the first five months of 2008.
Keleher said his unit has 40% annual growth in assets that it transitioned over the past three years and "we are already ahead of where we were last year. I have never seen a pipeline this big."
McLellan said State Street expects to maintain or increase its market share this year.
"A lot of providers have exited this business in the past year," he said. "I think we are well positioned to take advantage of that."
Beyond this year, Keleher said it is hard to predict if pension funds will keep changing asset managers at the current pace.
"There is a lot of activity coming right at us today," he said. "There is going to be a certain natural need to transition that is going to continue annually, but the exact reasons are hard to pinpoint in advance. We can see for certain that the demand for transition management will increase over the next few months."