William Cobbett
Cobbett: Yes, much of the activity we’re seeing is active to passive. According to Citi’s recent analysis of net investor flows, in the 18 months from January 2015 to June 2016, actively managed funds lost $683 billion while inflows into passively managed funds was +$800 billion. One reason many institutional and retail investors are moving into passive indexes, especially in the form of ETFs, is because of their liquidity.
Also, credit funds have recently attracted a tremendous amount of assets. As more people are retiring, asset managers and retail investors alike are looking for yield.
All that said, there is still plenty of opportunity in active investing. That’s because active managers may offer the potential to outperform, to strategically and precisely isolate risk factors, and to achieve superior risk-adjusted returns. The prospect of constructing a portfolio that has nearly the same upside as an index but has significantly less drawdown, that’s very attractive.
Speaking of flows, has there been a trend toward high active share funds?
Cobbett: Yes, from my transition management perch we definitely see a lot of flows toward concentrated, high-conviction funds. I think it would be fair to say that “high active share” is a term that barely existed three years ago, and now it’s what everybody talks about. It’s fairly straightforward to construct an index fund, whereas with high active share funds, the concentrated mandates often take longer, and may be susceptible to more market risk.
There’s been a lot of talk recently about asset dispersion. What are you seeing in the transition management space?
Cobbett: Beginning with the global financial crisis, the entirety of financial markets across asset classes could be summed up in two words: “risk on” or “risk off.”
But starting the second half of 2016, and really accelerating after the U.S. Presidential election, dispersion of asset prices returned to the market. This is likely a contributing factor to a noticeable pickup in transition management activity. Price dispersion creates opportunities and highlights risks inherent in plans’ asset allocation.
Dispersion is up not only between asset classes, but also at the sector and security level. This enables outperformance by active managers – in fact, we are seeing active managers beginning to outperform: preliminary data shows that a majority of US equity large cap managers beat their benchmark in 1H2017.
What is your approach to risk mitigation?
Cobbett: To mitigate risk, it has to be identified and understood. With that in mind, we employ multiple models. We don’t consider models right or wrong; rather, we find them either useful or not. For transition events, we look at risk management using at least two lenses. First, we look backward to see how portfolios have tracked each other historically. We look at closing prices going back a year, six months, three months. How well have the buy and sell portfolios tracked each other? Second, we review how those numbers line up with factor models based on forward-looking, predictive tracking. Then we have a discussion with the client about what we think the risks are, and give them ideas about how their risk could be minimized.
What role does technology play in transition management?
Cobbett: The world is governed by best execution, and next-generation technology is necessary to stay on top. Citi is continuously investing in trading technologies. For example, in equities, we recently rolled out Optimus 2.0, a tool to help assess and choose from an array of algorithms. It offers a road map to the optimal path to implement the transition. In fixed income, we have created technologies that allow us to map and optimize our holdings versus index and ETFs equivalents. We are now rolling out this technology to help clients lower their costs of execution.
What’s the biggest mistake that an asset manager may make in choosing a transition management partner?
Cobbett: Well, the most common mistake is one born of human nature. It’s inertia — just using the same partner they did last time. But in terms of the biggest mistake, I’d say it’s choosing a transition manager like choosing a roofer for your house. In other words, obtaining a few bids and going with the lowest one. But cost forecast shouldn’t be the sole determinant. A good transition partner offers meaningful pre-trade analytics (i.e. does not low-ball estimates to win business), has solid risk management capabilities, and access to liquidity. Citi’s global trading platform extends to trading desks in 77 markets, combined with technology to bring our clients innovative execution services. This provides a very attractive solution for asset owners seeking a transition manager they can trust.
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