switch on to risks of portfolio transition

The financial crisis has been a "brutal awakening" for Asian asset owners, who have belatedly learned the importance of good transition management, according to panel members at a Asia Risk transition management forum in Hong Kong this week.

Institutional investors and pension plan sponsors are now paying far more attention to how their transition managers are mitigating portfolio risks during the transition, and how this affects financial results after the transition is completed, they say.


Before the crisis, "their perception of risks – whether [the transition managers] were using value at risk or other methodologies – were decoupled from their financial results or performance of their portfolio during that period. There was a disintegration of risk modelling and risk outcome in real life," said Justin Balogh, State Street's senior managing director, global markets, based in Tokyo.


But since the crisis, clients have become far more attentive to risk management issues, and are seeking greater use of derivatives to hedge portfolio risk.


For example, in Asia excluding Japan, Balogh said, the bulk of institutions are fixed-income investors, and have focused on how transition managers are handling duration risks involved in shifting out of one asset portfolio into another, and how the manager handles the risks associated with trading fixed-income instruments.


Meanwhile, Kal Bassily, global division head of ConvergEx Group, an agency brokerage under BNY Mellon that provides proprietary electronic trading tools to financial institutions, said the drive towards more transparency will also mean a demand for more detailed cost-benefit analysis of derivatives trades.


"While we do not see many people in the region asking us to share the specifics of our risk models with them, going forward we would see more and more [especially] when it comes to use of derivatives," he said, adding that clients would increasingly "bring their preference to the table".


For example, they would ask for basis risk analysis of a proposed futures overlay, or pre-trade analysis of the effects of different historical volatility measures, he added.


Richard Surrency, Morgan Stanley's transition management executive director in Singapore, said increased concern about counterparty risk had changed the way transition managers worked. While, historically, a transition manager could take physical control of the underlying assets in transition, their team would now prefer to segregate assets instead to keep them off the bank's books.


"As a transition manager we want to execute on [clients'] behalf, but not necessarily end up with rehypothecation processes as owner of the underlying securities," he said.


Financial regulators around the world identified rehypothecation as one of the main drivers of contagion of the financial crisis following the collapse of Lehman Brothers. As clients' collateral was not preserved in segregated customer accounts, these clients became unsecured creditors in Lehman's bankruptcy, endangering them as their assets were trapped in the insolvency.