New Mexico State Investment Council Transition Management Review February 28, 2017
New Mexico State Investment Council Summary and Overview of Transition Management Program
Transition Management Basics What is Transition Management? • The movement of assets from a “legacy” portfolio to a “target” portfolio utilizing strategies designed to reduce overall risks and costs. When is Transition Management used? • Shifts in Asset Allocation • Changes in Investment Universe or Investment Style • Changes in Investment Managers • Fund Flows • Change from commingled vehicle to separate account What a Transition Manager Does • A transition manager develops a strategy to move assets from the legacy to the target portfolio that effectively manages the risks and the costs of the transition • Specifically, the transition manager will: Develop the appropriate “best practices” implementation strategy including in-kind transfers, o internal and external crosses, agency and principal trades Provide a detailed pre-trade cost estimate and time line of the transition process and obtain o approval Execute and monitor the transition and settlements on a real-time basis along with the o custodian, client, etc. Intervene in real time to minimize the fund’s exposure to adverse market impact and o opportunity costs should events cause the markets to move negatively against the transition Provide a detailed post trade report including analysis to quantify the success of the o transition 3
The Risks of a Transition Transition risk is primarily composed of three components. The job of the transition manager is to mitigate these risks. 1. Investment Risk: the undesired under/over exposure to various securities, geographies, or asset classes during the transition. • Utilization of various hedges can reduce but not eliminate investment risk. • Optimization strategies such as position netting help reduce risk further. Operational Risk: delays due to trade reconciliation errors, compliance failures, valuation 2. errors, and system failures. • Full understanding of the back-office process in the geography and asset class involved in the transition can help minimize operational risk. 3. Trading Risk: negative impact on cost that occurs by virtue of market participation. • Factors to consider include correlation of assets being traded, position size relative to market liquidity, and asset volatility. 4
The Costs of a Transition Explicit and Implicit Costs • Explicit Costs: Directly measurable costs incurred as a result of security transactions. Represents the most visible, but least significant cost of a trade. Commissions: typically paid on a cents per share basis in the US/Canada and in a % of value o (basis points) in the global marketplace SEC Fees in the US o Taxes/Stamp Duties in global markets including currency taxes o • Implicit Costs: Derived from the price performance achieved. Represents the least visible, but often the most significant costs of a trade. Com m issions Market Opportunity Spread + + + / - I m pact Risk Taxes Explicit Costs I m plicit Costs Transition costs that are directly controlled or influenced by transition m anager Not controlled by transition m anager, although tim ing im pacts opportunity risk 5
NMSIC Transition Management History Recap of NMSIC Transition Management Events (2013-2016) New Mexico SIC Transition Management Usage - CITI Expected Legacy Value Transition Commission Post-Trade Transition Type Assessment Event Performance Traded Manager Revenue Total Costs Range $12,368,008 +/- Within Range - No 9 Events $3,082,984,128 TOTALS CITI $884,039 $7,062,451 $14,215,653 Concerns New Mexico SIC Transition Management Usage - RUSSELL Expected Legacy Value Transition Commission Post-Trade Event Transition Type Performance Assessment Traded Manager Revenue Total Costs Range $6,411,609 +/- Within Range - No TOTALS 3 Events $1,284,509,301 RUSSELL $1,108,075 $6,531,682 $4,372,925 Concerns New Mexico SIC Transition Management Usage - STATE STREET Expected Legacy Value Transition Commission Post-Trade Transition Type Event Performance Assessment Traded Manager Revenue Total Costs Range Outside 1 Standard $6,691,861 +/- 4 Events $1,012,922,783 TOTALS STATE STREET $945,779 $13,369,918 Deviation in $5,961,781 Aggregate 6
2017 Pool Review Transition Manager Search Criteria RVK received survey information from 12 Transition Manager service providers in 2016 and believes that the following selection criteria remain relevant to NMSIC’s needs: RVK notes that providers should have the capability and organizational depth to properly service a large institutional investor like NMSIC. The firm, and/or its principals, have at least 3 years of experience transitioning assets for institutional clients. The firm carries the appropriate coverage for errors and omissions and professional liability insurance. The firm has successfully transitioned at least $5.0 billion of public market assets over the last twelve months. The firm has successfully executed at least one transition over the last twelve months in an amount equal to or greater than $250 million ( restated from an asset-class specific screen ) Ability to operate as a Fiduciary. Superior access to multiple execution venues (e.g. internal and external crossing networks, open market trading, principal trades, ability to offer interim portfolio management services). Organizational commitment to the transition management space. Diverse Business Models Strong pre- and post-transition analytics and reporting. Strong back-office capabilities. Quality process, team, and technology. 7
Transition Manager Industry Review Commission Cap Proposals – US Equity RVK notes that providers put forward commission cap proposals in the range of 0.7-1.25 cents per share dependent on traded volumes. Citi was among the most competitive proposers. Taking into account qualitative benefits of platform, observed strength and performance on NMSIC Pool, designation of CITI as US Equity TM Pool transition manager is recommended. 8
Transition Manager Industry Review Commission Cap Proposals – Non-US Developed Market Equity RVK notes that providers put forward commission cap proposals in the range of 2.5-6 basis points dependent on traded volumes. BlackRock was among the most competitive proposers. Taking into account qualitative benefits of platform and observed strength, designation of BLACKROCK as Non-US Equity TM Pool transition manager is recommended. 9
Transition Manager Industry Review Commission Cap Proposals – Non-US Emerging Market Equity RVK notes that providers put forward commission cap proposals in the range of 3.5-20 basis points dependent on traded volumes. BlackRock was among the most competitive proposers. Taking into account qualitative benefits of platform and observed strength, designation of BLACKROCK as Non-US Equity TM Pool transition manager is recommended. 10
RECOMMENDED NEXT STEPS Current TM Pool: • Citi, State Street and Russell RVK Recommendation: 1. RVK recommends retaining Citi and Russell. – Will require approval of the re-assignment of Russell given ownership changes. RVK recommends replacing State Street with BlackRock as the 3 rd TM Pool Member. 2. 3. SIC staff will select the most appropriate TM from the three-member pool prior to each transition and will provide a written report of the results of each transition to the Council. 4. The three-member TM pool will be comprehensively reviewed at least every five (5) years, or sooner depending on circumstances and potential developments within this industry. New TM Pool: • Citi, Russell and BlackRock 11
Tab 3 3. Investment Matters: Reporting, Investment Performance & Market Updates a. SIC Investment Performance Reporting (Smith & RVK) b. Private Equity: 2016 Q3 Performance Review c. Real Estate: 2016 Q3 Performance Review d. Real Return: 2016 Q3 Performance Review e. NM Private Equity: 2016 Q3 Performance Review f. Private Equity Informational Items i. 2016 Q3 NM Co-Investment Fund Review ii. National PE Required Reporting Items iii. NM PE Required Reporting Items
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