Best Practices For Fixed Income Restructures: Evaluating Four Portfolio Transition Strategies

It's no secret that in fixed income markets, excess performance above the benchmark is difficult to achieve over the long run. This is why we believe it's critical for institutional investors to have a comprehensive transition management approach in place for whenever an investment manager change is needed. Otherwise, alpha is at risk of being squandered, potentially preventing long-term risk and reaching return goals.

So, as a fiduciary, how do you minimize performance slippage during these transition events—and hold on to your hard-earned excess performance? Let's walk through a common scenario to see what we believe the best strategy for accomplishing this entails.

The scenario

A pension fund would like to terminate an existing U.S. core manager and hire a different manager but understandably does not want to give back years of hard-earned alpha during the transition. The fund's investment committee is also concerned that the portfolio structure and transaction costs associated with manager changes could erode the excess performance over the benchmark they have accumulated in previous years. The investment staff has been tasked with finding the best solution for making this manager change while preserving alpha.

The challenge

Typically, investment officers, consultants, and other delegated fiduciaries of the board are tasked with identifying the best approach to minimize the performance impact of restructuring the portfolio. Some choose to let the outgoing/incoming asset managers manage components of the restructure without accountability for performance during the change. This effectively leaves performance to chance and hopes that the unmanaged portfolio structure will not cost the pension too much. Simply put, this amounts to a coin flip.

Others take a more proactive approach. They want to understand the critical drivers of performance during this significant change period and want to control and manage them. The key drivers are the same as ongoing investment management mandates. Acknowledging these key drivers allows investors to evaluate different implementation options and choose the best implementation method. We believe there are three primary drivers of performance: oversight, asset allocation, and transaction costs.