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Building COMMENTARY 70
A PIJTTING GREENi A IRANSITION CASE STUDY
This commentarv describes the before, during and post-mortem process of what is perhaps the largest portfolio transition ever executed in a concentrated time frame. The presentation was given at the 8th Plexus Group Client Conference, featurinq Plexus' Steven Glass moderating, Paul Ballard, Executive Administrator of the Texas permanent School FJnd, and Alan Rubenfeld, Director of Deutsche Bank Alex. Brown, which handled the bulk of the transition trading.
ln October 2000, the Texas Permanent School Fund ("PSF") executed a $17.5 billion portfolio transition - perhaps the largest potl-
folio transition ever executed in
concentrated time frame.
Oper"ationally, ihe PSF's transition involved 40 asset managers,
2,200 securities, 20+ countries, and 500 million shares. PSF awarded a first tranche of $2.5 billion to Morgan Stanley
Dean Witter who executed the trades on an agency basis. Post-
mortem analysis was favorable. In early January 2001, the PSF solicited competitive bids from three transition management firms to execute the larger, far more difficult remainder. Ultimately, the PSF selected a hybrid proposal from Deutsche Bank under which 90% of the portfolio was traded on a pnncipal basis and the remaining 10% (US small/mid cap stocks)traded agency. The total loss of asset value incurred on the PSF transition was 66 bp. While this compares very favorably against Plexus' Posttrade PAEG/L Benchmark of 97 bp, Steve cautioned that trading is still more art than science. A better measure of the transition's success was reflected in the process and structure of the PSF's
several concerns. Various managers would be ready for funding before others. However, rather than funding each manager as they completed their paperuuork, Paul felt that any advantages of funding the managers ptecemealwould be more than offset by  tne cjisruption io ongorn$ iirvestmeni siraiegies, [fi ieakage oi information regarding the large sell portfolio which was funding the new managers,  increased market-impact as multiple managers bought common securities and sectors, and  diminished opportunities for crossing. Consequently, Paul decided to wait until all new managers were ready, even if it meant delaying the imolementation of the PSF's new asset allocation. Paul was also aware that the sheer size and complexity of the transition would exacerbate the normal strain on staff and transition manager resources. He therefore was attracted to the idea of a principal trade, which would complete everything at once. He also recognized the need to work with transition managers that had the technology and human resources necessary to handle large complicated transitions - and proven track records. As with many public plans, the PSF was not without internal politics. The fact that the transition would be implemented in a "fish bowl" environment only heightened the need for prudent strategies and policies. As a neutral third-party expert, Plexus enjoyed the confidence of both trustees and staff, and its retention was a key ingredient in providing the necessary comfort to all parties.
Transitions typically present plan sponsors with multiple implementation alternatives, each with strengths and weaknesses. As such, the development of a prudent transition strategy is one of choices and trade-offs. For the PSF transition, the person who made those choices was Paul Ballard, Executive Administrator of the PSF. On the Sell-side, Alan Rubenfeld coordinated the thinking, which drove Deutsche Bank's bidding and execution.
The PSF was concerned that the size of their transition might
tempt the bidding firms to act in ways that would not be in the best interest+ of the PSF. While ihis is a risk to buy-side firms as well,
Paul Ballard began by discussing his strategic policy level concerns. These issues represented considerations, the resolutton of which would overlay the PSF's tactical (execution-oriented) policies. They included  the need to minimize loss of asset value,  the involvement of multiple legacy and target managers,  the operational and administrative burden on the PSF's staff,  the internal politics often present in a public plan, and  the recognition that PSF ran a risk of being viewed as a "one night stand" with no on-going relationship to the broker. Paul stressed that while the PSF could certainly have used the $10-15 million or so in soft-dollar credits associated with trading 500 million shares, he was not prepared to jeopardize execution efficiency. Since the PSF was not permitted to use futures or ETF's to maintain market exposure, he felt the need to consider principal bids and/or firms capable of executing complicated dollar-neutral strategies. The fact that the transition involved multiple managers presented
those firms can always take their business elsewhere. For the PSF, there would not be another time. To address this concern, Paul considered only those firms with long and substantial track records as transition managers - those who had "franchise risk" if things fell apar1. He also felt the need to retain Plexus, not only for its experlise, but to piggyback on its ongoing relationships with brokers as a Transition Consultant. While the Transition Managers might not see a lot of subsequent transition business from PSF, Plexus routinely called upon them for transitions with other plan sponsors. In this fashion, Paul Ballard was able to 'rent' Plexus' continuing business.
From a tactical execution perspective, the PSF faced several additional challenges. These included  the optimal parsing of the transition portfolio so as to minimize costs,  identifying the Transition Management firms best suited to PSF's transition,  structuring the bidding process so as to encourage aggresslve bids thus minimizing leakage of information, and  evaluating
With respect to parsing the portfolio, a key factor was that most of the selling would come from one very large account. Consequently, Paul felt it was unrealistic to utilize more than one Transition Manager, since there would be no way to avoid unnecessary leakage of content without also disrupting the timing and holdings of the liquidating portfolio. However, the portfolio lent itself to splitting into pieces that could be executed with different trading techniques. So the PSF was open to hybrid proposals from bidders In identifying the most appropriate Transition Managers, Paul Ballard's interest in principal bids limited the field to a handful of firms. Of these, Paul utilized Plexus' broker database to assess each firm's order flow country by country. Into the stew went the PSF's and Plexus' past experiences with different brokers. In this manner, if the principal bids were unattractive, the PSF was ready to immediately award the transition to the firm best qualified to do the job on an agency basis.
well as their down-side risk if markets moved against them.
Given the size of the transition, even an unlikely outcome represented many millions of dollars in additional costs, so Paul was hopeful that a principal bid would "lay off'the more expensive worst-case scenarios onto the transition agent.
Once the trade was awarded, the PSF released the security names by region after the close of each respective market. Foreknowledge by the winning bidder (that they had won, not the actual names), allowed the building of futures positions
throughout the day, thereby lessening market-impact on closing
Following Paul Ballard's remarks, Alan Rubenfeld shared the
thinking of Deutsche Bank Alex Brown in submitting the winning
bid. The factors and considerations which drove Deutsche
The PSF was acutely aware that the likelihood of receiving
aggressive bids depended on the comfort level of the bidders that their interests would be protected. The degree to which firms felt other bidders could "shoot" against them if they won, would be reflected in their bids. Paul Ballard therefore wanted to provide a structure that would help protect the firm that was awarded the trade. This was accomplished by establishing a 10-day window during which the trade would be awarded. While bidders could refresh their bids as often as they wished throughout the '10-day period, only the winner would be notified that they won. Losing bidders would not be notified until after the window exoired. The PSF was under no illusions as to the absolute effectiveness of this strategy, but felt it introduced enough uncertainty to protect the winning broker.
2) As a general rule, Plan Sponsor transitions are "information-less" trades; 3) The unique features of PSF's transition structure, the information "lock-down," 1O-day bidding window, and willing-
Bank's pricing fell into four major areas: As an institution, Deutsche Bank has an "appetite" for principal bids (clue to a combination of their ability to menage risk and the trading backgrounds of their senior management);
ness to share risk through use of hybrid trading arrangements);and Pre-existing comfort and trust with Plexus as a transition
After discussing bidding considerations, Alan noted that the transition was a huge operational success as well. In this regard, Deutsche Bank worked with the PSF in advance to develop communication formats, Deutsche Bank dedicated personnel for each stage of the transition, and established
intensive communication with both the PSF and their custodial bank. Back-office personnel worked through the night to process the heavy volume of trades.
A related concern was the minimization of information leakage.
From both past experiences as well as pretransition meetings with the bidders, the PSF developed a healthy paranoia regarding the need for maximum secrecy. This manifested itself in several unorthodox policies.
Notwithstanding the lack of advance notice by the custodial
bank, the transition settled with virtually no difficulties. To summarize the entire experience, in many respects the PSF transition broke new ground. Key ingredients to success were mutual trust, creative design, and communication.
First and foremost, Plexus was identified as the sole point of contact regarding the transition. All communications to, or from, lhe FSF weni thi-ough Piexus. Seconci, the PSF's securities lender was not notified until after the transition. Third, the PSF's custodial bank was instructed to ooen a transition account and provide guaranteed lists five days before the window began. Each day thereafter, the bank was required to fonruard an updated guaranteed list each morning. In this manner, the bank knew a transition was in the offing, but not when. Perhaps most controversial of all, the bank was not informed until after the transition was awarded. While the bank was understandably perturbed at the late notice and conseouent need to scramble in order to process the trades, Paul felt the additional secrecy justified such action. To the bank's credit, virtually every trade
cleared and settled pedectly.
In anticipation of receiving agency, principal and hybrid propos-
While the costs incurred on the transition beat their Benchmark
by significant margins, the true measure of success was the pru-
dent process and structure established by the PSF. Anecdotal
evidence of the strategy's effectiveness include the fact that the
day following the transition, two major program trading firms
repoded that the prior day had been "boring, with little noticeable activity." Further, one week after completion of the transition, two other major program trading firms were still marketing their services in hopes of participating. Perhaps the bottom-line measure of success was: Paul Ballard kept his job.
Reprint any potlion with credit given to:
als, the PSF ran Plexus'cost estimates on the aggregate portfolio as well as numerous sub-portfolios. In this manner, PSF could make applesto-apples comparisons between various
bids. Further, each analysis provided a range of potential costs,
driven by potential market conditions. This enabled the PSF to understand and identifv their risk in relativelv flat markets, as
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W. Olympb Blvd., #900 Los Angetes, CASA1A 2. 5505 F AX : 31 0. 3 1 2. 5506 vvvrw. plexu sg rou p.ffim @ 2002 Plexus Group, lnc.
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