Transition trading is the movement of assets from one point to the other. It is used to drive the change in asset allocation, trading changes, funding of managers or redemption among others. In observation, no two transitions will be similar in nature. One transition might involve a simple shift between equity managers while another one might involve an extensive asset rebalance. While transition trading differs in their complexity, the goals remain the same i.e. to minimize the cost, minimize the risk and also to ensure an efficient and timely completion of the overall project.
Why Transition Trading?
The costs and risks are exposed due to the changes in the portfolio composition. The costs will increase when the assets are transferred between portfolios. The costs include commissions of the brokers, custody fees and spreads. Due to the restructuring of assets, there are numerous potential risks associated, namely financial and operational. The financial risks will include exposure risk which includes operating in different markets in various time zones that could lead to unintentional exposure and trading risks resulting from executing trades through a single trading platform rather than multiple ones. On the other hand, there are communication risks, where miscommunication can result in the development of investment risk and can cause administrative issues for the traders which are known as the operational risks.
Key Areas of Transition Trading
Minimization of costs which are related to transition trading is the primary job of the trader. It includes explicit and implicit costs. The former includes pooled funds, transaction fees, commission and taxes while the latter costs are comparatively harder to measure. The transition trader will have to develop a comprehensive understanding of the risks and costs associated with the requisite changes. It also involves developing numerous strategies to minimize the risks embedded in alignment with the overall objectives. The strategy will also outline when and how any necessary trades are to be executed. Implementing contemporary trading techniques, preserving client confidentiality and accessing multiple execution platforms to determine liquidity are some of the popular cost-saving methods.
The transition trader requires a robust risk control platform. The potential risks can be categorized under financial and operational risks. Financial risks involve managing the structure of the portfolio in transition, market exposure risks, trading risks and information leakage. Operational risks include communication risk, settlement risk and trading risk.
The transition trading will be effective only after proper planning, leading to the minimization of cost. This will ensure that the project is managed in a timely manner. The transition trader will remove the workload, provide sound governance and improved accountability, avoid performance holidays and provide detailed reporting.
Various securities holders are acquainted with the complexities of making changes to their asset portfolios. It includes changing the investment managers or rebalancing activities inferring from a financial study. However, before employing the transition trading strategy, one should try to comprehend the nuances of it.