Northern Trust Minds the Corporate Actions Gap

A successful investment strategy is about more than just buying and selling the right stocks at the right price at the right time.

It also depends on picking the best option when it comes to voluntary corporate actions or being able to recognize a bad decision after the fact. Northern Trust is helping its asset owner clients make sure that their fund managers do just that.

Using Scorpeo’s platform Harmonia, the Chicago-based global custodian will be offering pension plans and other asset owner clients the ability to measure the “gap” or opportunity costs fund managers are incurring by making less than the optimal choices for voluntary corporate actions. Mandatory corporate actions, such as income and dividend payments, typically don’t require the fund manager to make any decisions about the type of payment they wish to receive for participating. Reorganizations, such as tender or exchange offers, do. When it comes to scrip dividends, fund managers can pick either cash, stock, or a combination of the two.

Fund managers often select cash as the option for a payment on a voluntary corporate action, when they would have earned far more by selecting securities. Founded by securities finance and trading specialists in 2012, London-based Scorpeo aims to maximize the revenue fund managers can make through voluntary corporate actions. The more options besides cash that fund managers have, the greater the chance they are leaving money on the table if they habitually choose cash. Scorpeo’s internal analysis found that fund managers lost the opportunity to earn over US$1 billion last year on European scrips alone — corporate actions which allow an investor to receive stock instead of cash dividends. In the case of UK scrips, fund managers that choose cash miss the mark about 80 percent of the time.

Using Scorpeo’s Harmonia platform Northern Trust will consolidate data on the securities held by pension plan and other asset owner customers, the past voluntary corporate actions which took place on each security and the elections that were made, explains Chris Barrow, head of business development for Scorpeo. “The platform will then compute the comparative performance  of the decision made against the other decisions which could have been made.”

The analysis, which can incorporate four years of history, can be provided on a schedule such as every six-months or on demand. The research will show the total value missed and the percentage of sub-optimal choices at the individual fund and security level, highlighting trends of misses and gains.

Northern Trust is starting off using Scorpeo’s value analytics service for UK and European scrip dividends, a relatively simple corporate action event. The bank’s future plans are to expand the reach of the service both in terms of where the clients are located and where the events occur. Rolling out later this year will be global reflecting, which locates the underlying asset owners and where the events are taking place. Northern Trust handles 80,000 corporate actions a year.

What Goes Wrong 

“Fund managers might select cash for a multitude of reasons which have nothing to do with intentional bad judgement,” says Robert Angel, head of regulatory services for the product services group for Europe, the Middle East and Africa for Northern Trust in London. “They could have been mandated to do so by the pension plan, the manager may have made a decision to opt for cash due to sheer volume or complexity, or believe that cash would be far easier to handle operationally. Selecting securities would also require them to hold extra assets which they would have to eventually sell down the road.” Fund managers might not think the difference is worth the effort of making a conscious decision or they might not have the additional front office analysts to do the necessary evaluation.

Using the performance data provided by Scorpeo’s platform could help a pension plan’s board of directors or trustees in directing policy. They could change a previous mandate for the fund manager to select only cash into a proactive choice. Alternatively, they could require the fund managers  to review its entire corporate actions elections process or review their strategy for a particular set of stock. “We are not looking for the pension plan to berate a fund manager for bad decisions,” says Barrow. “We know it’s not easy making optimal elections every time without the resources and technology. So we are trying to help the pension plan and the fund manager optimize their return on investment and every little bit helps.”

Just how much performance can be improved depends on how many instruments that offer scrip dividends are in the portfolio, the types of corporate actions, the percentage of times the fund manager makes the optimal decision, as well as currency and market fluctuations. Although the amount of lost value is large, for most funds it usually amounts to basis points rather than percentage points, but these will more than offset the fees which Northern Trust charges for the service. Pension plans or other asset owners will pay an undisclosed fee for each corporate actions report on a per fund basis, irrespective of the size of the fund. So far, the handful of pension plans that are interested in using Scorpeo’s service through Northern Trust want two reports a year reflecting the quarterly distribution of scrip dividends.

Scorpeo is also promoting a separate value capture program to global custodians and fund managers in which it will make up the difference between the economically less than ideal choice and the best one.  Barrow won’t provide any specifics on Scorpeo’s methodology other than to say that if the Harmonia platform’s algorithm calculates that the fund manager’s decision is suboptimal it will “automate a transaction to lock in and capture the value for the fund.” The calculation is based on a designated point in time, but Barrow declined to specify the timing of the value capture. He insists there is no market risk involved.

Scorpeo is also in talks with other global custodians and investment managers to implement the value capture program. While the yet-to-go live service sounds like a win-win for users and Scorpeo, US compliance managers at fund management firms tell FinOps Report they are concerned about whether Scorpeo’s legal designation would pass regulatory muster in the US. According to Barrow, Scorpeo’s services were designed with the advice of US and UK legal counsel to be offered globally using its role as a registered investment company under the UK’s Financial Conduct Authority. The firm, he says, acts as a service provider and its value capture program is based on a technology which supports defined outcomes. It does not provide discretionary management advice.

For Scorpeo, the deal with Northern Trust allows it to more easily sell its services through a third-party channel which will provide it an entree into far more end users within a quicker time-frame than selling directly. Until recently, Scorpeo has focused its sales efforts for the value analysis and analytics services on fund managers. Barrow would not name which firms are using the value capture service or analytics services on an ongoing basis, but says that his firm has worked with with more fifty fund managers at one time or another.