AIMCo, Again & Again
July 14, 2020
Brett Friedman
Managing Partner
AIMCo is back in the news with both a board report on their volatility trading strategy (VOLTS) and public testimony by their CEO, CIO, and others.
First, the Board Report:
The long-awaited board report that promised an in-depth and comprehensive review of the volatility trading strategy (VOLTS), what happened and why, as well as recommendations, was issued on issued on June 30. It was commissioned by the Board last April after the losses came to light. The report was unsigned and its exact authorship unknown. It was prepared by KPMG, outside experts, and AIMCo staff.
The contents of the report have been reported in the popular financial press. In short, the VOLTS strategy has been going on since 2013, was ramped up in 2018, and caused a $2.1 billion realized loss. Management agrees that oversight was lacking and has instituted steps to better integrate risk and investment management. New investment approval thresholds have been put in place along with more stringent requirements for strategy risk review. The Board continues to review proper compensation levels and structures for investment and risk personnel.
Second, the testimony:
On July 13, AIMCo senior executives, including Kevin Uebelein (CEO) and Dale MacMaster (CIO), testified before the Standing Committee on the Alberta Heritage Savings Trust Fund. For approximately two hours, they answered questions regarding AIMCo’s performance, the annual report, the VOLTS strategy, and forthcoming investment and procedural changes.
They didn’t say much that was new or shocking and generally stuck to the script outlined in the VOLTS report. This was not the forum to get into details or arguments and the committee members (with certain exceptions) were generally accepting of their narrative. However, certain things were said that definitely merit closer scrutiny.
Needless to say, I have comments and questions on the report and the testimony:
First, the report is all of seven pages long. Kevin Uebelein stated in his testimony that the VOLTS report is the full report from the Board, not a summary, and that it was exactly what the Board promised. There will be no further reports on the subject. He went on to say that there were many contributors to the report, but it would be not be typical, indeed an exceptional situation, for their work product to be shared with the general public. I would be surprised if AIMCo’s clients did not consider this an “exceptional situation.”
So, after almost three months, the collaboration of KPMG, Barbara Zvan, AIMCO’s internal audit group, Chief Legal Officer, as well as other senior management, and all they have to show for all their efforts and expense is a “comprehensive review” seven pages long? So much for full transparency!
Given its length, the Board report is vague and glosses over some very important details. Bluntly, the changes adopted are completely obvious and should have always been present. For example, incorporating risk into the investment process should be expected of any fund, much less one with $116 billion in assets and 32 large clients.
Unanswered questions and comments:
What are the other 52 "value-added or alpha strategies" and what happened to them? The report indicates that “there were no other strategies with potential for outsized losses akin to VOLTs.” No further evidence is given. Given their recent history, and their renewed commitment to transparency, this should be fully addressed.
Why was the VOLTS strategy ramped up in terms of risk and complexity in January 2018?
Why was risk sounding the alarm in 2020, 7 years after the strategy began and 2 years after its ramp-up?
There is no discussion as to whether these strategies are suitable for a pension fund, however well managed and whatever the size
What was the role of outside consultants or derivatives salesmen in adopting the strategy?
Ominously, other funds that have implemented the changes outlined have suffered unexpected losses. Fully incorporating risk into the investment process will be ineffective if metrics and stress tests ignore other asset classes and focus only on the last highly volatile period.
In his testimony, Uebelein and MacMaster stuck with the “unprecedented” script and expressed that the vol losses were certainly a “learning experience” (and at $2.1 billion, they could have sent every AIMCo staff member to the Ivy League!). As I’ve written previously, the March volatility moves were only unprecedented if you were fixated on the last crisis (2008) but ignored October 1987 and price action from other asset classes, e.g. commodities. In those markets, sudden volatility moves over 100% are relatively common and should have been reviewed and taken into account.
Uebelein also stated that any return above a passive benchmark net of expenses (as he put it, their “value add”), is good, and that producing “even 1 basis point (.01%)” is good. Apart from the fact that every hedge fund investor would disagree, note that these are absolute net returns, not risk adjusted returns, and do not include risk as a factor in performance. As the VOLTS strategy demonstrated, relying on absolute performance measures is deceptive and usually leads to unexpected losses. Although their clients communicate certain risk tolerances, it is unclear how that then translates into the positions and strategies undertaken on their behalf. Clients should focus on that linkage and demand a full and complete explanation.
He went on to say that press reports in March were not helpful and cost the fund undetermined losses. This is debatable and again contrary to their commitment to transparency.
I did agree fully with one thing that Uebelein stressed in his testimony: AIMCo can’t stop taking risk. They have return objectives that must be met, and a certain amount of risk is therefore required. But how much? The question really is how much risk contained in the specific positions, products, and strategies must be undertaken to yield the benchmark return? In other words, how can risk adjusted returns be maximized given certain constraints? Providing the answer to that question, and not just defining downside risk and policing limits, should be the true function of risk management at any fund. Until AIMCo and its clients can quantify that on a continuous basis, risk and return will be out of line and surprises similar to VOLTs could occur again.