AIMCO to review volatility strategy
Linked to $3B loss
The Alberta Investment Management Corp. is conducting a review of a volatility- based investment program that reports have indicated cost the pension manager $ 3 billion amid market upheavals triggered by the coronavirus pandemic.
Jerrica Goodwin, spokesperson for the Treasury Board and Finance Alberta, said Thursday that AIMCO will be doing a review and providing updates to the minister.
The “volatility- based investment program” isn’t a recent strategy and “began well before the current UPC government,” Goodwin said in an interview, noting that the pension manager operates independently and at arm’s- length from government.
“We are facing unprecedented times and these are challenging market conditions for all investors,” she said. “It’s anticipated that all institutional investors will have some tough quarters due to the economic effects of the pandemic.”
She added that AIMCO, which had assets under management of almost $ 119 billion at the end of December, has a long track record of outperforming market benchmarks and is expected to continue to meet the long- term objectives of pension and endowment clients.
Dénes Németh, AIMCO’S director of corporate communications, said he could not comment on the volatility- based investment program or the suggested losses. But he called circumstances in March 2020 “exceptional,” as the “level of volatility that markets experienced … rose faster, and on a more sustained basis than at any other time in history.”
Németh said the pension giant is invested across a diversified portfolio of asset classes and strategies and that, so far in 2020, “some have performed well, while others have not.”
He added that, as a longterm investor, AIMCO can “withstand, and not overreact to, short- term market fluctuations.” This, he said, can mitigate against having to “crystallize” losses or “underperformance” when it occurs.
Jim Keohane, who retired this month as chief executive of the Healthcare of Ontario Pension Plan, said AIMCO’S losses from stock market declines in the first quarter were probably far greater than the suggested $3 billion from the volatility strategy.
“The difference is that that is an unrealized loss and a lot of that would have come back in the recent market rally,” he said. “The loss on this volatility strategy is money gone that is never coming back. It is a permanent loss of capital.”
Keohane said he suspects AIMCO had a short position in volatility taken via swaps.
If this were the case, the pension fund would collect each day volatility stayed below the level at which the transaction was made and pay out when volatility moved higher.
“The calculation is quite complicated, but an important aspect is that it is nonlinear — in other words as volatility goes up the loss per point increases,” Keohane said.
“Prior to the recent market decline volatility was trading around 10 and in the crisis it spiked to almost 90 which is the second- highest reading in history. It is still in the mid 40s so you will still be paying away significant amounts every day unless you close out the strategy.”
Keo han es aid the “opened- ended” risk of such a strategy has been described to him as “picking up dimes in front of a steamroller — most of the time you get your dime but occasionally you get run over by the steamroller.”
The slightly higher levels of volatility reached in 2008 should have been used as a “stress test,” Keohane said, but he added that what transpired was probably well outside risk models that would have been used as a worst-case scenario.
“The event that just occurred is the absolute worst outcome for a strategy like this,” he said. “The issue is that the loss is very high relative to what they could have ever made on the strategy.”
With few, if any, predicting the global economic hit from the pandemic, AIMCO is probably not alone in having investment strategies that aimed to profit from bets on volatility, according to another pension executive who spoke to Financial Post.
“I would say that most of the large Canadian pension plans have similar programs, of varying size and approach,” said Don Raymond, who was chief investment strategist at the Canada Pension Plan Investment Board until 2014 and now has a similar role at the Qatar Investment Authority.
“Selling volatility is like selling home insurance,” he explained. “You take in premiums and every once in a while the house burns down causing a loss.”
He said such strategies are “sensible for a long- term investor as they have a positive expected payoff, though the ride can be rough and they need to be sized appropriately so you are not forced out of the position early.”
Given recent market conditions, Raymond said a more apt analogy for market volatility might be “brushfires that caused many homes to burn down.”