Thursday, June 28, 2012

Beware of Currency Managers?

Chris Tobe of Stable Value Consultants sent me a guest comment, Beware of Currency Managers at Public Pensions Plans:
Public Pensions nationwide need to think long and hard before they hire a currency manager. As an investment consultant and trustee I had never heard of a public pension plan using an active currency manager.

In August 2011 in my role on the investment committee I noticed that the performance of the $12 billion Kentucky Retirement Systems (KRS) for the June 2011 fiscal year looked odd. I noticed that we trailed our overall benchmark 160bps or $250 million, while all the individual money managers all beat their benchmarks for the year. I asked our CIO to explain and told me that over $100 million of this loss was due to a currency manager (Record) I was not aware of (see here).

After this discovery I inquired from our investment consultant their views on currency managers. RV Kuhns did not think Currency Overlay managers were appropriate for Public Pension Plans. The reasoning behind this is that Public Plans buy international stocks because they move differently than domestic stocks and part of this is currency. Our international stock benchmark is not hedged so we do not need to or want to hedge.

Record was never mentioned at any of the investment committee meetings I attended until I discovered their existence in August 2011. Record as a manager was not in Investment reports from August 2009 to Aug 2011. When finally disclosed it was the first time that I had ever seen a negative balance reported for a manager with a negative -$27 million in the pension and a -$10 million in insurance funds (see here).

Not only was RV Kuhns not aware of Record’s existence, but neither was our auditor as the FY 2010 financials state that "KRS has no formal policy to limit currency risk".

The manner in which I discovered our currency manager did not add much to my confidence. It seems that very few public plans have currency managers. One notable exception is Maryland ERS which still employs Record despite a loss of $490 million in FY 2011 and has paid them over $53 million in fees.

Currency Managers need to be closely monitored. With most plans it is the staff and consultants responsibility to inform the investment committee if there are any major issues with any of our money managers. Consultants have systems set up to notify clients of any major issues with manager within days if not hours of the news, but in our case our Currency manager was kept secret from our consultant and the process broke down.In this case in October 2011 the staff should have informed the committee of Record losing a quarter of clients in three months.

Instead staff decided to keep things secret from the committee. If they had informed the committee, I would have pushed to terminate them immediately and most likely could have limited our losses by the tens of millions. Even after a major Reuters article in July 2011 which documented $400 million in outflows after poor returns the staff still kept this secret from their own board.

KRS staff admitted at the November Investment Committee that Record used leverage in their program in violation of our investment policy. Staff also disclosed to us that Record was paid over $7 million in fees by KRS over less than 3 years.

The Investment committee at Kentucky voted to fire Record and limit our losses in November 2011. I also believe that the non-disclosure of Record violated state laws that were cited in municipal bond offerings which may cause concern with the SEC. While KRS staff has chosen to release most manager changes to the investment trade press, they declined with Record.

Record has continued to have problems in January 2012 as two outlets reported continued poor performance and earnings trouble (see here and here). Reuters reported that “assets under management equivalents (AuME) fell 12 percent from the previous quarter due to loss of its second largest dynamic hedging client in November.” I believe this 2nd largest client was Kentucky, but that both Record and KRS were working hard to keep this quiet.

In April of 2012 the headline was Record shutters former flagship fund. In June the headline was “Record Currency Board takes 10% pay Cut”. Things must be pretty bad at the currency manager for this to happen.

Allowing currency managers especially those using leverage can be a disaster like it was to Kentucky and Maryland in FY 2011. I feel that public plans need to avoid expensive risky asset classes like currency management that add no apparent performance enhancement.
I thank Chris Tobe for sending me this comment and while I disagree with his conclusion, I am amazed at the lack of governance and outright attempt to hide huge losses from this currency manager.

You'll recall I already alluded to Kentucky Retirement Systems (KRS) in a previous comment of mine, Kentucky Fried Pensions, stating "something really stinks in Kentucky and it ain't grits. It's the stench of fried pensions."

Here is yet another example of terrible governance at US public pension plans leading to fast times in Pensionland. This is what happens when you have incompetent pension fund managers being supervised by incompetent board of directors who overly rely on their equally incompetent pension consultants for advice.

To be fair, in this case, it seems RV Kuhns, the investment consultant, wasn't informed of Record, but this begs the question, what exactly is the value of an investment consultant to the board if they're not grilling pension fund managers about all investments?

The governance model at most US public pension funds is terribly flawed. In this case, it was a currency manager but it could just as easily have been a Long/Short hedge fund, a fixed income arbitrage fund or whatever. When it's that easy to hide activity that leads to mammoth losses, you have to wonder what the hell is going on at these pathetic state pension funds.

A bunch of monkeys being paid monkey salaries and delivering monkey results. I would love to grill the pension fund managers who made the decision to hire Record. Where is the RFP? Who did the due diligence? Was the investment consultant aware? What were the terms of the contract? Was this a hedging mandate or an absolute return mandate? Were investment policy guidelines violated and if so, what remedial actions were taken?

I asked my former boss, Pierre Malo, now a currency manager at Perseus Capital, a Montreal global macro fund run by Jean Turmel, to weigh in on this topic:
My first reaction is that the title should read: “Beware of the disconnect between Investment committees and managers”.

In my opinion, the points reported have little to do with hiring currency managers or not. We are rather witnessing the end-result of a patent lack of communication/ understanding/experience.

Record is certainly not representative of the currency managers universe, and the lack of oversight is pathetic in my opinion.

That is the central point of this situation as I understand it.

My comments hold for any investment manager: there are good ones, bad ones and rotten ones in any asset class. Ultimately, it is the responsibility of investment committees to ensure they have the tools required to see the difference. Tools include, but are not limited to, hiring competent consultants and receiving the right information from management. Pointing solely to the investment manager and Management is a refusal to accept responsibility for your own mistakes.
Completely agree with Pierre's points above. This case just points to a gross governance gap at Kentucky Retirement Systems (KRS) and everyone is to blame, especially the board of directors.

A lot of the nonsense cited in the case above would never have happened if KRS was properly supervised, properly managed, if investment consultants did their job and if they used a managed account platform to supervise risks external managers take on daily basis (beware, just because you use a managed account, doesn't mean anything if you don't have competent staff overseeing risk limits).

Go back to read a previous comment on currency risk posted on my blog. Currency risk is underestimated by most pension funds but that doesn't mean they should ignore it or avoid currency managers. It's a tough space, I know that, but there are some excellent experienced currency managers out there with solid long-term track records (there are also others who deserve to be seeded).

Finally, Bloomberg reports the euro fell to a three-week low against the yen on speculation European Union leaders meeting for a two-day summit in Brussels will fail to agree on a strategy to solve the region’s debt crisis.

As everyone awaits to see what Germany will do, I remain confident that European leaders will finally emerge with a more solid game plan to tackle this never ending crisis. If so, risk assets and the euro will rally sharply as shorts cover their positions, leading to a solid summer rally.

Below, Nick Bennenbroek, head of currency strategy at Wells Fargo & Co., talks about the outlook for global currencies and Europe's debt crisis. He speaks with Sara Eisen and Stephanie Ruhle on Bloomberg Television's "Lunch Money." Dean Curnutt, chief executive officer of Macro Risk Advisors LLC, also speaks.