Risk Model From 2008 Crash Loses AIMCo $1.5 Billion During Covid

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Alberta’s pension fund manager was blindsided by the same risk-assessment model that failed investors in the 2008 financial crash, according to a review of losses during the Covid-19 market turmoil.

Volatility wagers that lost Alberta Investment Management Corp. about C$2.1 billion ($1.5 billion) were being assessed by a legacy value-at-risk model that breaks down when risks are non-linear and outside of its 95% confidence interval, the pension manager said in the review released Thursday.

“Unprecedented and sustained volatility caused by the Covid-19 crisis made it impossible to unwind the positions without considerable loss,” AIMCo said in the review.

AIMCo -- which manages about C$120 billion for 31 pension, endowment and government funds in the Canadian province -- has been under fire since April, when reports arose that it suffered outsized losses on a trading strategy meant to profit from low volatility in equity markets. The losses have led to calls to strip AIMCo from running some of the province’s funds, and at least one of its clients has said it’s reviewing its relationship with the firm.

Risk Model From 2008 Crash Loses AIMCo $1.5 Billion During Covid

Chief Executive Officer Kevin Uebelein said in a letter in April that the performance was “wholly unsatisfactory” and that the firm would review the strategy.

AIMCo said in the review that it had been investing in volatility contracts since 2013, and in 2018 it expanded the size of the strategy and broadened it to include instruments known as capped and uncapped variance swaps. Those changes increased the strategy’s risks, and “greatly magnified” its potential losses during times of extreme volatility, the Edmonton-based pension manager said.

Value-at-risk calculations like the ones AIMCo used were partly blamed for underestimating the risks of the subprime mortgage derivatives that fueled the 2008 financial crisis, leading banks to incur far larger losses than they had expected were possible. AIMCo said it realized the shortcoming in its assessment of the volatility strategy in January and began to try to unwind the strategy it March, but by then it was too late.

AIMCo is making 10 changes to improve its risk management, including greater involvement from the chief executive officer and chief investment officer in the process, revising investment approval thresholds for strategies involving over-the-counter derivatives and involving risk management more at the outset of new trading strategies.

©2020 Bloomberg L.P.

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