S&P Resistance

200 d moving average proved too formidable and I suspect we test the lows over the summer. May not be lead by financials this time, but I would look to hedge downside risk here.

GM Pension

In case anyone has missed it, pensions have become the centrepiece of negotiations on GM's potential bailout.

I understand why the unions have negotiated so hard for better pensions; what I am not sure is why they were so comfortable with the risks in the plan as of a year ago. The plan's deficit apparently exploded from 4.5B to over 7B under the watchful eye of the Investment Committee, GM executives and union representatives.

The lesson from this saga is clear (even if the provincial or federal government participate in teh pension bailout): union representatives must oversee all aspects of compensation for their members. This surely includes monitoring the future viability of those benefits. Time for union officials to read up on pension fund risk.

VAR

Is VAR broken? Frequently debated, it is the equivalent of trying to determine whether the entire past 10 years of financial innovation has been a mere column of smoke. The answer is Yes and No. It really depends on the application and the user.

Let's take an example of a firm that used a 95% VAR so that 1 day in 20 the P&L should exceed the VAR number in terms of gains and losses. This firm saw over the end of 2007 20 days in 60 where P&L exceeded VAR and 18 of the 20 times it exceeded VAR in the plus column. Management chose to ignore this fact because gains are far more appreciated than losses and why stop a trader on a roll. Management consciously avoided tough risk management decisions - can we really blame VAR for this failure?

VAR is not a holy grail. There are many shortcomings due to the many assumptions in the number. But much of the blame for VAR should fall on the shoulders of management who did not understand or chose to ignore the many signals that VAR was giving.

UTAM

The Globe has a revealing piece on University of Toronto Asset Management. Surely this is a debate throughout North America:

• are previous asset management methodologies no longer tenable?
• were 2008 returns predictable or within model expectations?
• do we fully appreciate risk?
• in an effort to make finance more quantitatively elegant have we made assumptions that are unrealistic?

Basically, is the model broken?

While I think we all recognize that many assumptions in our models are unrealistic, the real question is do we adjust for it? Are we equipped to interpret the data provided by our risk management systems and then make the mental adjustment for where we intuitively realize the risks in our portfolio exist?

In your organization: does management really understand the numbers put out by the risk system and do they know the limitations of said numbers?

Toronto CFA

Yesterday I attended the Toronto CFA Pension Seminar and 2 contradictory approaches to the past were apparent, one from Malcolm Hamilton and the other from Zev Frischman.

Hamilton is a leading consultant at Mercer, one of the firms that has advocated the "one-size-fits-all" 60-40 equity-fixed income asset mix. In what can be interpreted as a mea-culpa, Hamilton basically admitted that this approach was and remains inappropriate. Although not explicitly atoning for sins past by using the age old method of confession, it was obvious that Hamilton was departing from his firm's line of thinking as he emphasized at the start of his presentation that "he was giving his views only, not those representative of Mercer." Other issues Hamilton tackled were: the issue of MTM of illiquid assets (see my post), that superfunds try to solve problems but do not actually solve them (see my post) and the behavioural finance fear that plans are just hoping to get back to 100% solvency ratio to match assets to liabilities but will not do so once we get there.

On the other hand, Frischman, head of public equities at Ontario Teachers' Pension Plan remained unrepentant and emphasized that 2008 results were "well within the bounds predicted by our risk models." Therefore, Frischman emphasized, Teachers' sees no need to depart from historical approaches to investing and will continue in 2009 in what can only be described as "business as usual". Of course, this is nonsense as yours truly can attest, being part of the group let go from Teachers' in late 2008 because we did not fit in to the 2009 business plan.

Another point Frischman brought up was that if OTPP started matching the risk of their assets relative to liabilities, they would be locking in losses which would be untenable to the interested parties; namely, the teachers and the government of Ontario. That may be correct, however I respectfully disagree with the conclusion. In effect what Frischman is saying is "I will not take a loss because I cannot afford to do so." As a former trader, I cringe at the thought that someone in such a high position at a money manager could subscribe to such nonsense. As we all know, not taking small losses can lead to larger losses.

Other interesting notes from the seminar:
- LDI was a much discussed topic, with many admitting that it has generated much talk but not enough action
- regarding LDI (and this is corroborated by my discussions with clients and prospective clients), there is a mentality which Hamilton spoke of: I will do it once my solvency ratio is at 100%. The trading analogy is the guy whose position has gone way offside and decides "I will unwind it when I am back to flat P&L"
- it is unclear from the market whether or not inflation or deflation is the bigger risk, but curve steepening will precede a fear of inflation trade (note: there was much academic background to this conclusion which I have skipped in the interest of time)