The Arkansas Teacher Retirement System is suing investment and insurance giant Allianz for allegedly losing $774 million of the pension’s money in its volatility-trading funds.
This is the first major lawsuit to result from a salvo of blowups early this year. Industry insiders expect more to come over the summer.
Among the defunct and grievously injured vol vehicles, Allianz Global Investors’ stand out because they were owned by a deep-pocketed corporation. Standalone hedge funds that blew up, such as Malachite Capital, left little behind for burned investors to potentially recoup, although whispers of litigation continue to swirl.
The Arkansas Teacher Retirement System was among the largest investors in AllianzGI’s Structured Alpha products, a knowledgeable source told Institutional Investor. “The losses range from about $10 million into the nine figures,” or upwards of $1 billion, “but not many others are at the scale of Arkansas’.”
The public pension fund entered 2020 with about $1.62 billion of its $18.3 billion portfolio invested with three of the vehicles, according to plan documents.
The losses, as alleged, wiped out close to 5 percent of Arkansas teachers’ total pension savings.
“Active management missteps” and a “profound breakdown in risk management” caused the Allianz funds’ “extremely disappointing” results, ATRS’s consultant Aon told the pension fund in an analysis, according to the lawsuit. Aon “chastised AllianzGI for a ‘lack of transparency into the events that unfolded,’ which 'perpetuated... lost confidence in the risk management process’ and a loss of 'trust in the investment team.’ Moreover, AllianzGI has refused to explain to ATRS the investment decisions that led to the implosion of the Alpha funds.”
An AllianzGI spokesperson called the pension fund’s arguments “simply incorrect and without foundation” in a statement Tuesday. “While the losses suffered in the portfolio are deeply disappointing, there is no basis for legal liability.”
The lawsuit features marketing materials that AllianzGI allegedly provided to the pension fund, which touted its volatility-trading funds’ “ability to perform irrespective of the market environment” and objective to “protect against a market crash.”
The funds did not protect in this year’s dramatic crash.
[II Deep Dive: How to Lose a Billion Dollars Without Really Trying]
AllianzGI liquidated two of the vehicles at the end of March — called Structured Alpha 1000 and 1000 Plus — citing “significant realized losses.”
ATRS was not invested in either one. It held major stakes in the less aggressive versions — Structured Alpha 250, 350, and 500 — which nevertheless lost about 33, 56, and 75 percent respectively by the end of March. On April 6, the pension fund pulled its remaining money effective April 30.
But the products performed as intended, according to AllianzGI. “Our own analysis has revealed that the portfolio was at all times managed to its alpha targets and in accordance with its design,” the spokesperson said.
Notably, the lawsuit makes public for the first time a rumor circulating among certain volatility-market experts: That someone manipulated VIX futures prices in mid-March to secure more favorable settlement terms.
“Allianz’s desperation to generate gains and avoid losses across the entire family of Alpha Funds during March 2020 created the incentive to take extreme risks, and further deviate from the mandated investment strategy, including by potentially trading options in order to drive down the settlement price of the VIX futures contract on March 18, 2020,” the complaint states. “The opening price on March 18, which was anomalous to the pricing on the prior day, or at any time after the open on March 18, was used to calculate the settlement price of the March VIX Index futures and option contracts and thus determine the value of the options that Allianz had sold. The drop at the opening, followed by a rebound during the trading day, is one indicator of potential manipulation of the open.”
ATRS’s attorneys are investigating, a source said.
Few industry players had the heft and incentive to sway VIX futures, according to one expert. “Somebody sold the options used to calculate the VIX. You see that volume of some options — things that never trade — were traded in hundreds of thousands of lots. To do this, you need a lot of capital because you’re going to be selling a lot of options. Big banks can’t do it. It would have to be an institution.”
AllianzGI intends to defend itself vigorously against Arkansas Teachers’ allegations.