AIMCo’s Strategic Missteps: Lessons from VOLTS and Interest Rate Challenges
In a major shakeup, the Alberta government recently replaced the leadership of the Alberta Investment Management Corporation (AIMCo), signaling a turning point for the organization. AIMCo, responsible for managing nearly $160 billions in public assets, has faced repeated setbacks over the past few years. The roots of these issues can be traced to an investment in high-risk volatility trading, followed by a failure to adapt to rapid interest rate hikes. These missteps underscore the importance of aligning investment strategies with the fundamental principles of pension fund management, where stability and long-term security should take precedence over speculative strategies.
The VOLTS Strategy: Betting Against Market Turbulence
The volatility trading strategy known as VOLTS became AIMCo’s first major pitfall in 2020, resulting in a staggering $2.1 billion loss. The approach aimed to generate income by “selling volatility,” essentially betting that markets would remain calm. In stable conditions, this type of strategy can yield steady returns by taking advantage of low volatility premiums. However, it is also inherently risky: when market volatility surges, losses can escalate quickly.
During the early stages of the COVID-19 pandemic, financial markets entered a period of extreme instability. The sudden volatility spike proved catastrophic for AIMCo, as the VOLTS strategy wasn’t designed to withstand such abrupt market swings. This gamble on market stability, while potentially profitable in quieter periods, showed itself to be an inappropriate choice for a pension fund. The strategy highlighted a broader issue within AIMCo—prioritizing short-term gains over the preservation of capital, a principle fundamental to pension fund management.
Misreading the Interest Rate Landscape
Following the loss from VOLTS, AIMCo saw a rebound in 2021. However, it soon faced a new challenge: an aggressive rise in interest rates starting in 2022. As central banks around the world raised rates to combat inflation, AIMCo’s fixed-income investments faced declining values. Bond prices generally fall as interest rates rise, and AIMCo’s large allocation to fixed-income assets, normally a source of stability, instead became a drag on performance.
AIMCo’s high exposure to bonds left it vulnerable as rates continued to increase. The fund’s losses were compounded by the speed and scale of the rate hikes, which caught many investors off guard. This lack of proactive adjustment highlighted a gap in AIMCo’s risk management practices. In response, Alberta’s government cited this underperformance against benchmark as a reason for replacing the board, noting that despite rising costs, returns continued to lag behind targets.
Illiquid Private Assets: A Potential Long-Term Challenge
AIMCo’s portfolio also includes a significant proportion of private, illiquid assets like real estate and infrastructure. In favorable conditions, these assets can offer strong, consistent returns. However, they are not easily sold in times of economic distress, which can lead to challenges if market values decline or if economic conditions worsen. Higher interest rates can also impact leveraged private assets, as borrowing costs rise, potentially reducing the profitability of these investments.
These private assets are at risk of future write-downs, especially if the broader economy remains turbulent or if rising interest rates continue to affect property and infrastructure valuations. For AIMCo, this situation poses an ongoing risk, as these investments, while potentially rewarding, are not easily liquidated without potential loss.
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Lessons from AIMCo’s Strategy Missteps
The Alberta government’s recent intervention in AIMCo’s management reflects the broader importance of aligning strategies with the long-term goals of public pension funds. AIMCo’s approach with the VOLTS strategy and its mismanagement of interest rate risk underscore the need for caution in adopting high-risk investments, especially when managing public assets intended for pension funds. Pension funds are expected to prioritize stability and capital preservation, offering steady returns without exposing public funds to undue risk.
Embracing Systematic Processes for Enhanced Pension Fund Management
The challenges AIMCo faced highlight an emerging opportunity for pension funds: integrating automated investing and systematic approaches. Machines today can analyze vast amounts of historical and real-time data, identifying market patterns and potential risks that human analysts might miss. By using algorithms that continuously monitor volatility, interest rate shifts, and other economic indicators, pension fund managers could develop a more systematic and disciplined approach, avoiding reactive, high-risk bets.
Additionally, systematic approaches could reduce human short sighted errors. For instance, machines can analyst volatility patterns over decades to reveal early warning signs of extreme events, allowing for proactive hedging rather than reactive losses. Machine-driven insights can also offer robust asset allocation recommendations, helping funds balance risk more effectively across fixed income, equities, and illiquid assets.
By adopting these technologies, pension funds could not only avoid “rookie mistakes” like those seen with VOLTS but also bring a consistent, data-informed approach to managing public assets. The integration of AI represents a path forward that aligns with the core mission of stability and long-term growth, offering a clearer, more resilient approach to public fund management.
AIMCo Annual Reports
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1moThe old saying 'Anyone can make a mistake but you need a computer to really foul it up' will soon be extended to '...and if you want to generate an existential crisis, bet the farm on your AI & ML models'
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1moDo you think the portfolio was overly skewed to short term bets like the VOLTS strategy or it is just pure lack of duty of care? It’s mind boggling to see and hear such losses are common place with these supposed “big boys”. If you remember, JPM or GS was defrauded $200M+ by a startup few years ago.