Dutch Court Throws Lifeline for Non-US Class Action Lawsuits

Pension, endowment funds, and other international shareholders have a new avenue of enquiry to seek damages of alleged corporate fraud thanks to a European court decision.

(January 25, 2012) — The first class action lawsuit settlement to be approved for shareholders based outside the United States, since the Supreme Court tightened rules about international investors seeking redress through its legal system in 2010, has thrown a lifeline to asset owners suspicious of corporate fraud.

A case brought by international pension schemes, endowments and other large investors against Swiss reinsurer Converium Holding (now Scor Holding (Switzerland)), was settled out of court with damages of over $58 million being approved for distribution by the Amsterdam Court of Appeal last week.

The court was used once before in a similar case launched in 2007 against Royal Dutch Shell, when investors resolved their claims for €316 million with the oil giant. Since then, the US Supreme Court’s 2010 decision in Morrison vs. National Australia Bank, called time on investors seeking to recover damages incurred on securities purchased on an exchange outside of the US against non-US companies under the US securities laws.

Bruce Bernstein, Counsel at Bernstein, Litowitz, Berger and Grossmann, which served as co-lead counsel for the investor class in the Converium action, told aiCIO: “Following the Morrison decision, European investors and other non-US investors have faced new hurdles in seeking to recover losses due to alleged fraud.”

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The move by the Dutch legal system in the Coverium case has now thrown them a new lifeline.

Bernstein said: “This result is significant for non-US pension schemes and other large investors, in the Netherlands and elsewhere. It is possible, following the successful outcome in Converium, that we will see non-US investors taking similar efforts in other matters in the Netherlands.”

He added: “The approved settlement offers an avenue of redress that some thought had been significantly limited because of the Morrison decision. It also could provide defendants whose shares trade on a non-US exchange with the opportunity to achieve global peace through a class wide resolution.”

Coverium had not responded to calls for comment at the time of going to press.

GMO: Beware of Beta as a Measure of Risk

New research from Grantham, Mayo, Van Otterloo & Co. (GMO) explores the anomalies in investment strategies that generate returns greater than expected in light of their perceived risks, warning investors to be cautious of perceived inefficiencies in the market.

(January 23, 2012) — Investors must be cautious of beta as a measure of risk, a recent whitepaper by Boston-based Grantham, Mayo, Van Otterloo & Co. (GMO) warns.

According to the report, perceived inefficiencies in the market stem from a misunderstanding of risk.

“When behaviors differ in up markets and down markets, simple beta will not be a good measure of the real risk in a strategy,” the paper claims. “Hedge funds, for example, carry a relatively low beta, but this understates substantially the real risks they are taking, and allocations to this type of investment should take that into account.”

Meanwhile, the paper — written by David Cowan, portfolio manager within GMO’s quantitative equity team, and Sam Wilderman, co-head of the GMO Quantitative equity team and lead manager for US quantitative portfolios — concludes that strategies that attempt to take away downside risk will generally prove very costly over any reasonably long period of time. The paper — titled “Re-Thinking Risk: What the Beta Puzzle Tells Us about Investing” — asserts: “Tail risk protection strategies, which have become quite popular in recent years, seek to provide insurance against big down markets…Purchasing such protection on your portfolio might reduce your exposure to extreme down markets, and will likely help you sleep better at night, but will almost certainly come at the expense of long-term returns.”

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In June, GMO released another paper exploring the value of tail risk protection strategies for value investors. The paper by James Montier, a member of GMO’s asset allocation team, stated:

“Tail risk protection appears to be one of many investment fads du jour. All too often those seeking tail risk protection appear to be motivated by the fear of missing out (not fear at all, but greed). However, the surge of tail risk products may well not be the hoped-for panacea.”

Highlighting the importance of defining the risks that investors aim to guard themselves against, the paper asserted: “When considering tail risk protection, investors must start by defining the tail risk they are seeking to protect themselves against. This sounds obvious, but often seems to get scant attention in the tail risk discussion. Once you have identified the risk, you can start to think about how you would like to protect yourself against that risk.”

The reports by GMO follow similar assertions by Damon Krytzer, a trustee at the San Jose Police and Fire Retirement Plan and managing director of Waverly Advisors, who voiced similar sentiments about a misunderstanding of risk. Krytzer expressed his ideas about misperceptions behind dynamic asset allocation and risk parity strategies with aiCIO in October. Dynamic asset allocation and risk parity strategies are often based on incorrect assumptions, according to Krytzer, who noted that while he likes the idea that funds are using risk contribution as the focus rather than return distribution, their investment strategies should be based on different metrics. “These strategies assume that the asset allocation mix doesn’t change over time — with the false assumption based on diversification among asset classes rather than risk factors,” he said, noting that focusing on risk factors as opposed to asset classes is a more appropriate emphasis.

According to many in the industry, dynamic asset allocation and risk parity strategies have gained heightened attention because of the desperation among investors to achieve success in a difficult market environment. “Returns have been awful. People are scared, and markets aren’t reacting the way people would like. So, you turn to something that seems like a systematic way to manage a challenging market,” Krytzer said, highlighting his belief that these models have underlying problems in the way many of them are currently applied and executed.

Krytzer’s assertions questioning the assumptions behind investment strategies follow recent comments made by Mark Baumgartner, Director of Asset Allocation and Risk at the $11 billion Ford Foundation, who sat with aiCIO last year to discuss the market environment, ‘true’ diversification, and the end-goal of Foundation investing. “You have to make sure you are diversifying with risk factors, not just asset classes,” he asserted. “All investments have fat tails, all markets are irrational at times. However, something that is not widely acknowledged: You can reduce the impact of fat tails with good portfolio construction and ‘true’ diversification,” he said.