The Year in Risk: Developed and Emerging Markets Diverge

(December 18, 2013) — A divergent trend in developing and emerging markets’ (EM) risks marked a significant change in how investors allocated to EM assets, according to Axioma.

Melissa Brown, senior director of applied research at Axioma, concluded that market risk peaked in the second quarter of 013—a result of tapering talks by the US Federal Reserve.

“Although it was a ‘risk off’ for many investors at mid-year, large cap US stocks ended up having their best year since 2003, despite the government shutdown, with consumer discretionary stocks leading the way,” Brown told aiCIO.

Emerging markets took a bigger hit from the Fed’s announcement—its recent decline in risk has been steeper, leading to a wider gap between developing and emerging markets.

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The risk, Brown found, had mainly shifted eastward to Asia-Pacific markets. While North American and European markets’ risk fell after the second quarter, Asian markets had largely remained flat.

“One of the most significant trends of 2013 was the continued decoupling of developing markets from emerging markets,” Brown said. “We saw it across the board, in equity, bond, currency, and credit default swap markets. The divergence of risk and return had major investor implications in terms of stock and country selection in emerging markets.”

This trend led investors to be more discerning with their allocations in emerging markets: they could no longer be tied together as one unit.

“Lower correlations, along with the changes in risk geographically, resulted in investors becoming much more discriminating,” Brown said. “In the absence of a single overarching theme driving returns, investors placed their bets based on the individual merits of countries and individual assets within countries.”

These lower factor and asset correlations helped decrease risk in developed markets but less so in emerging markets, as high factor volatility could counterbalance the decline.

Brown said looking ahead, one could expect country selection in emerging markets to become critically important. However, understanding the risks undertaken for each individual countries should also play a greater part:

“You want to make sure that you’re in the right countries, estimating the risk properly for the markets you’re in in,” Brown told aiCIO.

“Volatility typically follows volatility. The chances are it’s going to be a while until the risks settle down.”

Tony Clark, CIO of the $27 billion fund, is also accused of withholding investment information regarding Tiger Asset Management, according to internal legal documents.

(December 18, 2013) — CIO of Pennsylvania State Employees’ Retirement System (SERS), Tony Clark, has been accused of trading on his own account and of withholding investment information, according to documents obtained by aiCIO.

The privileged and confidential document prepared by the law offices of Stradley Ronon Stevens & Young from December 10 outlined allegations against Clark during his tenure at the $27 billion fund. The redacted document Is largely based on an interview with one attorney at SERS who raised the allegations.

“It was clear throughout the interview that [redacted] has strong unfavorable opinions concerning Clark’s integrity and competency,” the report said.

Concerns about Clark’s behavior began even before he began his term at SERS, according to the document—it was believed that Clark’s appointment to CIO involved “some political horse trading.”

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Clark was additionally accused of trading on his own account using information he obtained from his position at the pension plan. The first alarm rang in May or June of 2013, the report stated.

The CIO was said to have asked an employee to contact an outside portfolio manager to discuss master limited partnerships—strategies SERS was not considering at the time. Clark continued to ask “questions that were kind of strange,” but employees were discouraged to report the issue to the Office of the Inspector General because “anyone challenging Mr. Clark was fired.”

An employee who did report it to the legal department never directly saw Clark trade on his own accounts. The Pennsylvania office of Attorney General collected Clark’s computer and files last week to conduct investigations.

Clark had allegedly withheld information regarding SERS’ investments from the board—particularly the $250 million held by Tiger Asset Management, the document concluded.

The concerned attorney said “the Tiger investment was Clark’s priority when he arrived at SERS and that Clark had a friendship with an individual at Tiger from his prior investment firm employment” and further believed “Clark was too hasty in entering into the Tiger Investment.”

The rush to partner with Tiger Asset Management—a firm usually concerned with individual investment pools for high net-worth individuals—resulted in an oversight of due diligence usually performed on managers, the report said. The attorney also stated that Clark rejected the idea of hiring a hedge fund consultant to fully understand the investment.

“Tiger had ownership interests in the underlying businesses in which SERS was investing through Tiger, and Tiger was paid fee from those businesses,” the report said. “In actuality, [redacted] believed that Tiger was freeing up the money of other high-end individual investors in Tiger by replacing their investment funds with funds from SERS.”

One year after investing with Tiger, SERS found a $20 million loss from the firm’s general underperformance, which is when “Clark removed the breakdown of the performance of each individual manager from the investment report provided to the board.”

Gary Tuma, the Pennsylvania Treasury communications director, previously told aiCIO that Treasurer Rob McCord found performance reports were repeatedly pulled from board meetings and audio transcripts of various meeting were frequently unavailable.

When McCord asked Clark about the missing information at the April 2013 board meeting, the CIO responded that the information has “never been there,” according to the report. After Clark refused to pull investments from Tiger, the attorney claimed that “there was something in it for him.”

The legal document also outlined areas of concern extending to SERS’ chairman Nicholas Maiale: outside managers were often taking Maiale out to lunch; Maiale, as chairman, is essentially responsible for Clark’s appointment; there is evidence of SERS’ securing “political deals” for Maiale that may not be suitable for the pension plan, and; the CIO “pushed whatever investment Maiale wanted.”

The law firm found there may be “insufficient information” to report Clark’s alleged actions to the Securities and Exchange Commission. However, it stated that the CIO’s conduct might have violated state ethics laws, allowing the Office of General Counsel to step in.

A person close to the Pennsylvania pension fund said there is more to be revealed about Clark’s actions, beyond the redacted version of the confidential document.