AIMCo Board of Directors
VOLTS Investment Strategy Review
Summary of Results
June 30, 2020
INTRODUCTION
This report provides a review of the AIMCo Board’s response to the recent VOLTS losses and
the measures it has taken to guide the organization going forward.
On March 14, 2020 the Board was advised of significant losses incurred by AIMCo on one
public equities strategy called VOLTS. VOLTS, or Volatility Trading Strategy, was one of 52
value-added or alpha strategies undertaken by the Public Equities group at AIMCo, and was
entirely internally managed.
The Impact of COVID-19 on global equity markets was a magnitude and abruptness of volatility
not seen since Black Monday in October 1987. While some losses on volatility strategies were
to be expected, AIMCo experienced a significantly larger than expected loss, which is now fixed
at $2.1 billion or about one sixth of the investment returns generated by AIMCo in 2019.
In response the Board took actions to:
1. mitigate further VOLTS losses and, on management’s recommendation, approve a plan to
wind down VOLTS and permanently close the strategy, fixing losses at $2.1 billion.
2. undertake a review of other value-added strategies to identify any with potential for
outsized losses. This review confirmed that there were no other strategies with potential for
outsized losses akin to VOLTS.
3. launch a comprehensive review of all aspects of VOLTS to determine changes to
management processes and governance necessary to prevent any reoccurrence of a similar
outcome. This report documents the review undertaken by the Board and summarizes the
changes adopted as a result of this review.
In conducting this review the Board utilized several key internal resources including AIMCo’s
Internal Audit Group and its Chief Legal Officer, as well as external advice from Barbara Zvan,
retired Chief Risk Officer of the Ontario Teachers’ Pension Plan, and KPMG. Separately,
AIMCo’s CEO provided the Board with changes he believes are called for. As a result, the Board
of AIMCo believes that it has a clear understanding of the events and circumstances which
occurred leading up to this loss and the changes required to prevent its reoccurrence.
BACKGROUND ON VOLTS
AIMCo began investing in volatility contracts as a strategy in 2013. It involved at different points
in time several distinct sub-strategies that involved trading over the counter derivative
contracts based on the degree of daily volatility in various global public equities markets, and a
downside risk component to mitigate deep tail risk. A detailed research paper prepared at the
time analyzed three primary strategies: a one-month variance swap to capture the so-called
implied versus actual volatility risk premium; a volatility term structure risk premium strategy;
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and a downside risk component to mitigate deep tail risk. A combination of the three was
recommended, with positions to be spread across multiple global equity markets to diversify
geographic risk.
For an extended period the magnitude of investment was small and the contracts were
predominantly one month simple variance swaps. Such swaps have a non-linear loss function
under which losses are magnified by extreme volatility events such as the March 2020 COVID-
induced market dislocation. However, the risk exposure in relation to the size of AIMCo’s public
equities portfolio was small and in keeping with similar strategies employed by many other
asset managers.
Beginning in January of 2018 the scope of the volatility investment strategy was expanded to
include capped/uncapped variance swaps. These swaps trade a relatively fixed return during
typical to moderately high volatility conditions for a significantly more steeply tilted and non-
linear loss function during high to very high volatility conditions and carry the risk of greatly
magnified losses from extreme volatility events, such as the COVID-related volatility
experienced in March or that experienced in the October 1987 Black Monday event.
At the same time that the VOLTS portfolio was being shifted towards the higher risk
capped/uncapped contracts the size of the portfolio was being substantially increased above
that of the pre-2018 strategy.
A legacy risk system was being used to measure and monitor the risks of public market
instruments. It assessed investment risk using a value at risk (VaR) measurement at a (95%)
confidence level on an annual basis. This is a common method of sizing active risk, which works
reasonably well when the returns of portfolio investments are linearly related to underlying
economic and market factors. However, it does not do a good job of assessing risk in a strategy
like VOLTS with nonlinear returns, especially when nonlinearity appears largely outside the
confidence interval. The VaR system would thus have reported minimal risks for the capped-
uncapped strategy. To fully understand the risk of an investment like VOLTS and the potential
for unacceptable losses, something more than active VaR is required. The limitations of the risk
system had previously been recognized, and its replacement had been identified and was in the
process of being implemented.
By January, 2020, Risk Management had modelled the risk involved in the capped-uncapped
strategy being utilized and called for increased attention to the very low probability but
nonetheless extreme tail risk of VOLTS. By the time Public Equities began to take action to
reduce VOLTS exposure in early March, it was too late. Unprecedented and sustained volatility
caused by the COVID-19 crisis made it impossible to unwind the positions without considerable
loss.
