An apparent lack of oversight by executives at the AXA Group over their AXA Rosenberg Investment Management unit might have left clients vulnerable to problems in the investment process of the once high-flying quantitative firm.
The details of transparency issues and the apparent untouchable status AXA Group gave to the investment management unit have emerged through Pensions & Investments' reports, which also revealed a Securities and Exchange Commission investigation.
The key issue is not that a coding error in a computer program might have affected the investment firm's performance, costing clients millions. Rather, it is that the parent's hands-off approach appears to have allowed a delay in notifying clients about the error.
Some clients have moved on, terminating AXA Rosenberg and hiring replacement managers. In all, since the firm notified clients about the error in April, AXA Rosenberg assets have fallen 54% to $32 billion as of Aug. 31 as clients defected.
But current or recent pension fund clients have a fiduciary duty to recover losses, and possibly investment management fees, from the error.
They also should seek an examination of the problems with the model, the lack of communication about it and the role of the company's governance structure. They also should quantify the performance problems. Such an examination would be revealing, not only about the AXA operations and losses associated with the error, but also possibly about potential risks at other money managers' investment processes and governance structures.
AXA Group owes clients a full explanation of what happened, including why a computer coding error in a quantitative model went unreported for two years, and why parent AXA Group and clients weren't immediately notified of the problem.
AXA Group said a review showed clients are owed $82 million because of the coding error.
But clients and former clients should ask how AXA came up with the $82 million. Can the model be deconstructed to quantify the costs of specific factors in error? What specifically was the coding error and how did it affect the investment process? What would AXA Group have done if the problem were more serious? Would it even have known?
The lack of disclosure might have kept clients from reacting sooner to AXA Rosenberg's problems. With any money manager, clients sometimes see performance drop periodically. But they typically won't terminate a manager even after one year or more of underperformance, so long as they remain confident in the integrity of the investment process.
One of AXA Rosenberg's largest strategies — U.S. large-cap equities — for the three years ended June 30 finished in the lowest quartile of a performance universe.
Among other issues for fiduciaries is what kind of compliance checks AXA Rosenberg had under the governance structure. With any firm, clients must have ways to verify that the firm is following the agreed-upon strategy within the agreed-upon risk parameters.
Complex models need better oversight to validate them. Any model could have a fundamental flaw.
AXA Rosenberg appears to have been subject to “key person risk” in Barr Rosenberg, founder and chairman, who might have been regarded as essential to the success of the model. When the coding error came to light, AXA Rosenberg hired a law firm to do a review, which found that Mr. Rosenberg and two others violated a firm policy by limiting dissemination of information about the error. Mr. Rosenberg and one of the other executives were also found to have violated the company's code of ethics. Mr. Rosenberg resigned but remains a consultant.
AXA Group, a huge sophisticated firm, planted the seed for potential problems with clients when it reportedly agreed to allow AXA Rosenberg latitude in running the investment operation, a concession apparently necessary to close the deal with the quant investment star.
Paying a premium in whatever form for star talent can be problematical, even though it is a cornerstone of the investment management business practice of recruitment. “But reliance on stars is a highly speculative managerial policy because we don't really know very much about what drives outstanding individual performance,” Boris Groysberg, associate professor in organizational behavior at Harvard Business School, said in his book, “Chasing Stars: The Myth of Talent and Portability of Performance,” published this year. “
Investors should demand an independent investigation to determine the full extent of the problems.
The findings could reveal lessons not only for AXA Rosenberg clients, but also for all institutional investors using quantitative managers.