Question

Case Study: The Clumsy Currency Traders

Amy Wentworth is the senior performance analyst at ACME Investments assigned to an international equity product line. She meets each fall with the Portfolio Managers, Research Analysts and various traders who work on the firm’s accounts to review the year to date results of each portfolio’s performance attribution analytics report. These reports use mathematical algorithms to “attribute” over or under performance versus a fund’s benchmark to various factors – in this case the high level contribution of each investment professional to the relative performance of the fund. The findings in these reports are a component of the performance review each of the players will receive at year end and has a significant bearing on their compensation. During the discussion of a global fixed income portfolio, the two currency traders, Donald Avery and Sherman Marshall, criticized findings in the report that showed a significantly negative contribution from currency management of the ABC Pension Account. The results do appear anomalous and Amy agrees to look into the issue to determine if a data or analytic error has skewed the results. Looking into the problem, Amy discovers one trade in the first quarter dominating the year-to-date results and which might be a data error with a major impact on the currency contribution calculation. While forward contract trades are communicated electronically to the custodian and counterparties, they are manually entered into the firm’s portfolio inventory and performance system. Amy has encountered manual errors in the input of these types of trades in the past, hence her initial concern that the trade data are incorrect. At a subsequent meeting with the traders and Frederic Barton, the portfolio manager of the account in question, Amy singles out this trade and askes Avery and Marshall to review their trade records. The traders immediately leave the room and come back a few minutes later and state somewhat sheepishly that the trade data was in fact correct. Avery referred to it cryptically as an “adjustment trade”. When asked by Amy what this meant, he explained that from time to time they encounter arbitrage opportunities between some of their currency markets which they can exploit to make a riskless profit. At the Portfolio Manager’s discretion, these are sometimes used to “tighten up” performance dispersion between otherwise like managed accounts – raising the total returns of one or more accounts deemed to be lagging their peers by too much. At the time, ABC was about a percent behind its average peer performance – a fairly large discrepancy for this asset class. “But,” Amy points out, “this trade hurt the account significantly. It dropped its total return by about 80 basis points!” As of the date of these conversations, ABC was now trailing its peers by about 2.1%. “Yes, I know,” Avery replied, “we messed up and put the trade in backwards.” Amy looked over to the Portfolio Manager for some response, but he just shrugged and said, “This sort of thing can happen. It’s part of the cost of doing business.” Troubled by these statements, Amy approaches you, the senior Risk and Compliance Officer assigned to oversee the performance department. You are able to confirm the facts as detailed above. You also question the manager of the performance analytics team and he agrees that the account performance has been a growing concern which he intended to discuss with the product management team in marketing at the annual product review process at the beginning of the new year. Please review and comment upon the facts and if appropriate what follow up actions you would recommend.

1. Identify the principal actors

2. Identify the stakeholders

3. Determine if there have been ethical or regulatory breaches and what principles have been violated.

4. Determine if there has been material harm to any stakeholder and what steps are required to mitigate or correct it.

5. Discuss any other issues of ethics, compliance or good governance that extend beyond the immediate details of this case.

Answer 1

1. The principal actors in the given case study are Amy Wentworth, Donald Avery and Sherman Marshall.

2.The stakeholders are the investors and managers of the company.

3. There has been an ethical breach where purely at the discretion of the portfolio manager and to cover up a breach where in the portfolio was lagging by it's peers by a margin, arbitrage was done which was not according to the rules of the portfolio management.This affected the trade adversely.Since the compensation of the managers is affected by portfolios performance, they caved in to the conflict of personal interest versus company interest.

4) This has harmed the investors of the portfolio monetarily and dropped the return by 80 basis points. Calculated and precise calculation should be done to manage the portfolio in such a way that the returns shoot up.

5.In this scenario, without considering the loss to the stakeholders the traders handled the portfolio in a casual manner. Professional competence should be exercised in all fields and investors money should be duly taken care of.