By Jeannette Neumann
William Atwood, head of the $11.2 billion Illinois investment
board, has taken a crash course in discovering his portfolio's
currency-trading costs, and he doesn't like what he sees.
A consultant said his fund paid $2 million more than the average
of other institutional investors on currency transactions during
most of last year. When Mr. Atwood tried to figure out the costs on
his own, he received a two-foot-high stack of trading documents
that he didn't know how to interpret.
"If you don't pay attention, you do so at your own peril," says
Mr. Atwood, a 49-year-old former money manager.
Now, Mr. Atwood is attempting something few public fund managers
have tried: building a paper and financial trail to monitor whether
advisers are charging his Illinois fund correct currency costs.
He has drastically pared currency trading through State Street
Corp., which executed the majority of the board's currency
transactions, and he now requires investment managers to provide
time stamps recording when all the trades were made. He also
receives quarterly updates on currency costs.
State Street said in a statement it doesn't comment on clients,
adding: "Overall our indirect foreign exchange services continue to
be widely used by the investment managers we serve" because of the
firm's "ability to efficiently meet their foreign exchange
execution needs."
Mr. Atwood's efforts come amid heightened scrutiny by regulators
and investors into the $4 trillion-a-day foreign-exchange market,
as custody banks face allegations they have overcharged state
pension funds to trade currency, charges the banks deny. His deep
dive offers a peek into struggles public pension fund managers
could face as they scrutinize financial firms that trade currencies
to carry out their securities transactions.
All this is important for custody banks, which historically have
acted as custodian for investment firms' securities while handling
mundane back-office administrative work. The banks also execute
currency transactions for institutional investors.
In a March report, Nomura Securities said custody banks may
"need to make serious price concessions and revamp the process in
which they execute FX trades for their clients."
U.S. public pension funds have poured into foreign securities,
nearly doubling overseas holdings in the past 20 years. Pension
managers only now are grappling with currency costs as they also
deal with underfunded pension plans.
Three pension plans that Mr. Atwood oversees on behalf of
125,000 Illinois workers and retirees are funded between 26.3% and
37.4%, for instance, and that is far shy of the 80% level that
actuaries recommend.
Inside Mr. Atwood's office, his team scrambled to get records
similar to stock transactions that show a date and time a currency
is traded.
Mr. Atwood asked Illinois' five investment managers for a
month's worth of records detailing the currency traded. That's when
he got the two-foot high stack of records. He didn't know what to
do with it.
For advice, Mr. Atwood turned to a friend, a former currency
trader, who told him foreign-exchange markets are far less
regulated than stocks or bonds. He grew more concerned.
Mr. Atwood worked with a consultant to put the data in a
digestible format. That's when he spotted the first of what he
considers red flags: The fund's investment managers had executed
more than 70% of the currency trades through State Street,
Illinois' custody bank.
Mr. Atwood was skeptical that one bank could provide the best
"execution"--or trades at the best available prices--70% of the
time. His fund's investment managers didn't have good answers, he
says.
He instructed the fund's investment managers to provide "time
stamps" on currency trades, indicating the specific time and price
a transaction took place.
The fund also instructed its investment managers to trade
through State Street only if the bank could bring the most
competitive price. Illinois' investment managers have shifted
trading to 20 different banks and now execute nearly 13% of trades
through State Street, Mr. Atwood says.
Illinois hasn't alleged wrongdoing or pursued a legal claim. And
while it hasn't fired its investment managers, it has put those
managers who are driving expenses on notice: If costs don't go down
over the next several quarters, their contract could be
terminated.
Illinois in January hired Global Trading Analytics, LLC, a
Rutherford, N.J-based, transaction-cost analysis consulting firm,
to mine its foreign exchange data. In February, Global Trading told
Mr. Atwood the fund had paid on average 16.5 "basis points," or
hundredths of a percentage point, more than the average of other
institutional investors for currency trades in 2010, or about $2
million.
That amount ate into the $266 million in gains Mr. Atwood's fund
earned in trading international stocks last year, he says.
The analysis showed that money manager Vontobel Asset
Management, primarily exchanging British pounds and U.S. dollars
for Illinois, was 0.25% above the consultant's market benchmark
over the last three quarters in 2010, according to information
obtained from a public-records request.
Among its five managers, Vontobel traded the most on behalf of
the Illinois fund, the amount being $822 million over 284 trades,
documents show.
A spokesman for Vontobel, a New York unit of Zurich-based
Vontobel Holding AG, called the analysis "flawed and misleading"
because the firm says the consultant doesn't accurately account for
currency hedging, a strategy Vontobel uses. Hedging involves taking
opposite trading positions to offset adverse market moves.
"Any conclusion...that such hedges have hurt performance over
the time we've managed funds for Illinois State Board of
Investments is simply false," Vontobel said in a statement.
Global Trading President John Halligan said in a statement that
the firm "has been accurately measuring all facets of foreign
exchange trading costs, including trading for currency hedging,
since 2005."
For his part, Mr. Atwood now requests currency costs every
quarter. "We expect to see improvement," he says.