Home Virginia Politics VRS and the Derivatives Craze

VRS and the Derivatives Craze


An AFL-CIO tweet yesterday jogged the memory. During the conclusion of Frontline’s series on the financial meltdown, the sorry tale of Larry Langford and Jefferson County, Alabama’s dance with derivatives had already created a question. With all of Delegate Purkey’s huffing about VRS, he’s never mentioned this.

Readily available information is insufficient to determine if future Virginia retirees should consider themselves fortunate, but they seemed to have dodged the bullet during a flight to risk taken by their pension trust. Standard accounting and reporting procedures have changed since the meltdown of 2008, but what is clear is that at the end of the last available reporting period (June 30, 2011) the fund had unwound itself from a derivatives position of nearly $7 billion reported in 2009 to a much more reasonable (but not necessarily justifiable) $1.3 billion.

What Delegate Purkey (R-Virginia Beach) has claimed is the result of his committee’s hand on the steering wheel, The Virginia Retirement System reported a one year return on investment of 19.1% last year. But what the fund holds in assets is an amount less than that reported three years earlier: $51.3 vs $51.7 billion. So a three year decline of half a billion dollars. Not bad at all, considering the turmoil during that time.

But here are some questions:

  • What was the net return on the derivatives?
  • Was the risk inherent in the derivatives justified?
  • If the return has justified the risk, why unwind?
  • Would a flight to quality have provided a similar return without the risk?

One other question: Will Bob McDonnell repay VRS with the 33% two year gain the funds would have earned had they been paid when obligated?

  • tgonthebay

    I’ll answer your posed questions in order.

    1. Irrelevant when the return of that part of the plan is included in the total plan return.  Why aren’t you concerned with the return of the treasury holdings?  Or the real estate holdings? Or any other compartmentalized piece of the plan?  Does it matter?  Especially if you aren’t made aware of whether the positions were speculative or not.

    2. If the positions were non-speculative, then this is also irrelevant.

    3. See 1 and 2 above.

    4. No.  Assuming you mean an immediate liquidation of a more risky asset in favor of a less risky asset, depending upon the speed of liquidation, transaction costs can erode any difference in return while actually raising intermediate risk.  And if by quality you meant treasuries, then absolutely no.  It would have been a MUCH lower return when you take into account treasuries have no where near the return of the equity piece as shown in Fig 2.20.  And again, the speed of the flight depresses return even more.

    My guess is the VRS uses these futures similarly to the way many other large pension funds do.  They use them to invest in the liquid derivative contract of the index they are tied to.  Rather than buying all 500 stocks in the S&P they might invest some money into the S&P futures contract instead.  In which case this entire article is just feeding the sensationalist media machine.

    Great job.

    Oh, I forgot to answer the last question.

    Probably not.  I think the loan was made with a non-adjustable interest rate attached to it.  But again, that’s just a guess.