UK – Mercury Asset Management (MAM) operated an inadequate system of risk control in managing £1bn in pension assets for the USF fund and took too long to change its risk profile under the terms of a new investment agreement proposed by the Unilever fund, the High Court was told today (November 12).

Jonathan Sumption Q.C. – acting on behalf of USF and continuing his cross-examination of Merrill Lynch COO, Carol Galley, questioned Galley’s defence that extreme moves in the value of sterling against the deutschmark at the time had been a key factor in the firm’s underperformance.

Sumption put it to Galley that the market was “full of surprises”, adding “otherwise there would not be a market, and fund managers would be out of a job”.

He continued by suggesting that Alistair Lennard, the portfolio manager of some £600m in UK equities for the USF fund had protected his investment positions to a much lesser degree than the rest of MAM’s Select investment team.
“If we look at the most currency sensitive parts of his portfolio, which are general industrials, the position is that he had three times the index weighting and more than twice the Select team average. You would expect in those circumstances, that his positions would be very much more vulnerable to currency movements than other people's?”

Galley conceded that this was true but countered that its source was extreme changes in the market environment and exceptional disparity between the pound and the deutschmark.
Commenting on the rise of sterling, she noted: “It rose by 30 per cent, which is hugely disruptive movement, one of the largest moves that had ever taken, if not had ever taken in a single year, that had, that and other factors that we have talked about, had the effect of magnifying, for want of a better expression, differences in portfolios….”
She said that MAM had therefore wanted to review its processes in order to see how best to deal with the new environment and to lower risk.

Sumption suggested that it had taken MAM over six months to react to an outline of risk tolerance set out by USF in the revised management agreement of November 1996 when the two parties met in May 1997.
“What you were actually saying was that the risk tolerance that had been defined the previous November required the different approach to risk control in Mr Lennard's own portfolio; and that was something that it was now, in May 1997, going to receive?”

Galley claimed that this gave a somewhat “inaccurate picture” of what had occurred.
“At the time of the change in the benchmarks we gave a lot of thought to the construction of the portfolio and believed it, at the time, to be appropriate. By the time we had moved on until March, April, May, for the reasons I outlined earlier, we all believed that we should lower the risk in the portfolio and that was what I was sitting in front of the client to agree a way forward to achieve.”

MLIM is arguing that with the benefit of hindsight it is easy to suggest that changes should have been made earlier.

USF is suing MLIM for £130m (e210m) alleging that Mercury Asset Management (MAM) - now part of MLIM, negligently took too much risk when managing £1bn for the fund between January 1, 1997 and March 31, 1998, following the introduction of the new investment agreement, which sought to achieve 1% outperformance with a downside risk tolerance of –3%.

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