279The figures under the heading "Loss to fund" represent the actual loss to the Portfolio from 30 June or 31 July 2011 to 31 August or 30 September 2011.
280The figures under the heading "ASX200 on fund" represent "the loss to the fund if had it fallen by the same percentage as the ASX".
281The figure under the heading "Loss" is the loss to the fund over and above that suffered by the ASX 200.
282MVIL submitted:
"Once the correct start and finish dates are selected, on MVIL's analysis the 'Loss to fund' column on the above table marks the high end of the loss recoverable, and the 'Loss' column the low end."
283MVIL accepted that this analysis was subject to the effect of the exclusion of liability clause, which I deal with below.
284This submission invites me to find that, had Woodlawn complied with its contractual obligations during the critical period, that is had it acquired derivatives with the objective purpose of both enhancing returns and also hedging volatility it would have, at best, protected the fund from any loss at all (the "neutral performance" to which MVIL refers) or, at worst, would have caused the fund to suffer a loss no worse than that suffered, overall, in the ASX200.
285I cannot see how, on the evidence before me, I could come to that conclusion.
286The evidence establishes that the first two weeks of August 2011 were, as Woodlawn has submitted, a "turbulent period of world economic history".
287Woodlawn described the situation as follows:
"It is common ground that after Standard & Poor's down-graded the credit rating of the United States from AAA to AA+ the previous Friday, what followed, starting with the early opening markets such as Australia and continuing in the manner of a Mexican wave all around the world was a dramatic loss of value on all equity and financial markets during Monday 8 August 2011. It is also common ground that, on the opening of Australian markets, on Tuesday 9 August 2011, the effect of the previous day's events on world markets produced a free fall during the first hour or more in which 5.5% of value was lost - and many investment managers, including Woodlawn, exited on margin calls rather than risk cash - followed by a rebound and the ASX200 finishing the day ahead."
288Somewhat less colourfully, Mr Risk described the situation in the following terms:
"114. In June and July of 2011, market sentiment and economic news was very negative with many market participants suggesting that European and indeed global markets would not be able to digest the debt levels that had been accumulated by the respective countries. By the end of June 2011, it was clear that Europe and the US were still struggling to manage the fallout from the Global Financial Crisis. The US had embarked on two rounds of quantitative easing, releasing billions of dollars into the US economy in an attempt to kick start the economy.
115. By June 2011, the second US quantitative easing had finished and there were major concerns that the US was running out of money and as to its inability to stimulate its own economy. Republicans and Democrats were arguing over the US debt ceiling and the Federal Reserve was struggling to come up with a new financial tool to stimulate the economy. Uncertainly and with it, the Volatility of the financial markets, were again on the rise.
116. In Europe the economic climate was more dramatic. By June 2011 Greece was unable to pay its debts, money sent by the EU to bail out the Greek economy a year earlier had been spent and there was no improvement in Greece's economic situation. Greece was asking for another 100 billion Euro's [sic] to pay its debts. There was concern in the market that Greece's failure to meet payment on its debts would lead to default and its expulsion from the Euro zone. Concerns were growing that a Greek exit from the Euro would in turn lead to a domino effect with other EU countries defaulting on their debts and leaving the Euro currency system. It was suggested by some financial commentators that these defaults would have catastrophic economic consequences that could possibly bring down the entire world economy.
117. This was a period of heightened economic concern and volatility. Globally markets struggled to contain the fear as economic news in June 2011 to September 2011 became more negative in nature and market movements mirrored these fears. The S&P/ASX200 dropped 13% during July 2011 to September 2011 and the S&P500 dropped 13.9%. Market participants were generally looking for the best way to lower their risk Exposure as the economic news rapidly became more negative.
118. The Australian market, while not suffering from the same Exposures and debt levels as other economies also felt the effects of the global economic downturn. The funding costs of our major banks were again on the rise across international debt markets. Struggling to borrow money abroad, which was a large source of Australian bank funding, meant interest margins for the banks were squeezed and consequently mortgage rates would remain high for the average Australian."
289In his report, Mr Risk gave this evidence:
"[54] In my opinion, to benefit from lower Volatility than the S&P/ASX200 a Portfolio consistent with competent professional practice would need to:
(a) Consist of Equities which have historically low Volatility over the long term. Ordinarily this will include Equities on the S&P/ASX50.
(b) Be properly diversified. In my experience, one sector (for example the commodities sector) could be exceptionally volatile; while at the same time the financial sector might have considerably lower Volatility. Diversification across the Financial Markets helps limit a Funds exposure to a particular volatile sector.
(c) Exclude Speculative Equities. Although Speculative Equities are not defined to a definite list, in my experience Speculative Equities will often include Equities in the commodities, biotech or technology sector. This is illustrated in Appendix E; which shows the ASX200 Small Cap Resource Index Volatility versus the S&P/ASX200 Index Volatility.
(d) Utilise Protection Strategies in a timely and cost effective manner.
...
[63] The simplest way to protect a Long Position is to:
(a) Buy a Put Option;
(b) Buy a Put Spread; or
(c) Create a Synthetic Short position."
290Mr Risk went to on explain the workings of each of those instruments, in theory. As I set below, in cross-examination, Mr Risk emphasised the virtues of purchasing put options (rather than, as Woodlawn did, selling put options) as a means to hedge loss. However, Mr Risk did not, at any stage in his report, indicate what particular put options (or put spreads, or synthetic short positions) a prudent funds manager could and would have put in place, or had in place, in the first two weeks of August 2011; let alone, as Woodlawn has pointed out, at what cost, and with what precise result.
291In response to my enquiry as to the evidence available (from Mr Risk or otherwise) as to precise steps or strategies Woodlawn should have employed during the critical first two weeks of August 2011 to achieve either a "neutral performance"(that is, no loss to the fund) or a loss no greater than that suffered by the ASX200, MVIL drew attention to the following passages from Mr Risk's report:
"[150] In my opinion, Woodlawn's trading strategy was not one of competent or careful Trader during the Second Period especially in light of the negative economic news at that time. The potential was for the market to go down even further than it did, because in my opinion, the market was nearing pressure points similar to during the GFC. With Volatility spiking it was difficult to argue that the Australian market would not become embroiled in an aggressive sell off (as happened through 2008 and early 2009). Yet, Woodlawn positioned its trades entirely for an improbable global share market rally. Consequently, Futures Positions, Equity Options Positions, Index Options Positions and the Equity Positions of the Fund (of mainly commodity and energy names) were all exposed to the falling market. At this time the Fund's actual and leveraged Notional Exposure was very large, exceeding the total value of the Fund.
...
[181] Option and Futures Contract positions incurred severe losses during the Second Period. A large majority of these Options and Future Contract were quickly closed out or Margin closed out in the first two weeks of August. Had the ASX200 Future Contracts positions been hedged with OTM Put Options [which Mr Risk described as a put option which had a strike price more than the price of the underlying contract at the time of execution] the majority of losses would not have been incurred. The hedge positions could have been maintained throughout the volatile markets and benefitted from any subsequent moves upward in the financial markets leading to capital growth. ...the use [by Woodlawn] of Derivatives was speculative in nature and not used as a Hedge to manage risk. That strategy is not consistent with building long term value positions or creating a potential for long term capital growth.
...
[187] In my opinion Woodlawn failed to undertake its duties with the due care, skill and diligence that is expected in the finance industry of a competent Trader. A competent Trader managing MVIL's Fund should understand risk, and would use skill and care to ensure that risk Exposures created by open positions were minimal through adhering to strict risk management procedures and policies. Woodlawn should have understood the changing dynamics of the financial market throughout the middle of 2011 to ensure that during the Second Period when there was heightened Volatility any Exposure to large negative market moves were removed or at the very least kept to a minimum." (emphasis added)
292This evidence made clear Mr Risk's criticisms of the manner in which Mr McNamara managed MVIL's Portfolio during the September 2011 quarter, but, apart from the passage in Mr Risk's [181] that I have highlighted, Mr Risk does not suggest a particular course that Mr McNamara could have followed which would have yielded either a "neutral" performance or one no worse than that suffered by the ASX200. I understand Mr Risk to mean, in the highlighted passage, that had Mr McNamara arranged for the ASX futures contracts set out at [253] and [254] above to be hedged with "OTM Put Options" then the "majority" of MVIL's losses would not have occurred. But Mr Risk does not specify what put options should, or could have been acquired; or when they should have been acquired; or at what strike price; or when they should have been exercised; or with what likely result. All that Mr Risk says is that, had there been an adoption of a process described in these general terms, "the majority" of loss would not have occurred.
293In cross-examination Mr Risk gave this evidence:
Q. "...but in the events which happened in the market indeed markets worldwide, it wouldn't matter which market you were in, in which security, of what type. All of these markets as a result of this calamitous event followed essentially the same path of rapid loss, did they not?
...
A. Woodlawn sold put options. If you had put options protecting your portfolio then your decision here would not need to be made because you would be able to absorb that. That would be a partial loss, so as the market fell your performance wouldn't directly correlate with this move in the market.
Q. I don't think I've made my question clear enough. It wouldn't matter what financial product you were in, in these market circumstances they are all adversely affected?
A. No, that's not correct. If you own put options...
Q. Can you identify for me a financial product, for want [of] a better description, that would not have suffered in these circumstances?
A. This is what I'm saying. A put option gives you the right to sell or sell cash at a high price if the market was to fall, and if you own put options here you would make money or if you own equity and a put option you would lower your volatility so the performance of your portfolio would not [be] reflected by this move.
HIS HONOUR
Q. Is that laying off the risk?
A. Yes, that's right. So if you owned a $10 million portfolio...of equities you could actually go out and buy a put option on $10 million, and as the market falls that option makes you money and gives you the ability to be able to put the stock.
Q. Because you exercise...
A. You can exercise it or at the very least it would cushion this loss.
MR KELLY
Q. That's the same thing as a stop loss order or a hedge. It's just an opposite transaction to provide you with an exit in the event of an adverse movement. That's what it boils down to?
A. It does at a future time, that's right. At the very same time it allows you on a day like that where the market has fallen substantially you are not as concerned about the move because you have that option in place. It's like owning house insurance. It protects you at extreme times.
Q. It causes you loss between 2 o'clock and 3 o'clock on the same day when you've got an inversion and the market goes in the opposite direction?
A. But you're quite happy with that because the percentage of money you've spent to protect your portfolio is very small. So when the market bounces you get your value back on your portfolio.
Q. Is this right, what you're talking about is an exercise of judgment?
A. Risk management.
Q. Judgment when it comes to balances the range of risk in the circumstances in which you are managing the particular portfolio?
A. It's a risk management tool. It's about capital preservation. You don't enter these products if you don't have a position on it. If you have money in the bank you don't need to worry about that, but when you start playing in the equities markets, and this is what I do for a job, we have an obligation to our clients that if we're running their money our mandate is very similar to the mandate here where our clients want capital preservation and lower than market volatility. So as such we actively buy put options that protect us in the instance that this would occur.
Q. On the other hand, if the market moved in the opposite direction you'd lose on those hedges and put options?
A. And those are a very small portion of your return, that's right. That's why we manage this risk through the use of these products. You can pick levels where you can choose as much insurance or as little insurance as you like.
Q. According to your managerial judgment?
A. According to your mandate, I would suggest." (emphasis added)
294In that evidence, Mr Risk repeated his view that Mr McNamara should have acquired put options, but said that all this would achieve would be to "absorb" or "cushion the loss", "lower your volatility" and that there would be a "partial" loss (see the passages I have emphasised).
295MVIL made the following submissions based on that evidence:
"That evidence demonstrates that adopting the strategies [Mr] Risk considered to be consistent with competent practice by using derivatives would have protected MVIL from loss commensurate with the fall in the market. The alternative counter-factual universes are available on the evidence. Neutral performance [that is no loss at all] adopts the use of derivatives as protecting against the loss while not adopting any gain from being able to hold positions through, for example, 8 August. That counter-factual is available on the evidence. The other counter-factual assumes in effect no protective measures other than investing in a basket of securities matching or which was a close proxy for the ASX200 Index. In that sense it is favourable to Woodlawn in allowing for losses which should have been avoided by adopting protective measures [Mr] Risk considers should have been adopted, but otherwise accords with the [Mandate]".
296I do not accept those submissions.
297 First Mr Risk has expressed his opinions in terms of what a "competent trader" would do and with conduct "consistent with competent professional practice" whereas the critical question is what would have occurred had Woodlawn complied with the Dual Object Term. Further, Mr Risk's report reveals that he was instructed to assume that Woodlawn was "obligated" to manage the fund in accordance with the Aims (see [11] of his first report) whereas, in final submissions before me, MVIL accepted that the Aims were "aspirational" and did not constitute a promise by Woodlawn that they would be achieved.
298In any event, I do not see Mr Risk's evidence as establishing that, had Mr McNamara adopted Mr Risk's "strategies...consistent with competent practice" the result, on the probabilities, would have been to protect MVIL from any loss at all, or limit its loss to that suffered by the ASX200 Index (that is 13 per cent over the quarter). Mr Risk's opinions are expressed at a high level of generality and without reference to what particular steps, consistent with the Mandate as I have construed it, it is said Woodlawn should have taken. MVIL may well have been better off had Mr McNamara adopted Mr Risk's strategies and hedged the ASX futures with stop loss contracts; but I am not able to say, on this evidence, by how much.
299I accept Woodlawn's submission that Mr Risk's propositions are generic; none has specific content, let alone content with sufficient precision to establish a reliable "counter-factual". Mr Risk did not express any opinion as to the precise set of steps, or the precise strategy which could have been adopted (particularly in the first two weeks of August 2011) to achieve either a neutral performance or a tracking of the ASX200. And no such steps or strategy were put to Mr McNamara.
300Mr Risk agreed that 8 and 9 August 2011 were the single largest loss making days in the history of world financial and equities markets for the preceding 10 years. The market was down 11.5 per cent over the course of the previous few days; and after the United States lost its AAA credit rating, the ASX made a loss of $35 billion in share value.
301As Woodlawn submitted:
"On Black Tuesday [9 August 2011] the ASX200 fell rapidly during the morning and recovered to close higher than the previous day. During the downward movement on that day, a point was reached at which Woodlawn decided that the Fund's exposure should be closed out with a crystallized loss of $642,000 rather than put in cash to meet a margin call... . That turned out to be an error of judgment because the ASX200 bottomed out later in the day then recovered to close at a figure higher than previous day's close - but Mr Risk did not identify any earlier, or other, point at which he would have had a put option in place and closed out the risk with a better result."
302In effect, MVIL asked me to conclude that Woodlawn could not have complied with, and discharged its contractual and general law duties, without at least confining the loss to the fund to that suffered, overall, by the ASX200.
303I see no basis upon which I could, on the evidence before me, come to that conclusion; or, indeed to any conclusion as to what loss MVIL has suffered that it would not have suffered in any event during critical weeks in August 2011, even with Mr Risk at the helm.