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Bridgewater under the Weather

'Depression mode' decision good news for competitors

Updated with clarification

Bridgewater Associates Inc.'s decision late last year to put its $21 billion All Weather strategy into “depression mode” could provide an opening for a bevy of new competitors looking to pick up market share.

Launched in 1996, All Weather remains the marquee name among diversified beta strategies, which leverage up exposure to higher Sharpe ratio-lower return asset classes, with the promise of equitylike returns and bondlike volatility.

While the Westport, Conn.-based firm had the field to itself for the better part of a decade, competition is heating up.

Over the past three or four years, AQR Capital Management LLC, Greenwich, Conn.; Barclays Global Investors, San Francisco; and PanAgora Asset Management Inc. and Putnam Investments, both in Boston, all launched competing products. More recent entrants include First Quadrant LP, Pasadena, Calif.; Invesco (IVZ) Ltd., Atlanta; Mellon Capital Management Corp., San Francisco; and State Street Global Advisors, Boston.

“We've been recommending these strategies for years,” but it's only been the past year or two where the universe has really started to develop, said Joseph Nankof, a partner with Norwalk, Conn.-based investment consultant Rocaton Investment Advisors.

While it remains the 800-pound gorilla, Bridgewater's decision to pull the plug on leverage late last year, when the financial system appeared to be teetering on a precipice, rankled some clients.

Bridgewater “panicked at the most negative inflection point” of the market's decline, walloping performance by delevering at the worst possible time, said one All Weather client, an executive from a defined benefit plan with more than $1.4 billion in assets, who asked not to be named.

Bridgewater partially reversed course in early spring, as the recovery was picking up steam, once again incurring heavy costs to lever up the portfolio at a less-than-opportune moment, the executive said.

Performance tracker eVestment Alliance, Marietta, Ga., reported that the All Weather strategy lost 7.7% of its value in the year ended Sept. 30. It trailed its benchmark — 40% MSCI World/60% Citi World Government Bond index — by 15.71 percentage points.

In an interview, Robert Prince, Bridgewater's co-chief investment officer, conceded the All Weather portfolio would have had higher returns over the past year — roughly double its actual 16% gain for the 12 months through Oct. 31 — if it hadn't gone into “safe” mode. (The dramatic shift from a decline for the year through Sept. 30 to a gain for the year through Oct. 31 reflected October 2008's figures, when the S&P 500 index tumbled 17%, falling out from the rolling 12-month performance data.)

Nonetheless, the decision to act on the “depression” trigger Bridgewater put in place eight years ago was the right one at a moment of tremendous uncertainty, when rock-bottom interest rates were constraining economic policymakers' ability to steady a credit system falling into a self-reinforcing debt-liquidation spiral, Mr. Prince said.

Only the Federal Reserve Board's decision in March to begin aggressively printing money finally turned the situation around, he said.

Wouldn't change

Occasional showers

“If we had it to do again, we would do it the same way,” he said, noting that for the 13 years since inception, All Weather has delivered annualized returns of 9.5% — 50% above the return of the average balanced institutional portfolio — with 25% less risk.

The risks to the system when the “safe” mode decision was made were “just tremendous,” and with no signs yet of private-sector credit creation that would allow the central bank to take its foot off the gas, those systemic risks “remain tremendous” today, Mr. Prince said.

The next time around, however, clients will have the choice of defusing Bridgewater's “depression” trigger, an option the firm began offering in October because “some clients wanted to have that ability,” Mr. Prince said.

Investment consultants said the market leader's recent rocky road could help the growing ranks of firms with leveraged, diversified beta strategies win mandates from clients looking to diversify their “risk parity” manager lineups.

All Weather defines the risk parity market segment, but newer competitors are distinguishing themselves by the amount of active portfolio construction and asset allocation in their processes, including tactical shifts in accord with the type of economic or market environment prevailing at a given point in time, said Eyal Bilgrai, managing senior research analyst with Menlo Park, Calif.-based investment consultant Alan D. Biller & Associates Inc.

Competitors report growing interest in the strategies.

Coming out of the recent market volatility, “we're seeing an increase not only in plan sponsor interest” but from consultants as well over the past six to eight months, said Michael Anderson, director of strategic relations with PanAgora.

PanAgora's Risk Parity Total Return strategy, which has attracted roughly $200 million since its launch in 2006, is garnering a lot more attention this year and could easily see its assets double or triple by mid-2010, Mr. Anderson said.

Better insurance

Scott Wolle, Invesco (IVZ)'s CIO of global asset allocation, said his firm's Premia Plus strategy — with equity assets for growth periods, levered holdings of fixed-income assets for recessionary times and commodity exposure for inflationary periods — provides a “better insurance policy” at a time of great economic uncertainty.

Launched at the height of market volatility on Sept. 30, 2008, Premia Plus has returned 17% for the past 13 months, garnering $400 million in institutional assets and another $300 million in retail assets so far.

These kinds of strategies “work very well in choppy, directionless markets,” said Robert L. Borden, chief investment officer of the $23 billion South Carolina Retirement System, Columbia. The likelihood that such markets could prevail for the next few years led South Carolina to double its combined tactical asset allocation-risk parity allocation target to 10% at the start of 2009, he said.

Currently, Bridgewater's All Weather strategy accounts for roughly 2.7%, or $640 million, of South Carolina's total assets, with another 2%, or $460 million, in Putnam's risk-parity offering. Staffers are studying how to boost the state fund's risk-parity investments, Mr. Borden said.

A wide variety of views exists on how investors should incorporate these strategies into their portfolios.

In a better version of a balanced portfolio, investors putting $100 million into the strategy could carve out $60 million from their equity holdings and $40 million from their bond holdings, said Ralph Goldsticker, managing director of strategic investments with Mellon Capital. Mellon launched its Advanced Beta strategy in July 2008.

Dan Farley, a managing director with SSgA and head of U.S. multiasset class solutions, said investors looking at risk-parity strategies primarily as a way to diversify away some of their equity risk, to limit damage to their portfolios when stock markets swoon without overly sacrificing returns, can either carve out holdings from their equity allocation or consider it an alternatives allocation.

SSgA has just brought out its Optimized Beta strategy, which uses a blend of the firm's commingled funds and derivatives, with a dynamic process to adjust its set of equity, fixed-income and real asset exposure, he said.

Some observers see a broader role for the strategy in institutional portfolios. “If you buy into the philosophy” that this is the way to organize your portfolio's beta asset allocation decisions, then it makes sense for investors to consider putting all of their assets into the strategy, said Steven J. Foresti, managing director and head of the investment research group of Wilshire Associates Inc., Santa Monica, Calif.

Mr. Borden said officials at South Carolina have decided to look at that option, with “an action item in our strategic plan to study just that.”

Mr. Wolle noted that, effective Nov. 4, Invesco took a step in that direction on the defined contribution side, making Invesco's Premia Plus strategy the centerpiece of its target-date funds, in place of the old mix of Invesco-related mutual funds and exchange traded funds.

Mr. Borden wouldn't rule out further increases in South Carolina's risk-parity allocations over time. He declined to second-guess Bridgewater's decision last year to derisk its All Weather portfolio, praising the firm's skill and culture.

Ed Peters, co-director of global macro with First Quadrant, said his firm launched its Essential Beta portfolio early this year, with risk-budgeted weights of 42.5% each for equities and bonds, and 15% for real assets, and shifts in exposure to maintain a constant risk budget. Searches being conducted now suggest both growing institutional interest in risk parity products, and a desire by investors to diversify their manager lineups, he said.