Money managers want to use leverage, but plan sponsors still consider it a dirty word.
The latest firm to push the idea of using leverage is PanAgora Asset Management, Boston, which is incubating its "Risk Parity Plus" portfolio. The new product will take the traditional 60/40 split between stocks and bonds, but boost leverage of the bond portfolio so the risk represented by it equals that of the stock portfolio, said Ed Peters, chief investment officer.
The strategy is similar to the All-Weather Fund, managed by Bridgewater Associates, Inc., Westport, Conn. That fund, which was created in 1997, takes the traditional 60/40 portfolio and increases leverage of the bond portfolio by about 2 to 1 through borrowing and futures, said Ray Dalio, president and chief investment officer. Mr. Dalio said the fund has about $8 billion, mostly from institutional clients, and is designed to return about 10% on an annual basis.
"We don't have to borrow much," said Mr. Dalio. "We can use futures, so there need not be a lot of borrowing."
But plan sponsors — jaded by the high-profile blowups of hedge funds that used excessive leverage, such as the 1997 demise of Long Term Capital Management LLC — are still not convinced that leverage is safe.
"You'll notice the hedge fund managers that have gone bad all used an excessive amount of leverage," said Richard Curtis, executive director at the $600 million Ohio Highway Patrol Retirement System, Columbus. "I have a great deal of concern about borrowing assets so that you can invest more in one strategy, because if something goes wrong, you're on the hook for those borrowed assets. I think some people have learned to use leverage to their advantage. I think you can dampen risk by putting borrowed assets into someplace that's counter-correlated with what you're already invested in. But I think public plans should have leverage limits and enforce them in their contracts."
John Thompson, trust investment manager at TXU Corp., Dallas, a utility that manages a total of $4.3 billion in defined benefit and nuclear decommissioning trust assets, said, "We don't use (explicit) leverage in any of our portfolios, primarily because using leverage increases your risk. We believe that there are other ways to gain alpha without using leverage. We do use futures and swaps in our portfolios, but they are all backed by cash so we don't consider that leverage."