Over the past year or two, risk parity has shed its “oddball” image and become mainstream, said David G. Kabiller, founding principal and head of client strategies with AQR.
Robert Job, head of global business development and client relations with Boston-based PanAgora Asset Management, reported similar trends. Net inflows this year of just less than $700 million to PanAgora's risk-parity strategies have helped its AUM reach $2 billion, he said.
Investors who have brought out strategies within the past few years predict greater institutional inflows for their products as well, as they achieve three- to five-year track records. Scott Walle, Atlanta-based CIO of Invesco Global Asset Allocation, said his firm's $2.6 billion Premia Plus risk-parity strategy, which has attracted strong mutual fund inflows this year, is getting more attention from large institutional clients and investment consultants. The strategy, which was launched Sept. 30, 2008, has an annualized gain of more than 14%.
Risk parity has attracted greater scrutiny this year from market analysts as well as investors. For some it remains unclear whether attractive risk-parity performance gains over the past decade prove the strategy's merits or simply reflect the particular market conditions that prevailed during that period.
Without a thorough explanation of what optimization problem risk parity solves, it's tough to draw any conclusions about the strategy, noted Peter Rappoport, a New York-based managing director and head of the strategy group with J.P. Morgan Asset Management. “Anybody who's leveraged bonds as opposed to equities has done very well in the last 10 years,” but people shouldn't confuse a secular decline in interest rates with the success of risk parity, he said.
Do positive risk-parity returns this year suggest superior risk management, or did those strategies “just happen to have levered the year's best performing strategies and hedged down the worst performing strategies?” asked David Holmgren, investment director with Hartford, Conn.-based Hartford HealthCare.
While the argument for risk-based portfolio allocations is a strong one, the argument for leveraging a “low risk” asset such as bonds — essentially “doubling down on a beta trade” — is less obvious, said Mr. Holmgren, who oversees roughly $2 billion in endowment and pension assets for the non-profit. “Levering up an asset class which could fall a little holds the same potential outcome as holding funds in an asset class that could fall a lot,” he said, adding “the (risk-parity) soup smells delicious but the recipe calls for some ingredients I can't swallow.”
Other market analysts — while conceding there's no theoretical reason to conclude that a risk-parity-based portfolio will produce superior investment returns — are more favorable.
Either a traditional 60%-40% portfolio or alternative portfolios can make sense, depending on one's expectations for returns and correlations among asset classes, said Wai Lee, New York-based chief investment officer of Neuberger Berman Group LLC's quantitative investment division. But Neuberger's team found strong evidence that “risk parity is the best starting point” in an environment where there's considerable uncertainty about those forecasts, Mr. Lee said.
By contrast, a 60%-40% portfolio would only be optimal when investors are extremely bullish about the risk-reward trade-off stocks are offering relative to bonds, he noted.
Neuberger Berman will introduce its first risk-parity offering — Neuberger's Dynamic Beta Navigator strategy — later this year, with seed investments from some clients, Mr. Lee said. He declined to identify the clients.
Risk-parity veterans concede that leveraging bonds when yields are near historic lows remains a point of concern for existing and prospective clients alike.
An executive at a multibillion-dollar corporate defined benefit plan with risk-parity allocations, who declined to be named, said “The jury is still out on (Mr. Inker's) warnings.”
Risk parity relies on a negative correlation between bond prices and stock prices, and things will be tougher if some trigger — such as inflation or a “China buyers strike” — causes bond prices and stock prices to become positively correlated, the pension executive noted.
David Graham, a spokesman for the $11.2 billion Ohio Police & Fire Pension Fund, Columbus, said his fund is moving ahead with a three-year plan adopted in 2010 to put a portfolio-wide risk-parity structure in place, even as historic low bond yields have left staff there reviewing how to move forward.
Last year, OP&F levered its global inflation-protected securities allocation by a factor of two while trimming the system's equity holdings, but delayed adding a leveraged long-duration bond component to its portfolio due to concerns about low rates — which ultimately went even lower. “We remain believers that risk parity will in the long run deliver superior returns to traditional allocations, but are nonetheless discussing how to implement the remaining fixed-income piece,” he said.
Still, several managers and investment consultants insist the current extremely low yield environment doesn't undermine the case for risk parity.
Concerns about leveraging bonds in this environment remain a challenge, but depending on the pace of the rebound in yields, relative to expectations, and how it's spread out over the yield curve, a risk-parity strategy should still be able to do better than a traditional 60%-40% portfolio over the long run, said Erik Knutzen, CIO with Cambridge, Mass.-based investment consultant NEPC LLC.