Risk-parity managers seeing promise in China

Risk-parity managers have been planting their flags in China this year, and some observers expect volatility-battered investors on the mainland to prove receptive to the strategy's promise of steady, superior risk-adjusted returns.

On July 7, Boston-based PanAgora Asset Management Inc. announced a risk-parity-focused strategic tie-up with China Asset Management Co., a top fund management company in China with 526.6 billion renminbi ($78.7 billion) in assets under management.

Under the partnership, China Asset Management began offering a Chinese risk-parity strategy —built on PanAgora's research and investment approach — to local institutional and retail investors earlier this month, with plans to follow it up with a broader suite of products.

The same day, AQR Capital Management LLC — a Greenwich, Conn.-based manager of hedge funds, quantitative long-only equity and risk-parity strategies — won regulatory approval to set up an office in Hong Kong.

In May, meanwhile, news emerged that China's regulators had granted a license to Bridgewater Associates LP, the Westport, Conn.-based money manager that pioneered risk parity, to set up a wholly foreign-owned investment arm in China.

A spokesman for Bridgewater declined to discuss the company's plans.

In a July 11 telephone interview, Jesse Huang, a Boston-based director of strategic relations with PanAgora and leader of the firm's business efforts in Asia, said “now is the right time” — after the Chinese stock market's violent gyrations of the past 18 months — to introduce an approach offering local investors less volatility and higher risk-adjusted returns.

PanAgora, which manages a quarter of its $40 billion in hedge fund, long-only equity and risk-parity AUM on behalf of Asia-Pacific clients, began studying its China options a year ago, and quickly focused on China Asset Management as a strategic partner, Mr. Huang said.

The fact that PanAgora's majority stakeholder, Montreal-based Power Financial Corp., acquired a 10% stake in China Asset Management in 2011 helped bring the two firms to the table, but they only moved ahead with a partnership after both sides considered a range of options, he said.

China Asset Management announced its tie-up with PanAgora in Beijing to an audience of roughly 350 local institutional investors.

Mr. Huang predicted broad potential interest from Chinese insurance companies, corporate “enterprise annuities” retirement plans, other big pension and sovereign wealth funds as well as high-net-worth individuals.

Some analysts concur.

Risk parity “will attract institutional interest,” led by banks — which have seen returns from a pure fixed-income portfolio drop below 3% from around 5% a few years ago — but also big public pension plans, sovereign wealth funds and enterprise annuities, among others, predicted Ivan Shi, Shanghai-based director of research with financial markets consulting firm Z-Ben Advisors.

However, some observers said local insurance companies might still have to clear regulatory hurdles governing their exposure to leverage or derivatives before making allocations to risk-parity strategies.

Mr. Huang pointed to China Asset Management's knowledge of local markets and regulations as a means of working through such issues in structuring the firms' risk-parity offerings.

Executives at China Asset Management couldn't be reached for comment.

Meanwhile, after three years of uneven returns, an upturn in performance this year could provide a helpful backdrop for efforts to introduce a broader Chinese audience to risk parity, which leverages a portfolio's exposure to fixed income and other asset classes, such as commodities, to bring their contribution to a portfolio's overall risk in line with that of more volatile equities.

As of July 21, the Salient Risk Parity index was up 19%, with a 7% gain in June.

If 2013's “taper tantrum,” when the first hints of a U.S. retreat from quantitative easing sent global stocks plunging and interest rates spiking, was a risk-parity nightmare, this year — with government bonds, commodities, Treasury inflation-protected securities and emerging markets all rebounding — has been a sweet spot, said Gregor Andrade, a New York-based principal with AQR and head of the firm's international team.

While many institutional investors have been struggling to get above mid-single-digit returns this year, a number of risk-parity strategies have posted double-digit returns for the first half. Mr. Huang said PanAgora's main risk-parity strategy has achieved a 17% gain for the first six months of the year.

If PanAgora and China Asset Management are the only ones talking about a Chinese risk-parity strategy now, a number of industry veterans predict the continued inefficiency of China's volatile, retail-dominated equity market and the policy-driven nature of its equity and bond markets won't prove major obstacles to crafting a local offering.

That's not to say that the idiosyncrasies of China's deep equity and bond markets wouldn't require a risk-parity strategy with “Chinese characteristics,” as some observers noted.

A dearth of derivative instruments, relatively high execution costs and the fact that different investor segments dominate China's stock and bond markets should cause a local strategy's outcomes to differ from a global one's, but not to the extent of negating the benefits of targeting risk exposures in portfolio allocations, said Keith Pogson, senior partner, Asia-Pacific financial services, with Ernst & Young in Hong Kong.

By way of example, over the past 18 months, stocks and bonds in China have often not moved, in relation to each other, the way those asset classes would be expected to move in a global risk-parity portfolio, where a risk-off stampede out of stocks would likely lead to safe-haven buying of bonds.

For January 2016, when the Shanghai composite plunged more than 19%, the price of 10-year Chinese government bonds actually slipped, lifting yields. And between mid-2014 and June 12, 2015, when the Shanghai composite more than doubled, bond prices rose as well, lowering the yield on the benchmark bond to 3.66% from 4.17%.

Mr. Huang said PanAgora and China Asset Management's decision to pursue a partnership rested on extensive research — and back testing — by both firms, which confirmed that the application of a “risk-parity philosophy to Chinese asset classes works well,” even if some adaptations were needed, in areas such as how to lever different exposures.

China Asset Management's expertise in local markets has been key to meeting those challenges, he said.

From a broader perspective, AQR's Mr. Andrade noted that geographic diversification is a major component, together with asset-class diversification, of the broader diversification that's a strength of risk parity, so the costs and benefits of narrowing a strategy's geographic footprint need to be carefully considered.

Mr. Huang said the back tests by PanAgora and China Asset Management showed a “very compelling” case for a Chinese risk-parity strategy, and that over the long term it should work well in delivering more stable returns than alternative approaches. Back testing, for example, showed a more than 50% Sharpe ratio improvement for their risk parity product, compared to the prevailing Sharpe ratios Chinese institutional investors get with their traditional asset allocation approaches, Mr. Huang said.

The fact that its performance doesn't always trace a global developed markets risk-parity strategy could make a Chinese risk-parity strategy a great option to consider for foreign investors looking for efficient and uncorrelated exposures to Chinese assets, he said. n