Institutional investors, money managers and a hedge fund index developer collaborated to create a series of investible risk-parity benchmarks that's catching the attention of chief investment officers, investment committees and trustees.
The new risk-parity indexes were developed by Hedge Fund Research Inc. in collaboration with the $81 billion Ohio Public Employees Retirement System, Columbus, to solve the problem investment staff encountered in finding an appropriate benchmark for the fund's $4 billion risk-parity portfolio.
In 2012, OPERS allocated 5% to risk parity — "a rules-based leveraged investment strategy" — but the benchmark for the portfolio assumed the allocation was to unleveraged stocks and bonds, said Richard D. Shafer, chief investment officer, in a memo to the board of trustees.
The resulting disconnect between the returns of OPERS' risk-parity portfolio and its benchmark resulted in tracking error of more than eight percentage points over a three-year period, Mr. Shafer said, prompting investment staff and the fund's investment consultant, NEPC LLC, to try to "improve the fit" because "no common industry benchmark existed."
OPERS provided "active assistance" to HFR in creating the peer-group risk-parity indexes and staff has found that "OPERS' realized results now closely match the HFR Risk Parity Vol 15 Institutional index (back-tested),'' Mr. Shafer said in the memo.
The Ohio public employees' risk-parity benchmarking dilemma is universal, sources said.
"Risk parity is a blanket term that covers a very large universe of investment approaches that tend to be very different from each other,'' said Colin Bebee, senior vice president and consultant at Pension Consulting Alliance LLC, Portland, Ore.
"It's a portfolio construction, an asset allocation strategy, rather than a traditional asset class," Mr. Bebee said. "You end up with an apples-to-oranges comparison if you try to compare individual managers," a problem that is exacerbated when investors try to find a suitable benchmark for comparison with a multimanager risk-parity portfolio, he added.
"Everybody needed (an index like) this but nobody had asked us to create one," said Kenneth J. Heinz, president of Chicago-based HFR, adding that "risk-parity managers have wanted something like this for a long time."
HFR, best known for its extensive range of peer group-based hedge fund indexes, applied the same portfolio construction methodology to build the risk-parity indexes.
Index construction equal-weights a peer universe of 25 risk-parity strategies managed by 16 money managers with aggregate risk-parity assets of about $110 billion.
The indexes are based on three levels of volatility targets: 10% (or less); 12% (with a range of between 10% and 15%); and 15% (or greater).
Each volatility level also offers an institutional version, for risk-parity strategies with at least $500 million under management.
Sister company HFR Asset Management is prepping a series of manager-of-managers tracker funds for investors who want to invest in the entire universe of each equal-weighted index.
Mr. Heinz declined to provide a list of the risk-parity managers in the HFR peer-universe indexes but sources said some of the industry's largest managers, such as Bridgewater Associates LP, AQR Capital Management LLC, Panagora Asset Management Inc., BlackRock Inc. and First Quadrant LP, are included.
Risk-parity managers' eagerness to provide historical returns and to assist HFR in creating the indexes was driven by recognition of the difficulty clients were having with benchmarking their approaches.
"Over the years, benchmarking risk-parity strategies has been difficult. Institutional investors have struggled with finding a good benchmark," said Michael Mendelson, principal and a portfolio manager of risk-parity investments for AQR Capital Management, Greenwich, Conn.