The investment industry is slowly catching up with investors' need for more accurate benchmarking of risk-parity strategies.
Asset owners have lacked an appropriate performance measure to gauge the performance of their risk-parity investments since the strategy debuted on the institutional investor stage a dozen years ago, sources said.
But the industry's first commercial risk-parity indexes only were introduced within the past two years.
In 2017, Chicago-based Hedge Fund Research Inc.'s peer universe-based, non-investible HFR Risk Parity indexes was launched.
In 2018, New York-based Standard & Poor's Financial Services LLC created investible risk-parity indexes composed of futures contracts for three asset classes — equity, fixed income and commodities.
Both firms offer the indexes in versions that match the expected 10%, 12% and 15% volatility targets of risk-parity strategies.
The commercial risk-parity indexes are producing returns that are "getting closer to the strategic asset allocation of a risk-parity approach with less tracking error," than commonly used risk-parity benchmarks such as a U.S. or global 60% equity/40% bond composite, said Robert "Bob" Prince, co-chief investment officer of Bridgewater Associates LP, Westport Connecticut.
For example, Bridgewater's All Weather risk-parity strategy has a 3.5% tracking error against the 10% volatility target version of HFR's risk-parity index and 5.5% compared to the 10-volatility S&P risk-parity index, which are better than the 8.5% tracking error vs. a 60% equity/40% bond allocation.
Bridgewater manages $160 billion, $75 billion of which is managed in the All-Weather strategy.
A new entrant — Wilshire Analytics — will debut new risk-parity indexes in the next month or two. The new index family stems from a research project initiated some years ago by sister company Wilshire Consulting in response to questions from institutional clients about better ways to benchmark risk-parity strategies, said Steve J. Foresti, managing director and chief investment officer of the consulting practice, Santa Monica, Calif.
Wilshire's team created an internal benchmark, which captures how risk-parity managers invest across three main factors — growth (equity), safety (fixed income) and inflation-sensitive assets (commodities) — as well as targeted volatility in both the short and long term.
Wilshire's clients used the benchmark as one of several to measure the performance of their risk-parity investments, Mr. Foresti said, and more recently, expressed demand for a tradable transparent version of the benchmark that they could find managers to implement.
The soon-to-be launched indexes use published indexes to determine the components of the asset classes and gain exposure through derivatives. Mr. Foresti declined to describe the new indexes and their target volatility levels.
The advantage of the tradable risk-parity indexes for investors is the transparent performance attribution as well as "a steep discount for a risk-parity strategy. It's a compelling story for investors," he said.
He declined to provide the cost of subscribing to Wilshire's indexes but estimated the total cost for the investor of hiring a manager to run a strategy based on a Wilshire risk-parity index would be less than half the 35-basis-point cost of a traditionally managed turnkey risk-parity portfolio.
Mr. Foresti declined to name Wilshire clients that use its internal benchmark or those considering the new indexes for benchmarking existing investments.
Because the strategies are new, isources said they could not comment on Wilshire's forthcoming risk-parity strategy indexes.