“During our 10 years of managing risk parity portfolios we have seen it generate strong performance in rising and declining rate environments as well as bull and bear equity markets. This experience is a testament to the robustness of diversification in RP portfolios.”
His colleague, Rob Job, head of PanAgora’s business development and client solutions, adds: “When you have a well-diversified portfolio across a broad set of asset classes which participate in growth, such as equities, or offer protection in contractions such as bonds as well as inflation protected assets, it is very rare that all three will be negative for a long period of time. The results have played out well in terms of our own performance where we were positive in both 2013 and 2014 which were very different market environments.”
Many risk fund managers have also adopted a much more proactive tone.
“The concept has evolved from its origins as a pretty much static portfolio, to one that actively manages the risk level and diversification to one where managers can also express active views,” says Mike Mendelson, principal of AQR. “The essential idea is still to build a risk diversified portfolio, and, we believe, to keep it that way as the market environment evolves. This means changing the expo-sures to different asset classes to maintain risk balance as market volatility changes. To the extent that active views can add value, that’s great and we do that in some of our risk parity funds, but managers need to be modest about this – strong views come at the expense of diversification and so the bar should be pretty high before implementing them.”
STOP PLAYING WITH IT
Dan Mikulskis, director, ALM & Investment Strategy at consultancy Redington warns though that investors need to look at the extent of the tinkering.
“One of the key areas is how managers are allowing for the dynamism. A lot of little decisions require skill but you do not want them to be too dynamic and respond to every change. The good managers will be able to strike a balance.
“To us it is important that the process is systematic because the whole point of risk parity is to provide systematic exposures to core asset classes’ betas, without too much discretionary intervention.”
Matthias Scheiber, multi-asset fund manager at Schroders, adds: “Risk parity is not a magic bullet. One of its biggest limitations is that diversification can become compromised if all the assets are expensive. If you need to put in more leverage to get the returns then that should be a warning sign for too high return expectations. We start with a risk parity approach but tilt the holdings based on valuations. The aim is to build a portfolio that can weather most storms. The upside will not be as much if equities gain in a strong economic growth environment but will smooth returns in a downturn and throughout a market cycle we will make a decent return.”
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