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Not All Risk Parity Strategies Sucked Last Year

One firm argues for a less tactical approach — and the data (for at least one year) backs them up.

Edward Qian, chief investment officer of multi-asset at PanAgora Asset Management, believes there is enough value in risk parity without managers also trying to figure out where the market is headed. It’s an approach that made PanAgora’s risk parity investments outperform peers by wide margins in 2020, a year when many competitors disappointed investors.

Risk parity is an alternative to the classic portfolio made up of 60 percent stocks and 40 percent fixed income. Instead, it balances risk across asset classes, including commodities, with the intention of doing well over different cycles and with less volatility than a 60-40 portfolio.

Last year, many managers significantly de-levered their strategies — meaning they targeted less risk — in March, when markets cratered as a result of the pandemic and stay-at-home orders. As a result, many missed the rebound later in the year.

“If you stick with a passive risk parity strategy, where a manager can add some tactical decisions but in a very controlled way, we believe risk parity is going to deliver,” said Quian, who is credited with coming up with the name risk parity, which now defines a whole category of funds. “But if you make big decisions like deleveraging or big tactical shifts, then you are actually contradicting the spirit of risk parity.”

PanAgora refused to provide performance numbers because of strict compliance restrictions, but according to information from multiple institutional databases, the PanAgora strategy that targets 10 percent volatility returned 13.4 percent in 2020; its 12 percent volatility strategy returned more than 15 percent; and its 15 percent version of the strategy returned almost 19 percent. Over 10 years, the risk parity 15 percent strategy returned 11 percent on an annualized basis, according to the databases. 

PanAgora’s funds outperformed one of the largest managers in the category. Bridgewater’s All Weather 10 percent portfolio delivered 9.47 percent in 2020 and has an 7.83 percent annualized return since inception, according to sources familiar with the firm. Meanwhile, Bridgewater’s All Weather 12 percent returned 10.16 percent in 2020 and 8.05 percent annualized since inception. “Last year, like many other investors, Bridgewater experienced a drawdown in March,” a source said. “While the firm spent substantial time researching pandemics and significantly adjusted its risk management controls in Q1, it ultimately wasn’t enough to overcome the size and speed at which the global economy collapsed in this short time.”

The HFR risk parity index that targets 10 percent volatility, which represents the returns of the largest risk parity managers in that category, returned 3.6 percent in 2020. Conversely, the S&P risk parity index 10 percent, which is passive, returned 11.5 percent. 

“That tells you a lot of risk parity managers have implemented a deleveraging process, and totally missed the rebound in Q2 and Q3,” said Qian. “Only in Q4 did they catch up. They view risk parity products like hedge fund strategies. It’s not a hedge fund. I say this not because I know what specific managers were doing. I’m just comparing two existing public risk parity indices.”

Qian said that during the global financial crisis, risk parity managers were rewarded for deleveraging. Even though the GFC was an exception, many risk parity managers put a deleveraging process into their strategies, he said. 

“There are a lot of parallels with active management in general,” he said. “Investors want to claim they can make tactical calls in terms of interest rates or where the  market is going.”

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