Daily Management Review

Risk-parity Strategy Added Shine by Fed and BOJ


09/29/2016




Risk-parity Strategy Added Shine by Fed and BOJ
An alternative investment strategy that relies on cheap money and low market volatility to produce outsized returns was given a second wing by the Federal Reserve and Bank of Japan's actions last week.
 
Some big hedge funds and other institutional investors starved for yield by eight years of record low global interest rates have favored risk parity trades, which involve borrowing to take long positions in both stocks and bonds.
 
According to Morningstar, due to concerns about China's economy and tumbling oil prices there was spike in volatility which prompted investors to yank more than $2 billion from risk parity portfolios resulting in a rough 2015 for the funds. Delivering on balance returns more than twice as high as the mid-single-digit total returns from this year's sputtering U.S. equity and fixed-income markets, they have bounced back as volatility has fallen since January.
 
The $62 billion All Weather fund of Bridgewater Associates posted a 13.1 percent return from January through end of August. The firm pioneered risk parity investing two decades ago.
 
But market turned choppy as several policymakers seemed to suggest that a rate rise was in the cards in the run up to the Fed's Sept. 20-21 policy meeting and hence the rebound looked under threat then.
 
But the Fed effectively assured investors that borrowing costs will stay low for longer as it not only held fire, but also lowered its forecasts for future policy rates. The BOJ, on the other hand made a new pledge to keep 10-year bond yields near current levels around zero and affirmed its commitment to more asset purchases.
 
Gains in stocks, junk bonds, emerging market debt and other risky assets that risk parity funds target have been stoked by the action of the central banks. Market measures of risks of big swings in the stock and bond markets were also brought to their lowest so far this year by the action of the banks.
 
"So I would say if the Fed's latest move dampens cross-asset volatility, then leverage applied via risk parity funds should increase," Chintan Kotecha, senior equity derivatives strategist at Bank of America Merrill Lynch in New York.
 
But the question is whether the strategy that badly underperformed in 2015 and only started delivering again this year would be able to regain the confidence of the investors remains to be answered. For example, the AQR Risk Parity Fund, lost 8.1 percent compared with fractionally positive total returns for equities and bonds and Bridgewater's All Weather lost 7 percent in 2015.
 
Investors have so far remained skeptical while the case to buy risk-parity funds looks solid.
 
In the first eight months of 2016 to $8.50 billion, open-ended funds that employ risk parity have seen about $957 million in net outflows estimates Morningstar.
 
Bridgewater, the world's largest hedge fund company, declined to comment or provide data on investor flows. The Nasdaq-listed AQR fund is on pace for its 12th straight month of outflows with around $442 million in assets.
 
Despite a total return of 14.2 percent so far this year, including a 2.6 percent bounce last week after the Fed meeting, it has bled more than $200 million since September 2015, according to Lipper data.
 
A spokesman for AQR declined to comment.
 
(Source:www.reuters.com) 






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