Risk Parity: Innovation or Marketing Fad?

Risk Parity Innovation or Marketing Fad?“Business has only two functions: marketing and innovation,” according to Milan Kundera, author of The Unbearable Lightness of Being. The question asked by Chief Investment Officer is whether risk parity, an alleged “revolution in how to construct a portfolio and manage assets,” is more about the former or the latter – marketing or legitimate innovation. To find out the answer, CIO conducted a survey of institutional investors between August 26 and September 22, 2014, asking their views on risk parity investment strategies and asset managers. The results, which are summarized below, can be reviewed in greater detail on CIO‘s web page for the 2014 Risk Parity Survey.

Survey Respondents

CIO’s survey included “risk parity users and potential users,” such as private and public pension funds, endowments and foundations, defined contribution plans, and other institutional investors. Each group’s level of participation is summarized below:

  • Corporate pension fund (25.8%)
  • Public pension fund (27.3%)
  • Endowment/foundation (15.1%)
  • Defined contribution plan (24.2%)
  • Other (7.6%)

In terms of assets 22% of respondents managed less than $1 billion; 15% managed $1 billion to $5 billion; and 64% managed more than $5 billion. All percentages here have been rounded.

Risk Parity Trends

While the percentage of respondents using risk parity increased from 37.4% in 2013 to 46.3% in 2014, the percentage “considering” an allocation to risk parity products fell from 17.7% to 8.3% in that same time. This drop likely reflects a concern with the disappointing 2013 returns of three of the major risk parity providers: AQR, Invesco, and Bridgewater. “I think it has scared off new activity,” said one industry consultant, in an article published by CIO.

Investors with less than $1 billion under management were most interested in allocating to risk parity for the first time, with 20.8% saying they were “considering” doing so – an increase from 2013’s 15%. Funds with more than $5 billion in assets were the least interested in initiating risk parity investments, with only 6.3% “considering,” down from 23.1% last year. Of course, part of the reason for these results is that more of the larger investors have already allocated to risk parity than smaller investors.

Among current risk parity users, 27.1% said they planned to increase their allocations in the next 12 months, and two-thirds said they planned to maintain their existing allocations. Only 6.3% said they planned to reduce their risk parity holdings.

Nearly half of current risk parity users said they had less than 5% of their assets allocated to risk parity, and only 10.2% said risk parity accounted for more than 25% of their assets.

Strategy Comparison

When given the choice between the “60/40” approach, the endowment model, and risk parity, only 24% of respondents said risk parity would likely be the strategy that performs the best over the next ten years. Twenty-six percent said “60/40,” while the endowment model was the most popular strategy, with 36.5% of respondents saying they think it will be the best performer. Thirteen-and-a-half percent of respondents favored an approach other than “60/40,” the endowment model, or risk parity.

Risk Parity Survey CIO Magazine

Conclusion

“There is definitely some valid theory behind risk parity,” according to Josh Charlson, director of alternative funds research at Morningstar. “And while I don’t say that it is purely a marketing endeavor, I think there has been some strong, if you will, marketing behind it as well.”

Timothy McCusker, CIO of NEPC, agrees: “I do think risk parity is a revolution in how to construct a portfolio and manage assets. I do not think it is just a marketing fad. This is something legitimate that leads to better solutions for clients.”

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