From Tyler Durden: Variously marketed as “all-weather”, “all-season”, or “bulletproof”, the so-called “risk-parity” strategies of some of the world’s largest hedge funds have been anything but ‘stable’ since the election as the combination of leverage and bond losses have crushed the gains from an exuberant equity market.
Promise people something for nothing and you are going to attract a lot of attention. Stumble in the process and the critics will be quick to pounce.
As The Wall Street Journal reports, the weeks since the election have been rough for one of the most polarizing investment strategies out there: risk parity.
The strategy – which simply put, involves using diversification – and sometimes borrowed money (leverage) – to find an (historically-optimized) balance between risk and return.
Bridgewater’s variant of this strategy, for example, has historically used borrowed money to invest about $1.50 for each dollar in assets, often putting the leverage in historically less-volatile bonds. The goal is stocklike returns with less volatility.
Problems occur when histroical relationships between asset-classes break down… just as they did during this year (when the historical norm of inversely correlated bond and stock prices reversed completely)…
The post-election rally in stocks and selloff in bonds hit these portfolios, embolding critics of the approach…
Bonds have been in a bull market for 35 years, so adding leverage would have produced strong returns for a modest increase in volatility, says Ben Inker of fund management firm GMO. He also argues that “volatility and risk are not the same.”
As WSJ concludes, the strategy has sharply underperformed both stocks and a traditional 60% stock 40% bond index fund offered by Vanguard since 1993.
Without the benefit of leverage, lower volatility equals lower returns. Even with it, though, there are occasional bumps in the road. For investors whose moods are as fickle as the weather, risk parity may involve more risk than reward.
SPDR S&P 500 ETF Trust (NYSE:SPY) closed at $223.53 on Friday, down $-0.82 (-0.37%). In 2016 as a whole, the SPY gained 10.78%, including dividends.
This article is brought to you courtesy of ZeroHedge.