Ask these seven questions before putting clients into these challenging funds.
If the concept of risk-parity investing intrigues you, but you’re not keen on assembling a portfolio yourself, the mutual-fund industry offers a handful of solutions.
Indeed, risk-parity mutual funds have had a bit of a coming-out party over the past year. The biggest splash comes from the Invesco Balanced-Risk Allocation series, which launched in late 2008 and has steadily expanded its profile, gathering $7.7 billion in assets over the past 12 months through January to reach its total of more than $12 billion. AQR, meanwhile, is one of the largest risk-parity players in the institutional world. It recently saw its mutual fund assets in the AQR Risk Parity strategy exceed $1 billion. And over the past year and half, Putnam, Columbia, and Salient have all added their flavors of risk-parity to the mix.
Any advisor considering risk-parity vehicles can learn about the field and narrow down the options by asking a series of questions:
1. What does the fund aim to do?
Beyond two broad common principles—allocating by risk rather than nominal asset class weights and using leverage to amplify returns—no two strategies are the same. Risk-parity funds’ short track records and weak disclosure make them more difficult to understand. Study the prospectus closely to glean risk and return objectives, strategies and instruments the managers may use, and internal benchmarks.
Morningstar currently identifies six mutual funds that follow a risk-parity strategy (Exhibit 1). We place all of these funds in the world allocation category. (Another candidate, RPG Diversified Risk Parity, is excluded because it defines its primary objective as producing returns similar to those of a hedge fund index.)
2. Who is managing the assets and what is the team’s track record running such strategies?
The short answer is that the public track record for risk-parity funds is thin, which is unsurprising given that the concept itself hasn’t been around for long. Still, some providers have noteworthy experience on the institutional side. AQR has the longest-running institutional, pure risk-parity strategy, and the alternatives-oriented firm has ample experience and resources for dealing with sophisticated risk-management and derivatives- based strategies.
Invesco has the mutual fund with the longest record, and it has a strong asset-allocation team, but it’s only been running the institutional version of the strategy a few months longer than the mutual fund. Putnam is perhaps better known for its retail offerings, but its global asset-allocation team is a long-tenured group that has run an institutional version of its strategy since 2006. (Longtime asset-allocation head Jeff Knight, however, recently departed Putnam for Columbia, which offers a rival risk-parity fund.)
First Quadrant, the subadvisor for Managers AMG FQ Global Essentials, is a known quantity when it comes to global macro investing and subadvises several alternativesoriented vehicles.