Readers' Friday

Risk Parity
Wednesday's column on the new allocation strategy of risk parity elicited several comments about the imprecision of its name. Risk, after all, can be variously defined. CrocInTheMoat writes, "I think a more accurate name for the risk-parity approach would be 'historical volatility parity.' "

True enough for those risk-parity providers who blend assets based solely on the historical data. However, I suspect that some (and perhaps many) modify the initial data to create "forward-looking estimates," thereby eliminating the charge that their investment approach only looks backward. I don't think that changes the outcome, though. No matter how risk is defined, it seems that risk parity will have more bonds and fewer stocks than does a standard asset allocation.

That's been a big problem over the past couple of months. Today's The Wall Street Journal covers the carnage in "Fashionable Funds Hit Hard" (no link, paywalled). Per data from some company called Morningstar, risk-parity mutual funds are down 6.75% on average for the year to date, while a hypothetical standard balanced fund consisting of 60% S&P 500 and 40% Barclays Aggregate Bond Index would be up by 6.76%. Thirteen and one half percentage points is a whole lot of ground to concede in less than half a year.

Ah well, risk-parity providers can cheer themselves with this comic take from Buzzfeed. In truth, it's not very funny, but as Samuel Johnson said about a dog walking on his hind legs, the wonder is not that a comedy article on risk parity is done well, but that it is done at all. Which might also be said about a daily mutual funds column.

Too Good To Be True
That same column's observation about the allure of bond funds carrying high yields and low volatility brought this comment from duanej: "Who remembers Managers Intermediate Mortgage fund? It was 20 years ago when these fund managers were the grand masters of good yield and low duration. No other operator in the mortgage fund business could touch them ... until 1994 happened. As I recall, they posted losses of 20%-30% during that year."

Oh yes, I remember. In 1994, I was the fund analyst covering Managers Intermediate Mortgage. I dutifully reported on the fund's very high usage of exotic mortgage derivatives, and dutifully pointed out that there was no other fund in the marketplace like it, but I did not foresee the fund's collapse should interest rates spike. At that time, Morningstar did not have access to a bond database; I couldn't check up on the manager's claim that he hedged his long and short bets on interest rates. I was too trusting. The lunch most decidedly was not free. It rarely is.

Functionary, Please
Tuesday's column on hedge funds led to a debate between those who shared the column's view that hedge funds mostly exist to shear the wealthy, and those who believe that outsiders don't know a thing about the subject. Trenchantly expressing the latter view was capecod, who wrote, "Thank God the wealthy are so foolish and ignorant, otherwise [there'd] be no hope for the common man ... er ... ah, or [something] like that! You don't want to get on the wrong side of the former clerk in charge of M*'s hedge fund database."

That would be "functionary," thanks very much. 

Actually, while I was decidedly clerkish in covering Managers Intermediate Mortgage, I was a good hedge fund analyst. I gave this talk in June 2008 when hedge funds were at their peak in prestige, assets, and performance. For the time, the presentation was a downer, carrying warnings about the quality of hedge fund performance data and the increasing correlation between hedge funds and the stock market. The speech wasn't particularly popular, of course.

The U.K. Experiment
Finally, I wrote twice this week about sales commissions. Monday's column explored the idea of unbundling commissions entirely from mutual fund prices, so that those giving financial advice would not be paid by fund assets. It was a discussion and not a recommendation. Thursday's column, in contrast, was an attack at one particular commission structure, the 12b-1 fee, leading to a call that it be abolished. 

The comments, naturally, became a battle between advisors and direct investors, with each tending to regard me as a stooge for the other side.

There was a useful exchange on the proposal to eliminate 12b-1 fees. I wrote, "I appreciate the logic that a) investors need advice, b) advice costs money, and c) smaller investors do cost more per dollar amount to service. In such cases, it would seem that the new model of institutional share + separate advisory fee is the way to go." A defender of 12b-1 fees, jimmy23, responded that this solution would be "impossible, 1) you would need too many clients, which would become impossible to service; 2) the barriers to entry for FAs would make it impossible to enter the business; and 3) clients wouldn't send in their checks for service fees when the market is down and FAs would need to turn into collection agencies."

That could be, jimmy23. I do appreciate the argument that a solution might make sense in theory but not in practice. Fortunately, another country is doing the test work for us. Beginning this year, the United Kingdom is eliminating all commissions from new sales of fund shares. No front-end commissions, no back-end commissions, no ongoing trail fees. And funds in the U.K. are distributed almost entirely through financial advisors. So ... we shall see.

Great Minds
Trade-industry publication Ignites asked those who work at fund companies if the star manager is indeed (almost) extinct, as this column pondered last week. The vote was 70% to 30% that yes, star managers are a dying breed. When asked this same question less than two years ago, less than 41% of respondents responded yes.

Black (and Red) Friday
It's 6:45 a.m., and Blackhawks fans are already lined up in front of the office for when the parade marches by around 11 a.m. How is it possible to get all of those suburban teens up so early on a summer day? It will be a long, loud day.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.