Is It Time Party With Parity

A look at how retail products offer an institutional strategy.

Part of the work as an advisor is time spent looking for tools to use in client portfolios that could allow for better risk adjusted result and while I end up using far fewer new things than I actually look at it is still a lot of fun. A case in point is risk parity. The catalyst for this post was a brief article at Bloomberg that tried to make the point that risk parity funds will become more accessible to individual investors. The article never closed the loop on that, it mentioned one fund from Putnam without giving the full name or symbol and never mentioned the AQR Risk Parity Fund (AQRIX). The Putnam fund is the Putnam PanAgora Risk Parity (PPRYX).

I did a little further looking and found the Wealthfront Risk Parity Fund (WFRPX) and in Canada there is the Horizons Global Risk Parity ETF which trades in Canada with symbol HRA. Traditional mutual funds are an alphabet soup of ticker symbols as is the case with AQR and Putnam so if you're interested, take a proper inventory of the fund classes to make sure you consider the right one. Morningstar shows the Wealthfront fund having a $5 million minimum so that might mean it is only available at Wealthfront. Per Yahoo Finance and otcmarkets.com there is no five letter OTC symbol for US access to the Horizons fund. There is still plenty to look at and learn from.

The first chart looks at AQRIX compared to SPDR S&P 500 (SPY) and the iShares Core Aggregate Bond ETF (AGG) going back to 2010;

And HRA compared to SPY and AGG since its inception;

PPRYX and WFRPX have been around for less than a year so I did not chart them.

As a quick reminder, risk parity tries to balance out the risk of holding various asset classes. This is usually accomplished by levering up the fixed income exposure in order for that exposure's risk to equal the risk of the equity exposure. Different funds come at differently but for understanding and as an example only, if you have a $100,000 account and wanted to include leverage to implement risk parity maybe you'd put $20,000 in equities and $120,000 in fixed income.

Aside from generic risks of using leverage, if interest rates go up then a risk parity fund that owns the wrong part of the fixed income market as rates rise would likely get crushed. An active manager can of course attempt to allocate around this threat.

If you click through to the holdings of AQRIX or PPRYX, you can see the asset allocations decisions made but the holdings won't really make sense to many people, it is mostly-entirely futures contracts and certainly is not something that the typical do-it-yourselfer could replicate nor could the typical advisor replicate what they're doing. Buying either fund boils down to a belief in the fund manager and of course liking what you can see from their track records. Yes, past performance does not guarantee future results but if the charts moved sharply from the upper left to the lower right, is there any chance you'd buy?

Where risk parity generically owns equity and fixed income you might expect that the funds charted would perform somewhere between the two asset classes and that has been the case. If you look closely at the charts, you'll see that both AQRIX and HRA are capable of having noticeable declines every now and then. Taking the longer standing AQRIX $10,000 has grown to about $15,000 while $10,000 60/40 SPY/AGG would be about $22,000. Playing around with Morningstar a little shows the beta for AQRIX surprisingly high at 0.88 versus 1.00 for SPY. As a single holding, a substitute for a 60/40 portfolio, it may not be too compelling but what is? However substituting for a 50/50 portfolio which would have gone from $10,000 to a little over $16,000 for the period studied it might be a little more interesting.

HMA's portfolio would be much easier to replicate. Here it is;

The Horizon funds listed are easily replaced by funds traded in the US. HRA appears to not use leverage and the prospectus says it can't used levered ETFs, like 2x or 3x funds. When I first thought about writing this post, I thought about whether using 2x or 3x bond funds could replicate risk parity. It might even be possible to figure a way to use currency funds as part of the strategy.

Were I to do this, I would not want to take interest rate risk and there are levered ETNs at the shorter end of the treasury market, could they work without too much interest rate sensitivity?

Maybe not. DTUL is the iPath US Treasury 2-year Bull ETN and DFVL is the iPath US Treasury 5-Year Bull ETN. They are not that sensitive to rising rates at the long end of the market but appear to be sensitive to the FOMC rate rising cycle, it is said that the two year is most sensitive to FOMC policy. Also both ETNs are relatively complicated which is saying something for ETN, have no AUM and don't trade. In a completely differently light the ETNs might have utility for having what appears to be a negative correlation to the S&P 500.

Going back under the hood of HRA it could be argued that it is more of a mutli asset fund than a true risk parity strategy. It can go global as the name indicates but a similar asset mix with more US equity exposure instead of its international probably would have allowed it to be more competitive with a 60/40 SPY/AGG mix which would have returned about 14% as HRA gained 2% over the last couple of years.

Where a lot of smart investors talk about trying to keep things as simple as possible, of all the things risk parity is, what it isn't is simple. I'm not sure risk parity is the answer for my clients but if you're interested in it, the path of least resistance might be AQRIX or PPRYX which both have expense ratios in the low one percents.

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