Corporate & Securities Law

This is an alert related to a new type of fund known as a risk parity fund.  It's become a substitute for balanced funds that hold stocks and bonds and form the core of many investors' portfolios.  According to a recent Wall Street Journal article, these new parity-funds may be creating new risk of their own. 

Like balanced-funds, the new risk parity funds generally hold stocks, bonds and other investments, but the difference is, that unlike standard balanced funds, which are often tilted toward stocks, risk parity funds focus on balancing risk across asset classes.  As a starting point, these funds roughly equalize the level of risk that stocks, bonds and other investments contribute to the portfolio, hence the "risk parity" label.  That generally means scaling back allocations to riskier assets such as stocks, but levering up lower-risk investments such as bonds, often by using derivatives.  Firms involved in these funds are AQR Capital Management, Managers Investment Group (which has launched Managers AMG FQ Global Essentials Fund), Invesco and Putnam Investments.

The funds' use of leverage and tendency to boost bond allocations have sparked controversy among money managers and research firms. That said, more funds are on the way.  Invesco, for example, plans to introduce a risk parity commodity fund, which will seek to balance risk among hard-asset categories like energy and precious metals.

Risk parity portfolios tend to look far different from the standard 60/40 approach, partly because managers use derivatives to boost allocations to lower-risk assets.  Putnam Investments' institutional risk parity fund, for example, generally has up to $1.50 of market exposure for every $1 shareholders invest.  Most of that exposure is currently in bonds, with smaller weightings in stocks, real estate and commodities. 

But given the volatility in the markets, risk parity funds' use of leverage concerns some analysts.  According to the Wall Street Journal, leverage magnifies an investment's ups and downs.  It wrought havoc for many investors during the financial crisis.  In their defense, risk parity managers say they reduce the risk of leverage by sticking with easily traded derivatives.  However, amid market upheaval, even some high-quality bonds can become difficult to trade.

SNSFE continues to monitor this issue as the risk of those funds, we believe, is not being adequately communicated to investors, especially on the retail level.  Those with information should feel free to contact attorneys at SNSFE.

Source:  Wall Street Journal