Risk parity strategies were hit hard by the
fallout from the UK’s referendum on European Union membership, data show—and they could be
caught off guard again.
Such funds loaded up on equities and other risk
assets immediately prior to the referendum on June 23, according to
analysis by Markov Processes International (MPI). This left risk parity
investors exposed to the spike in volatility that followed the vote in favor of
“The volatility prior to
the vote in risky asset classes not only decreased, but decreased more than
fixed income, a traditionally safe haven during periods of crisis,” MPI’s
report stated. As risk parity strategies favor low-volatility asset classes in
order to balance out risk across their portfolios, “more responsive” funds
shifted allocations towards equities, MPI said.
“This suggests that any anticipation within the
markets of the dramatic sell-off did not surface in shifts in volatility,” the
report said. “In fact, risk parity portfolios were being positioned for an
appreciation of risk assets.”
A number of funds experienced losses close to, or higher than, their stated maximum value at risk measure.
Performance of risk parity funds on June 24 following Brexit.
Last August risk parity funds were blamed by some
investors for contributing to sharp sell-offs, as they are more likely to
reduce equity exposure during periods of high volatility. A number of products
performed poorly in 2015, but prior to the UK’s referendum they had in aggregate
recouped most of the losses incurred during 2016.
AQR Co-Founder Cliff Asness argued in
December that investors should not be put off by short-term
performance. “Drawdowns in real life always seem to feel longer and induce more
pain than you’d imagine looking back,” Asness said. “This is true for risk
parity and all of investing.”
MPI warned that a short period of positive
performance was equally no reason for investors to “let their guard down.”
should be wary of the types of events to which risk parity funds are calibrated
to adapt,” MPI said. “What we just experienced could very well be the beginning
of a new cycle of volatility surprises.”
Parity Investment Survey & Waking Up
to a Different Europe