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In the American camp/classic television show Happy Days, the height of cool was The Fonz. With his leather jacket and mop of dark hair, The Fonz (always capitalized, even when spoken) epitomized what men of a certain age wanted to be: edgy, funny, desired, and a lovable rogue through-and-through. The Fonz was all these things, that is, until he took to the water and jumped a shark—literally, at least for television—with the aid of water skis, a powerboat, and a very bad script. All of a sudden, The Fonz wasn’t that cool anymore. The show’s popularity quickly declined. Thus the phrase “jumping the shark” was born: a good thing gone overboard, an idea whose time has passed.
In March, aiCIO asked whether risk parity jumped the shark. It was a question that three years ago would have seemed absurd. At that point, panel discussions on the topic had to start with a basic definition of risk parity; answers on aiCIO‘s inaugural Risk Parity Investment Survey suggested more confusion than cohesive thinking.
Not anymore. While there is still much debate over what constitutes “true” risk parity (passive or active? product or strategy?), there is no longer the need to define its basic meaning. Instead, at least according to the amount of mail received in response to our question, the debate du jour is whether risk parity has been too successful and has, like The Fonz, passed its prime.
Responses have ranged from the negative (“this strategy makes too much intuitive sense to be a fad”) to the affirmative (“it certainly has jumped the shark because why would you buy levered bonds now?”) to the aggressive (“one risk parity vendor is acting like an intellectual bully”). Perhaps the most interesting argument, however, was that the nascent trend of risk parity’s inclusion in defined contribution (DC) plans mimicked the sadly common trend of “less sophisticated” investors being sold something right before a crash. “Isn’t this just like every other financial instrument that then blew up?” one respondent asked. So we went looking to see if this analogy held true.
We ended up in Denver, Colorado. Denver, it turned out, is home to one of the first DC plans to use risk parity (although as part of a target-date fund, and not as a stand-alone option). CenturyLink Investment Management, which runs the defined benefit plan for communications giant CenturyLink, also has a hand in choosing the company’s DC investment options. “We began investing in the Bridgewater Risk Parity (All Weather) DC fund in December 2011,” said CIO Kathy Lutito. “Risk parity is really a portfolio construction strategy. It aims to have solid returns with low volatility, which is definitely aligned with the same objectives of a good DC plan. Think about that in a target date fund framework: as workers get closer to retirement, that’s exactly what they want.”
Clearly, neither Lutito nor her investment committee are concerned that the construct has jumped the shark—although she admitted that she didn’t understand the reference right away. “We’ve had risk parity in our defined benefit plan for a long time,” she said. “When we suggested it for the DC plan, we already had a well-educated investment committee on the subject, so we didn’t get much pushback.”
If asset gathering success is a sign that a shark has yet to be jumped, then the success of Bridgewater, and of other asset managers guiding risk parity into DC plans, seems to belie The Fonz comparison. Risk parity is more popular than ever. According to sources, the DC-focused cousin of Bridgewater’s All Weather fund had $480 million in the DC assets at the end of January, with three clients. They expect to have more than $1 billion by the end of the summer.
Bridgewater, of course, had nothing but praise for Lutito and her pioneering commitment. “We’ve worked with CenturyLink going back to their US West days in the early 1990s,” said Bob Prince, co-CIO at Bridgewater. “Over that time they’ve been first-movers into innovative strategies such as inflation-indexed bonds (three years before the US issued TIPS), separating alpha and beta, and adopting the All Weather principles eight years ago. Adding a risk parity allocation to their target date funds is just the latest chapter in what has been a great 20-year partnership, and one of constant innovation by Kathy and her team.”
Whatever this DC-in-risk-parity growth suggests, one respondent summarized the shark-jumping quandary best. “It probably hasn’t jumped the shark, and we probably aren’t in a bubble, but risk parity will likely hit the same wall as every other popular asset class,” he wrote. “With so many assets flowing in, much risk parity will likely see subpar returns compared to the earlier years.” A recent signal out of Westport, Connecticut supports this claim: Bridgewater’s All Weather strategy will soon be closed to new investors, with new allocators being moved into a risk parity-lite fund. “There are only so many Bulgarian bonds, or whatever, that you can invest in,” one investor commented, referring to the passive approach (through which many bonds are bought) used by the firm.
If it’s true that risk parity’s future holds subpar returns, The Fonz analogy will have to be tweaked. It’s not that risk parity jumped the shark. It’s that investors might be swimming with them.