Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
What went wrong for risk-parity funds in 2013, and how concerned should investors be going forward? For one thing, a long-expressed concern about risk-parity funds--that their leveraged exposure to bonds is exactly the wrong stance in the face of a potential secular rise in interest rates--reared its head when the bond market slumped at midyear on fears of early tightening by the Fed. While bond exposure remains a longer-term issue, it wasn't the only problem. Indeed, risk-parity strategies are designed on the assumption that not every asset class will be cruising at the same time, and stocks certainly held up their end of the bargain.
Commodities were another story. Many of the models likely assume that rising inflation usually accompanies falling bond prices, a positive for commodities. But that wasn't the case last year. Not only did inflation remain tame, but demand in key markets such as China continued to slacken. In contrast to the merely de minimis returns of the Barclays Aggregate Bond Index last year, commodity indexes generally lost money (the Dow Jones-UBS Commodity Index lost 9.5%, for example), and the active strategies used by certain risk-parity managers in some cases lost even more than the indexes.
But I think it concludes a bit too politically correct, based on my (poor) experience with AQR Funds...
More broadly speaking, the recent difficulties of risk-parity funds point to the challenges that advisors and investors face integrating outcome-oriented investments (such as many alternative strategies) into traditional, benchmark-oriented portfolios. As much as investors in theory may favor the notion of curbing downside risk and improving diversification, when they see the S&P 500 rocketing skyward they are likely to wonder, "Where's my beta?" Thus, it's incumbent on fund companies and advisors to properly educate investors on the purpose of vehicles like risk-parity funds, and to point investors to a wider array of benchmarks and risk-adjusted metrics (such as Sharpe ratio and beta) than the standard stock-only comparisons.
Basically, I found that when AQRIX was doing well, the firm was quick "to properly educate investors on the purpose of vehicles like risk-parity funds..." But when things headed south, the classroom door shut and communication about strategy shortfalls, lessons-learned, and needed improvements stopped completely. The emperor appeared to have no clothes after all...the strategy was just a black box!
Honestly, I remain intrigued by risk parity and other alternative strategies. Just need to ensure more shareholder friendly fund houses/managers, which I find in WBMIX, ALSIX, and RGHIX...to name a few.
It is when strategies are not doing well (and that will happen to all funds at one time or another) that its managers need to "educate investors" the most. So, with that foot-stomp (and venting), I believe Josh Charlson is spot-on.
Basically, I found that when AQRIX was doing well, the firm was quick "to properly educate investors on the purpose of vehicles like risk-parity funds..." But when things headed south, the classroom door shut and communication about strategy shortfalls, lessons-learned, and needed improvements stopped completely. The emperor appeared to have no clothes after all...the strategy was just a black box!
I'm not saying you're wrong, but just to throw out a "flip side",
one: is it AQR's responsibility to educate an investor on a strategy? Should it be the investor's responsibility to educate themselves as to what they're getting into?
two: AQR basically stopped marketing their funds to retail early on (and if I remember correctly, said as such.) They are focused on advisors and therefore, may believe that it is their responsibility to inform clients and educate themselves.
three: specific strategies are not going to have good years every year. The largest hedge fund - Bridgewater - had their risk parity fund not exactly have a good year, either. Was it AQR's handling of the strategy or an aspect of the strategy itself? Certain strategies just aren't going to have a good year every year.
However, I think there's an element of investors not educating themselves on strategies and therefore, their time horizon is "as long as it works" - when it stops working, they don't understand why and they dump it.
Was AQR perfect? No. However, I think there is an aspect of it where investors should take some responsibility.
I absolutely agree that "...investors should take some responsibility."
In the case of AQR, I believe several of us made active inquiries directly with the firm, but to no avail.
And, while I know I'm pretty slow, I felt comfortable enough with the strategy to be compelled by it, especially given its published mandates, like "drawdown control, stress testing, and volatility forecasting to help manage risk." And, AQR is a quant shop, with folks like Cliff Asness at the helm.
But, at the end of the end, the firm simply refused to publish its commentary the quarter it tanked. And if there was ever a quarter to not communicate, that was not the one.
If communication is not forthcoming from a fund manager, how else can investors know whether the strategy is being followed consistently or has changed, for better or worse?
That is one reason I find the MFO teleconferences so refreshing. And, several fund houses are regularly holding such teleconferences with shareholders, like Akre, Whitebox, RiverNorth. Ha, even DoubleLine!
I guess philosophically, I do indeed believe that investment firms have "responsibility to educate an investor on a strategy." Else, just not sure they can ever be considered shareholder friendly.
Even those not available on retail market - although AQRIX remains available on retail market, despite as you say, being geared toward advisers. It has it both ways, I suspect.
Not unlike shareholders in a company. Or, patrons of any business entity.
It wasn't meant to be harsh at all, so apologies if it came off as such. Fund shops do have some responsibility to educate shareholders, but I think at some point it's an investor's responsibility to understand the strategy and manage expectations. There's also the matter of time horizon for a particular strategy and more specific strategies are not going to have a good year every year or a good quarter every quarter. If you are expecting a good year every year, you're going to be disappointed, whether it's something like AQR Risk Parity or Marketfield.
I guess the whole thing comes out of situations like Pimco All Asset All Authority and the upset over that fund. That fund may have had a bad year, but I think there's a real aspect of unrealistic expectations based upon the strategy and stated goals.
If AQR did not publish reports on time, that's a definite negative but I think at the same time it becomes not knowing why - was it only that report that they didn't publish? If so, then that's a real issue.
"drawdown control, stress testing, and volatility forecasting to help manage risk."
I suppose my issue with that is my issue with managed futures mutual funds that can be long-short just about any asset class. How nimble can a mutual fund be? How much can a risk parity strategy deviate from the core strategy? Stress testing - well, what is their definition of "stress"? "Drawdown control" - well, what is the definition of "acceptable drawdown"? It's the investment version of "it depends on what your definition of is is."
My thought is that it cannot be that nimble and I believe the fund eventually did make changes, but not to the speed that people would have liked. If a fund with a strategy like this can't be as responsive to market movements as one would like, then it goes back to what is your time horizon and where does this strategy fit into your overall portfolio?
There is a desire for a fund that can be an "all-weather hedge fund", but when specific strategies come into play, then there is the real possibility that it can run into year-specific (or multi-year specific) problems. Even Bridgewater's "All Weather" fund did not have a good year last year.
"All Weather", which is effectively a risk parity vehicle, lost about 4% last year. That fund has $70B in assets.
I'm not saying that you're wrong - not at all and AQR probably could have handled the situation better - it's just the "variables" that I think come into play, too.
...was it only that report that they didn't publish? If so, then that's a real issue.
Scott, it was so weird. It was indeed the only quarter not published. They resumed again in September, never mentioning what went wrong or what was learned or how the strategy was modified or any of those things.
Remain incredulous to this date.
Again, good lesson for me. Will try to make sure I never make that mistake again.
Comments
Honestly, I remain intrigued by risk parity and other alternative strategies. Just need to ensure more shareholder friendly fund houses/managers, which I find in WBMIX, ALSIX, and RGHIX...to name a few.
It is when strategies are not doing well (and that will happen to all funds at one time or another) that its managers need to "educate investors" the most. So, with that foot-stomp (and venting), I believe Josh Charlson is spot-on.
one: is it AQR's responsibility to educate an investor on a strategy? Should it be the investor's responsibility to educate themselves as to what they're getting into?
two: AQR basically stopped marketing their funds to retail early on (and if I remember correctly, said as such.) They are focused on advisors and therefore, may believe that it is their responsibility to inform clients and educate themselves.
three: specific strategies are not going to have good years every year. The largest hedge fund - Bridgewater - had their risk parity fund not exactly have a good year, either. Was it AQR's handling of the strategy or an aspect of the strategy itself? Certain strategies just aren't going to have a good year every year.
However, I think there's an element of investors not educating themselves on strategies and therefore, their time horizon is "as long as it works" - when it stops working, they don't understand why and they dump it.
Was AQR perfect? No. However, I think there is an aspect of it where investors should take some responsibility.
Just my 2 cents.
I absolutely agree that "...investors should take some responsibility."
In the case of AQR, I believe several of us made active inquiries directly with the firm, but to no avail.
And, while I know I'm pretty slow, I felt comfortable enough with the strategy to be compelled by it, especially given its published mandates, like "drawdown control, stress testing, and volatility forecasting to help manage risk." And, AQR is a quant shop, with folks like Cliff Asness at the helm.
But, at the end of the end, the firm simply refused to publish its commentary the quarter it tanked. And if there was ever a quarter to not communicate, that was not the one.
If communication is not forthcoming from a fund manager, how else can investors know whether the strategy is being followed consistently or has changed, for better or worse?
That is one reason I find the MFO teleconferences so refreshing. And, several fund houses are regularly holding such teleconferences with shareholders, like Akre, Whitebox, RiverNorth. Ha, even DoubleLine!
I guess philosophically, I do indeed believe that investment firms have "responsibility to educate an investor on a strategy." Else, just not sure they can ever be considered shareholder friendly.
Even those not available on retail market - although AQRIX remains available on retail market, despite as you say, being geared toward advisers. It has it both ways, I suspect.
Not unlike shareholders in a company. Or, patrons of any business entity.
I guess the whole thing comes out of situations like Pimco All Asset All Authority and the upset over that fund. That fund may have had a bad year, but I think there's a real aspect of unrealistic expectations based upon the strategy and stated goals.
If AQR did not publish reports on time, that's a definite negative but I think at the same time it becomes not knowing why - was it only that report that they didn't publish? If so, then that's a real issue.
"drawdown control, stress testing, and volatility forecasting to help manage risk."
I suppose my issue with that is my issue with managed futures mutual funds that can be long-short just about any asset class. How nimble can a mutual fund be? How much can a risk parity strategy deviate from the core strategy? Stress testing - well, what is their definition of "stress"? "Drawdown control" - well, what is the definition of "acceptable drawdown"? It's the investment version of "it depends on what your definition of is is."
My thought is that it cannot be that nimble and I believe the fund eventually did make changes, but not to the speed that people would have liked. If a fund with a strategy like this can't be as responsive to market movements as one would like, then it goes back to what is your time horizon and where does this strategy fit into your overall portfolio?
There is a desire for a fund that can be an "all-weather hedge fund", but when specific strategies come into play, then there is the real possibility that it can run into year-specific (or multi-year specific) problems. Even Bridgewater's "All Weather" fund did not have a good year last year.
http://finance.fortune.cnn.com/2014/01/09/ray-dalios-all-weather-fund-goes-cold/
"All Weather", which is effectively a risk parity vehicle, lost about 4% last year. That fund has $70B in assets.
I'm not saying that you're wrong - not at all and AQR probably could have handled the situation better - it's just the "variables" that I think come into play, too.
It was a good lesson-learned for me.
Remain incredulous to this date.
Again, good lesson for me. Will try to make sure I never make that mistake again.