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PERSONAL FINANCE
Bloomberg Businessweek
May 14, 2018
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better explain to me why I should have it over
passive investing,” tweeted Austin Johnsen, head
of corporate development at the game streaming
site Twitch Interactive Inc.
Wealthfront’s plunge into risk parity represents
one of the biggest attempts yet to take the strategy
into the mainstream. A handful of other mutual
funds ofer some version of the approach, but
it’s largely been the domain of hedge funds and
institutional investors. There may be as much
as $500 billion invested in risk parity, making it
common enough that it’s sometimes singled out
as a likely suspect—fairly or not—for unexplained
bouts of volatility in stock and bond markets. Last
year, Paul Tudor Jones II, the billionaire founder
of Tudor Investment Corp., said risk parity could
act as “the hammer on the downside” when tur-
moil returns to equity markets as managers rush
to adjust their strategies.
So what the heck is it? The strategy begins from
a premise familiar to many investors: diversiica-
tion. For example, in addition to stocks, you want
to have some bonds, which won’t necessarily fall
in value at the same time as equities. The problem,
risk-parity advocates say, is that even if you’re split
pretty evenly between stocks and bonds, most of
the volatility in your portfolio will come from the
equities. In a bear market, holding even a little bit
in stocks can expose you to losses. You can equal-
ize this by tilting more heavily to bonds, but then
you end up in a low-risk portfolio that gives up
potential return.
Many risk-parity funds try to solve this with
leverage. A manager might create a portfolio heav-
ily exposed to the bond market but do so using
derivatives that increase the value of the fund’s
bets, magnifying potential gains as well as poten-
tial losses. The hope is that the fund will provide
some protection when the stock market drops but
deliver higher returns than a simple bond-heavy
portfolio. Throw in exposure to other asset classes,
such as commodities, real estate investment trusts,
and emerging-market bonds, and the risk is even
more spread out.
Risk parity looked really good during the inan-
cial crisis, when stocks fell sharply. A long stretch
of strong bond returns also helped. But lately
bond yields have been rising, with the benchmark
10-year Treasury at about 3 percent. (Bonds fall in
value as yields and interest rates rise.) JPMorgan
Asset Management, Jefrey Gundlach of DoubleLine
Capital, and others say a bond bear market is on
the way. If so, some risk-parity strategies could be
in for a bumpier ride.
The approach varies in terms of how complicated
or simple it is, with each irm having its own spin.
Wealthfront’s fund gets leveraged exposure to asset
classes using derivatives called swaps. The fund
reweights investments to try to keep the portfolio
at a set level of annual volatility, but that’s just a tar-
get. The prospectus says actual volatility could fall
above or below the fund’s goal. Wealthfront’s web-
site says it doesn’t consider this active management,
because it’s a “rules-based” approach.
Risk-parity elements such as leverage and
other complicated inputs have historically been
conined to quantitative money managers work-
ing with sophisticated investors. There’s a reason
for that. Individual investors shouldn’t be putting
money in strategies they don’t understand well,
says Maneesh Shanbhag, who, after ive years at
Bridgewater, co-founded Greenline Partners. “The
issue isn’t that it’s a bad strategy. It’s that investors
don’t know when they’ll underperform and outper-
form and why,” he says. “They’ll sell at the bottom,
while an informed investor stays in.”
Wealthfront has acknowledged some investor
qualms, speciically about costs. The risk-parity
fund originally had an expense ratio of 0.5 per-
cent of assets per year. That compares with
expenses averaging 0.15 percent for other ETFs in
Wealthfront’s portfolios. Because of the backlash,
the company cut its expense ratio to 0.25 percent
just a couple of months after the fund’s launch.
Andy Rachlef, a co-founder of Wealthfront, told
Bloomberg News in April he was caught by sur-
prise when customers were upset about the higher
fee. “We thought continuing our policy of always
delivering existing services at better prices than
available would be compelling,” he said, adding
that if he could launch the product over again, he
would have chosen the lower fee to begin with.
“Most of our clients shared our excitement on
the launch of Risk Parity, and we have signiicant
assets committed to the fund,” says Wealthfront
spokeswoman Kate Wauck. About $900 million is
committed, although some is still in the process
of being moved to the fund in a tax-eicient way.
Investing by and large has been getting simpler
for individuals, who can diversify broadly across
markets at a very low cost. But fund companies and
advisers still want to be able to ofer an edge to jus-
tify even low fees in an increasingly cost-competitive
market. “I look at it as this race occurring to add
more strategies, more capabilities,” says Devin Ryan,
an analyst at JMP Securities LLC. In short, complex-
ity isn’t dead.
—Julie Verhage and Dani Burger
THE BOTTOM LINE Wealthfront built its business on helping
people get into simple, low-cost investments. Now it’s putting some
clients into a strategy favored by hedge funds.
○ Rachlef