Morningstar Advisor - April/May 2013 - (Page 46)

Spotlight A Guide to Mutual Funds Running Risk-Parity Strategies By Josh Charlson Ask these seven questions before putting clients into these challenging funds. If the concept of risk-parity investing intrigues you, but you’re not keen on assembling a portfolio yourself, the mutual-fund industry offers a handful of solutions. Indeed, risk-parity mutual funds have had a bit of a coming-out party over the past year. The biggest splash comes from the Invesco Balanced-Risk Allocation series, which launched in late 2008 and has steadily expanded its profile, gathering $7.7 billion in assets over the past 12 months through January to reach its total of more than $12 billion. AQR, meanwhile, is one of the largest risk-parity players in the institutional world. It recently saw its mutual fund assets in the AQR Risk Parity strategy exceed $1 billion. And over the past year and half, Putnam, Columbia, and Salient have all added their flavors of risk-parity to the mix. glean risk and return objectives, strategies and instruments the managers may use, and internal benchmarks. Morningstar currently identifies six mutual funds that follow a risk-parity strategy (Exhibit 1). We place all of these funds in the world allocation category. (Another candidate, RPG Diversified Risk Parity, is excluded because it defines its primary objective as producing returns similar to those of a hedge fund index.) 2. Who is managing the assets and what is the team’s track record running such strategies? 1. What does the fund aim to do? The short answer is that the public track record for risk-parity funds is thin, which is unsurprising given that the concept itself hasn’t been around for long. Still, some providers have noteworthy experience on the institutional side. AQR has the longest-running institutional, pure risk-parity strategy, and the alternatives-oriented firm has ample experience and resources for dealing with sophisticated risk-management and derivatives-based strategies. Beyond two broad common principles—allocating by risk rather than nominal asset class weights and using leverage to amplify returns—no two strategies are the same. Risk-parity funds’ short track records and weak disclosure make them more difficult to understand. Study the prospectus closely to Invesco has the mutual fund with the longest record, and it has a strong asset-allocation team, but it’s only been running the institutional version of the strategy a few months longer than the mutual fund. Putnam is perhaps better known for its retail offerings, Any advisor considering risk-parity vehicles can learn about the field and narrow down the options by asking a series of questions: 46 Morningstar Advisor April/May 2013 but its global asset-allocation team is a long-tenured group that has run an institutional version of its strategy since 2006. (Longtime asset-allocation head Jeff Knight, however, recently departed Putnam for Columbia, which offers a rival risk-parity fund.) First Quadrant, the subadvisor for Managers AMG FQ Global Essentials, is a known quantity when it comes to global macro investing and subadvises several alternativesoriented vehicles. 3. What asset classes will the fund hold? Risk-parity funds all may allocate to asset classes based on risk rather than dollar amounts, but they often differ in the asset classes they hold. Whether labeled asset classes, risk exposures, or risk factors, every risk-parity fund provides exposure to at least one growth factor (usually stocks), interest-rate factor (usually sovereign bonds), and inflation hedge (commodities or inflationprotected bonds, sometimes both). The strategies diverge when it comes to credit or high-yield bonds. Invesco does not include credit exposure, believing the correlation with equities is too high, nor does Columbia, whose managers worry about the sector’s liquidity. Other providers, including AQR, Putnam, and AMG First Quadrant, do hold high-yield bonds.

Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013

Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot

Morningstar Advisor - April/May 2013