PaulSingerElliottManagement:RiskyParity

GrantsInterestRateObserverFall2013ConferenceOctober22,2013
Whydoesfinancialinnovationfrequentlyfail?
Portfolioinsurance
o Inventedinthe80s
o Buyingfuturescouldreplicateputoptionsmorecheaplywithmoreliquidity
o Allowedfundstopurchaseriskierassets
Riskparityhassomeofthesameattributesofportfolioinsurance
o Currentlyabout$1trillionmanagedunderthisstrategy
Thereareforcesthatcouldreshufflethedeck
TherearesomekeyassumptionsofRiskParity
o Thelowerriskassetshavethesameriskadjustedreturnasthehigherriskassets
However,bondsareactuallymuchriskierthantheythink
o Stocksandbondsarenegativelycorrelated
Riskparityistheideathatina60/40bond/equityportfolio,~90%oftheriskmeasuredby
volatilityisinthestocksegment.Byapplyingleveragetothebondportionandreallocating
itspossibletoachievethesameexpectedreturnbutwithvolatilityspreadevenly
Commentariesonriskparity
o Leverageisnotinherentlygoodorbad
However,thisleverageisconcentratedonbondswhichhavebeenina30
yearbullmarket
o Volatilityneedstobeestimatedfrequently
Inotherwordsitsaveryactiveapproach
TheFedsmoneyprintingisunprecedented
TheFedbuyinghasdistortedthestockandbondmarketsandnooneknowswhatasset
classeswouldlooklikewithoutit
Inflationisastrongpossibility
o Everyonepointstodownwardwagepressurebutmarketscanturnonadime
Ifbothstocksandbondsgodown,volatilityisabust
o Volatility=risksointheeventthatbondsdropsignificantly,bondvolatilitygoesup
andriskparitydemandsthatmorebondsaresoldtolessenthevolatilityexposure
Inafewyearswemaybeleftwonderingwhyweleveredupourbondportfolioswhen
yieldswerenearalltimelowsfollowinga30yearbullmarketwithmassivegovernment
interventionthatwassoontoberemoved.