To view this article in digital format, click here.
If the US response to risk parity has been mixed, it’s fair to say the European one has been muted—but one set of investors may be about to turn all that around.
Confusion over definitions, applications, and allocation is rife among European defined benefit pensions. But increasingly on the continent, it’s the defined contribution (DC) schemes that are taking the risk parity plunge.
“DC investors will typically use this type of strategy for their ‘better balanced’ allocation, aiming to achieve capital growth but, importantly, with much lower risk than equities or traditional 60/40 portfolios,” says Rita Gemelou, investment strategist at BlackRock. “Some investors will use the approach for their entire beta allocation due to the high diversification it offers, combining with alpha generating strategies.”
Swiss investment manager Lombard Odier was one of the earliest adopters in Europe, applying risk parity to its own defined benefit pension fund in 2009. But according to Jérôme Teiletche, head of the company’s Solutions Group, since its inception, the approach’s definition and what it tries to achieve have changed-not least because it now works well for DC.
“It is still rare to see investors allocating 100% to a risk parity framework, although this should change as pooled multi-asset risk parity strategies become more available to those looking for a diversified growth fund-style option within DC default strategies,” Teiletche says. “Most of our clients come to us for a sizeable allocation—at least 20% to 30%. We are also starting to see interest in risk parity approaches from ‘alternative’ allocations of pension funds, due to risk parity’s absolute return profile.”
For pensions on the continent, the move towards bonds-heavy portfolios is not a giant leap, with many of them already heavily weighted towards sovereign debt. Risk parity’s levered bond skew also offers better liability matching for interest-rate risk.
But for the UK, with its historical preference for equities, it can seem rather different. In the current volatile market, a process which smooths returns might seem attractive now, but risk parity strategies might well underperform traditional approaches during certain periods of the economic cycle.
It’s not a bad idea for risk parity providers to latch on to the DC set-after all, DC assets are the fastest growing in the world. Now, who mentioned “capacity constraints”? —CT