Bringing ‘Risk Parity Thinking’ to UK DC Pensions

CIO does not usually write about product launches, but when a fund manager claims to be bringing a risk parity-type strategy to the defined contribution (DC) market for the first time and combining it with insurance companies’ risk management methods, we start to get interested.

Defined benefit pension funds have long known of the pros (and cons) of investing in risk parity products, but the concept is virtually unknown to defined contribution (DC) plans.“Risk parity has performed exceptionally well and gained a lot of currency from institutional investors.” —John McLaughlin, Schroders

One of the outliers in this sector, United Technologies in the US, added a risk parity product to its DC range early last year, but even back in CIO’s 2013 Risk Parity Survey, 15.2% of CIOs said they were using or would consider using risk parity as part of a custom target-date fund in a DC plan.

In the UK, fund manager Schroders sees this revolution happening across the Atlantic too.

“Risk parity has performed exceptionally well and gained a lot of currency from institutional investors,” said Schroders’ Head of Investment Solutions John McLaughlin, adding that the company’s product combined the latest thinking in multi-asset and risk management.

Despite McLaughlin’s enthusiasm for this type of strategy, the new product is not, strictly speaking, risk parity. Instead, as Fund Manager Ugo Montrucchio explained, it makes use of “risk budgeting” but does not add leverage or use shorting. It also places a far greater emphasis on inflation protection: roughly 20% of assets will be in inflation linked bonds, according to its core allocation at launch.

On top of this, McLaughlin said the strategy would aim to limit losses to a maximum 8% drawdown by capping volatility and moving assets into cash at times of market stress, a technique popular in the insurance industry.

Related Content: 2014 Risk Parity Investment Survey