Failing Unconventionally—Or Not at All?

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Writing about risk parity in Europe is not as straightforward as it is in the United States. The topic that divides the educated investment classes on one side of the Atlantic —imagine GMO’s Ben Inker, AQR’s Cliff Asness, and Bridgewater’s Bob Prince (metaphorically) squaring off over the strategy’s relative merits and drawbacks—barely raises an eyebrow on the other.

On this side of the pond, the term “risk parity” is not commonly used. We in the United Kingdom and Europe talk of risk management and asset allocation, but neither is deemed a particularly inflammatory topic. Risk parity is something that has not (yet) made its way onto discussion boards — or into many board rooms for that matter.

Ralph Frank, Head of Solutions at Anglo-Dutch Risk Management firm Cardano, knew what it was, but said that the idea had not found many followers in Europe for two main reasons. First, and fundamentally, it is easier to observe capital than risk. “You have to talk to the decisionmakers in terms they are comfortable with. The majority of institutions are still allocating in capital terms despite claiming they have shifted their focus to risk,” he said. Second, many investors prefer to overweight those risks they expect to be better rewarded for. However, Frank said, it is important to maintain a reasonable balance of exposures to various risks across the portfolio rather than outsize concentrations of a small number of risks.

Cardano has gathered an impressive roster of large European clients on this risk allocation basis, but these clients are by no means a representative slice of the market in terms of the way they go about structuring their portfolios. One of the funds that has embraced the concept is Danish public sector manager ATP. Lars Rohde, Chief Executive of the DKK778 billion/US$139 billion fund, put the lack of following down to the human condition: “Maybe it’s a case of bad habits, maybe peer pressure,” he said. “As John Maynard Keynes said: ‘It’s better to fail conventionally than to succeed unconventionally.’ ”

Judging by aiCIO’s survey results from last fall, risk parity is by no means failing conventionally—or failing at all—on the American side of the divide. On the European frontier, however, even finding a common consensus on what it represents is difficult. Maybe we will figure it out soon, of course—but we’ll just let you fight it out until then.