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Investing in Risk Parity Strategies (PDF) INVESTING IN RISK PARITY STRATEGIES, NORTH AMERICA PUBLISHED BY OCTOBER 2012 Considering the use of risk parity strategies for balancing risk and protecting members from volatility in their investments. REPORT PARTNER MEDIA PARTNERS C ONTENTS INVESTING IN RISK PARITY STRATEGIES, NORTH AMERICA MAS D GosVIG S ECTION 1 5 Chief Executive 1.1 White PAPER Officer Risk Parity: Challenging the Traditional Asset Allocation Framework NOW: Pensions of Target Date Funds • PETER GALLAGHER, National Sales Manager, Institutional Business Development, Invesco • SCOTT WOLLE, Chief Investment Officer, Global Asset Allocation, Invesco S ECTION 2 9 INTEGRATING RISK PARITY STRATEGIES INTO A DB AND DC PENSION PLANS RH UT HUGHES- GudeN 2.1 ROUNDTABLE debATE 10 Managing Director - What are The Merits of Risk Parity Strategies in the Modern Investment US Institutional Sales Portfolio and How Can They Equalize Risk in an Era of Market Volatility? & Service Team MODERATOR: Invesco • NOEL HillmANN, Managing Director & Head of Publishing, Clear Path Analysis PANELLISTS: • RUTH HUGHES-GUDEN, Managing Director- US Institutional Sales & Service Team, Invesco • PATRICK BAUMANN, Assistant Treasurer, Harris Corporation PA TRICK BAUMANN • RON Virtue, Investments Manager, JM Family Enterprises Assistant Treasurer Harris Corporation 2.2 SPECIAL INTERVIEW 13 How has Risk Parity Proved Itself in the European Investment Market? INTERVIEW: • NOEL HillmANN, Managing Director & Head of Publishing, Clear Path Analysis INTERVIEWEE: • MADS GosVIG, Chief Executive Officer, NOW: Pensions S COTT WOLLE Chief Investment Officer, Global Asset Allocation Invesco R ON Virtue Investments Manager JM Family Enterprises CLEAR PATH ANALYSIS: INVESTING IN RISK PARITY STRATEGIES, NORTH AMERICA 2 REPORT PARTNER nvesco is one of the largest global, independent investment managers, with more Ithan 600 dedicated investment professionals worldwide and an operational network spanning more than 20 countries. Our philosophy is Intentional InvestingSM - the science and art of investing with purpose, prudence and diligence. Intentional Investing forms the foundation of our “investors first” approach, exemplified by our commitment to investment excellence, depth of investment capabilities and organizational strength. MEDIA PARTNERS TO READ MORE FREE REPORTS VISIT: www.clearpathanalysis.com T: +44 (0) 207 936 9450 E: [email protected] NOEL HillmANN L IBBY de FRAINE JIM AlleN Managing Director Marketing & Operations Graphic Design & Head of Publishing Manager & Web Manager +44 (0) 207 936 9447 +44 (0) 207 936 9450 +44 (0) 207 936 9475 J ESSICA MCGHIE J ENNIFER MENoscAL Publisher & PR Manager Marketing Assistant +44 (0) 207 936 9357 +44 (0) 207 936 9450 CLEAR PATH ANALYSIS: INVESTING IN RISK PARITY STRATEGIES, NORTH AMERICA 3 DOWNLOAD FREE FINANCIAL REPORTS FROM WWW.CLEARPATHANALYSIS.COM R E INFLATION HEDGING INVESTING IN RISK PARITY AUTO-ENROLMENT RT PARTN RT PUBLISHED BY PUBLISHED BY PUBLISHED & REAL RETURN 2012 SOLUTIONS, NORTH AMERICA BY PUBLISHED REPO FOR PENSION SCHEMES OCTOBER 2012 OCTOBER 2012 JANUARY 2012 Exploring the outlook for inflation, setting an asset allocation plan, creating out performance (in either a Considering the use of risk parity solutions for balancing risk and protecting members from volatility in THE ONLINE REPORT WHERE PENSION SCHEME MANAGERS, HR AND FINANCE DIRECTORS DISCUSS high or recessionary inflation environment) as well as examining the tools and processes to manage the their investments. KEY ISSUES FACED WITH AUTo-ENROLMENT, PARTICULARLY FROM AN SME PERSPECTIVE, AND WAYS risks involved. TO OVERCOME THE CHALLENGES OF RESPONSIBILITY, FLEXIBILITY AND COSTS OF IMPLEMENTATION. SPONSOR MEDIA PARTNERS REPORT PARTNER MEDIA PARTNERS SPONSOR MEDIA PARTNERS GLOBAL EXCHANGE SOLVENCY II: FUND OUTSOURCING 2012 PUBLISHED BY PUBLISHED TECHNOLOGY & DATA BY PUBLISHED THE GLOBAL DIMENSION BY PUBLISHED SEPTEMBER 2012 JUNE 2012 SEPTEMBER 2012 The second annual report where hedge fund, private equity, traditional and alternative fund managers The global exchange community, comes together, with technology solution providers to consider how the Solvency II will drive a sea change in how insurers do business here in Europe and further afield, this report share their insights regarding outsourcing key functions to a third party in the current market environment. best exchange groups are innovating and upgrading systems and data platforms. looks at some of the key issues those on the global stage will face. SPONSORS MEDIA PARTNERS SPONSOR MEDIA PARTNERS Sponsored by Clear Path Analysis specialises in the publishing of high quality, free online reports in the financial services and investment sectors, including: • F INANCE TECHNOLOGY • F UND MANAGEMENT OperATIONS • INRN SU A CE • INV ESTMENT STRATEGY • P ENSIONS AdmiNISTRATION & OperATIONS • PIAE R V T & RETAIL INVESTMENT www.clearpathanalysis.com FOR more INFORMATION VISIT: www.clearpathanalysis.com T: +44 (0) 207 936 9450 E: [email protected] S ECTION 1 WHITE PAPER Risk Parity: Challenging the Traditional Asset Allocation Framework of Target Date Funds PETER GALLAGHER S COTT WOLLE National Sales Manager, Chief Investment Officer, Institutional Business Global Asset Allocation Development Invesco Invesco ince the Pension Protection Act of 2006, target date funds (TDFs) have been the focus of many discussions by those who are Sfocused on the retirement security of plan participants. At the same time, defined contribution (DC) plans are in the midst of a major shift from supplemental assets for retirees to the primary means of saving for retirement. Combine these trends with the fact that TDFs are projected to be the largest recipient of future DC participant contributions, and you definitely have something worth monitoring closely. The “to vs. through” glide path debate is important, but the backbone of the TDF — the asset allocation framework itself and its embedded assumptions — certainly deserves more attention. THE chALLENGE AND risK of TARGET DATE FUNDS From a fiduciary perspective, the focus and resources dedicated to a plan’s TDFs will likely increase due to the expected concentration of assets that is expected to occur in the near future. As auto-enrollment, auto-escalation and qualified default investment alternatives become more popular plan design features, the TDFs’ risk to the plan participants in aggregate will become greater. This will present a challenge, or at least a heightened awareness, to plan sponsors, due to sheer scale of the participants’ allocation to the TDF option. TA RGET DATE FUNDS Are PROJECTED TO BE THE LARGEST HOLDING OF U.S. defiNED coNTRIBUTION PARTICIPANTS BY 2020 Predicted allocation of the $7.7 trillion in U.S. defined “Risk parity strategies are all contribution assets in 2020 about winning by minimizing Target date funds losses. If you can do better on 52% All other DC investment options the downside, you don’t have to do quite as well in those equity bull markets.” 48% Scott Wolle Source: Casey Quirk & Associates P eter: Scott, as CIO of Invesco Global Asset Allocation — including a team that has been managing assets using a risk parity approach — you have some very strongly held convictions on this topic. So, as you see it, what are the major issues or weaknesses with relying on a mean-variance optimized glide path to help plan participants achieve real long-term growth while avoiding major drawdowns as they approach retirement? And why do you think that risk parity is a better approach for designing the asset allocation framework? FOR INSTITUTIONAL INVESTOR USE ONLY – NOT FOR USE WITH THE PUBLIC CLEAR PATH ANALYSIS: INVESTING IN RISK PARITY STRATEGIES, NORTH AMERICA 5 Risk Parity: Challenging the Traditional Asset Allocation Framework of Target Date Funds S COTT: Well, in order to say that risk parity is a better way to go, Then lastly, from a glide path perspective, mean-variance you need to compare that to the starting point, which is typically optimization keeps you on the efficient frontier, whereas in mean-variance optimization. Mean-variance optimization has principle you should get a better risk/return trade-off by going some theoretical shortcomings in our view, as well as some out on the capital market line, which is the tangent line to the shortcomings in practice. efficient frontier. Mean-variance optimized portfolios simply don’t do that because of a lack of leverage. First, in our view, the theory has an over reliance on return estimates. A simple example for that is if you believe that stocks will return 10% and bonds 5%, you end up with roughly a 60/40 H ISTORICAL Asset CLASS RESPONSE to ECONomic ENViroNMENTS portfolio mix of stocks and bonds. If instead you think stocks Inflationary Noninflationary Recessionary/ will return 9% and bonds 6%, then all of a sudden that 60/40 Growth Growth Deflationary portfolio turns into a 30/70 portfolio based upon mean-variance optimization. So, the 100 basis point misestimation results in a Equities 30-percentage point difference in allocation. We think this is a very important shortcoming. Fixed Income (Government SL MAL ERRORS IN FORECASTED RETURNS CREATE HUGE Bonds) ERRORS IN AllocATIONS Commodities Forecasted asset class return (%) Equities 10 9 12 Source: Invesco. Time period represented September 1976 through March 2012. Fixed income 5 6 5 For illustrative purposes only. Commodities are represented by the S&P Goldman Sachs Commodity Index, which is an unmanaged composite index of commodity sector returns representing
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