The Return of a Risky Hedge Fund Trade
Hedge funds have long been known for their risky investments, and one of the riskiest trades of all is making a comeback. The trade, known as “risk-parity,” has a history of blowups, but that hasn’t stopped some of the world’s biggest hedge funds from jumping back in.
What is Risk-Parity?
Risk-parity is a strategy that seeks to balance risk across different asset classes. It involves taking a portfolio of assets and adjusting the weights of each asset so that the risk of each asset is equal. This means that if one asset class is more volatile than another, the portfolio will be adjusted to reduce the risk of the more volatile asset.
The idea behind risk-parity is that it can provide a more consistent return over time, as the portfolio is rebalanced to maintain the same level of risk.
Risk-Parity’s Troubled History
Risk-parity has a troubled history. In the past, the strategy has been blamed for some of the biggest hedge fund blowups. In 2008, for example, a risk-parity fund run by Bear Stearns collapsed after the financial crisis.
In 2011, a risk-parity fund run by the hedge fund firm AQR Capital Management suffered losses of more than 20 percent. And in 2015, a risk-parity fund run by Bridgewater Associates lost more than 10 percent.
Risk-Parity’s Comeback
Despite its troubled history, risk-parity is making a comeback. According to Bloomberg, some of the world’s biggest hedge funds, including Bridgewater, AQR, and Renaissance Technologies, are investing in risk-parity strategies.
The reason for the renewed interest in risk-parity is that it can provide a more consistent return over time. With interest rates at historic lows, investors are looking for ways to generate returns without taking on too much risk. Risk-parity can provide a way to do this.
The Risks of Risk-Parity
Despite its potential benefits, risk-parity carries some significant risks. The biggest risk is that the strategy can be highly leveraged, meaning that a small move in the markets can have a large impact on the portfolio. This means that if the markets move against the portfolio, the losses can be significant.
Another risk is that the strategy can be difficult to manage. Risk-parity portfolios are complex and require constant monitoring and rebalancing. This can be difficult for investors who don’t have the time or expertise to manage the portfolio.
The Bottom Line
Risk-parity is a risky strategy that has a history of blowups. Despite this, some of the world’s biggest hedge funds are investing in risk-parity strategies. The strategy can provide a more consistent return over time, but it carries significant risks. Investors should be aware of these risks before investing in risk-parity strategies.