2/8/18, 6(53 AMIs This Obscure Wall Street Invention Responsible for the Market Selloff? - WSJ

Page 1 of 3https://www.wsj.com/articles/is-this-obscure-wall-street-invention-responsible-for-the-market-selloff-1518085802

The surge in market volatility this week, after a long period of tranquility, left investors seeking

a culprit. Critics began pointing to an obscure investment strategy pioneered by the world’s

largest hedge fund, Bridgewater Associates.

So-called risk-parity funds aim to reduce the danger from a collapse in any one market by

limiting bets on more volatile assets like stocks and commodities and using leverage to load up

on safer assets like government bonds. When volatility jumps, that leverage can in theory force

the funds’ automated trading strategies to dump those assets, accelerating the selloff.

But some risk-parity strategies outperformed the broader market as the Dow Jones Industrial

Average plunged more than 1,800 points over two days and Wall Street’s “fear gauge,” the VIX,

on Monday more than doubled in its largest one-day move in history. Some leading risk-parity

fund managers said they haven’t traded much during the past several days, arguing they would

pare positions gradually, not all at once, if necessary.

AQR Capital Management LLC co-founder Clifford Asness said his funds were performing as

expected even during the frenzy in stock and bond markets.

“We have done pretty much no trading in risk parity” since Friday’s stock fall, Mr. Asness said

in an interview. Michael Mendelson, a principal at AQR, added that risk-parity strategies will

decline when “everything is down,” but that the current shake-up has been too short-lived for

there to be any meaningful trading by risk-parity managers.

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MARKETS

Is This Obscure Wall Street InventionResponsible for the Market Selloff?Risk-parity funds, which balance portfolios based on the volatility of assets, were blamed for theprice swings, but some outperformed the broader market

Clifford Asness, co-founder of AQR Capital Management LLC, said the firm’s risk-parity funds performed as expectedduring the frenzy in stock and bond markets. PHOTO: CHRIS GOODNEY/BLOOMBERG NEWS

Feb. 8, 2018 5:30 a.m. ETBy Corrie Driebusch and Rob Copeland

2/8/18, 6(53 AMIs This Obscure Wall Street Invention Responsible for the Market Selloff? - WSJ

Page 2 of 3https://www.wsj.com/articles/is-this-obscure-wall-street-invention-responsible-for-the-market-selloff-1518085802

The AQR Risk Parity Fund fell

1.9% on Monday, less than half of

the more than 4% decline by the

broader stock market. Last

Friday it was down 2%, just

under the S&P 500’s 2.1% fall.

AQR says it wasn’t forced to sell because it already held a smaller equity position than its

models called for due to its leverage caps, putting it under less pressure as volatility rose.

AQR is one of the well-known players in risk parity; its AQR Risk Parity fund has more than

$460 million in assets. It is tough to gauge how much risk-parity funds manage in total;

estimates range as high as hundreds of billions of dollars.

Bridgewater, for its part, has told clients that in times of market stress its risk-parity funds

actually purchase assets that are down, acting as a ballast in a free fall, people close to the firm

say. Bridgewater, with $160 billion under management, uses risk-parity trading not just in its

dedicated funds but also in its flagship hedge fund, these people say.

Bridgewater co-chief investment officer Bob Prince in an interview described the funds as “so

basic…the most boring thing, really.” He added: “It is definitely not driving global asset prices.

It just sits there like a turtle.”

The firm’s risk-parity operation has made few trades of size in the past week, according to a

person familiar with the matter.

Though most traders agree fears of rising inflation sparked the most recent stock-market

selloff, market observers were quick to blame various trading strategies as factors that could

have exacerbated the declines. Treasury Secretary Steven Mnuchin fingered algorithmic

traders for heightening turbulence. Quantitative managers of all stripes rejected that claim.

Still, critics say a prolonged period of volatility could force risk-parity funds to sell, which could

exacerbate declines in the market. The argument against risk-parity goes like this: If volatility

in one asset picks up, managers must shrink that position to maintain the fund’s overall risk,

either by reducing leverage or shifting client money between asset classes. Both involve selling

an asset that is under stress.

“The biggest issue with risk parity, and all systematic, semi-passive strategies, is they all act

simultaneously when the market is on autopilot,” said hedge-fund manager Katina Stefanova,

who bet against these funds with a series of complicated financial instruments that would pay

off when market uncertainty rises. Her Marto Capital fund, which manages more than $200

million, is up 4% this year.

“If the stock market falls, everyone starts selling at the exact same trigger points,” she said.

Some analysts also note that during the recent yearslong stretch of stock-market calm, risk-

parity strategies were becoming more heavily invested in equities than normal because stocks

appeared disproportionately safe. The equity exposure of a typical risk-parity strategy recently

neared five-year highs, partly as a result of low volatility, according to Deutsche Bank ’s

modeling estimates in January.

There is some research suggesting that risk-parity funds can act as sellers in tumultuous

periods. Deutsche Bank estimates such funds’ equity bets drop by roughly 15% to 20% when

stock volatility is up. Whether such moves increase volatility is debatable given the funds’ small

size compared with overall markets.

“Even if we are going to reduce equities because of heightened risk, we would not do it

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2/8/18, 6(53 AMIs This Obscure Wall Street Invention Responsible for the Market Selloff? - WSJ

Page 3 of 3https://www.wsj.com/articles/is-this-obscure-wall-street-invention-responsible-for-the-market-selloff-1518085802

immediately,” said Hakan Kaya, who oversees $60 million for Neuberger Berman’s fledgling

risk-parity strategy. If he did sell, Mr. Kaya said he would likely pare equity positions gradually,

rather than all at once.

Mr. Kaya said his portfolios worked as intended in recent days, as Treasurys and commodity

holdings took the edge off a big drop in stocks.

The particularly unfavorable scenario for a risk-parity portfolio is stocks and bonds falling in

lockstep, Mr. Kaya said.

“If everything goes down, there’s no place to hide,” he said.

—Ira Iosebashvili and James Mackintosh contributed to this article.

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