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Institutional Investment in Hedge Funds: Evolving Investor Portfolio Construction Drives Product Convergence
mimic the approach he used in managing his own personal
wealth. In subsequent years, other market leaders such as
AQR followed with similar products. These portfolios were
able to significantly outperform traditional 60/40 portfolios
in the 2008 crisis and have since gained many proponents.
The principles of the All-weather fund are illustrated in
Chart 12. The portfolio incorporates all of the assets typically
held in the equity risk and stable value/inflation bucket.
The portfolio manager then applies an active management
overlay to those assets that indicates the optimal mix of
assets based on varying economic circumstances related
to growth and inflation. More of certain assets and less of
others are required to keep the portfolio in parity during each
scenario—rising growth, falling growth, rising inflation, or
falling inflation. The overall portfolio is actively rebalanced
in order to hold theassets in parity and to adjust for shifts in
view between varying scenarios.
Massive amounts of money have reportedly been diverted to
these risk-parity funds. One clue of how popular they are can
be found in looking at Bridgewater’s AUM holdings as shown in
Absolute Return’s Billion Dollar Club. In 2004, Bridgewater’s
overall AUM was listed at $10.5 billion, and by the end of 2011
that figure had jumped to $76.6 billion.
Allocating to a risk-parity fund is an alternate approach to
reordering an institution’s entire portfolio configuration into
risk-aligned buckets. It can offer institutions an opportunity
to get comfortable with the concept of risk budgeting and
allows them to monitor how this approach performs relative
to their traditional portfolio without being overcommitted
to the risk-budget paradigm. In this way, the risk-parity
fund provides much the same function that a multi-strategy
hedge fund does for investors just beginning their direct
investing programs.
“ The Bridgewater all-weather fund is a very diversified
portfolio, they activelymove assets around based on this idea
that they are always adjusting to economic developments.
They have frameworks that explain what the asset classes
are going to do. They know what their risk boundaries are.
There’s no question that Bridgewater has an active risk view
and that they trade like crazy around those views. AQR too.
The reason that people are interested in these all weather
fund type products is that you can show a recent back test
where this approach worked.”
- <$1 Billion AUM Hedge Fund
“ The all-weather fund is creating a change in allocation logic
whereby an alternative manager can be part of the core of
the investors allocation and not a part of the satellite hedge
fund allocation,”
- $1-$5 Billion AUM Hedge Fund
“ We look at Bridgewater and like their approach toward risk
parity. It would be a perfect fit with our portfolio,”
- US Public Pension
Chart 20
Macro
Equity Risk
Long/
Short
Event
Driven
Macro
& CTA
Distressed
Volatility
& Tail Risk
Active
Equity &
Credit Long
Only
Passive
Corporate
Private Equity
Commodities
Stable Value/
Inflation Risk
Rising Growth
Falling Growth
Rising Inflation
Falling Inflation
All
Weather
Chart 12: Illustration of All Weather Fund Overlay to Equity Risk & Stable Value/Inflation Asset Categories
Source: Source: Citi Prime Finance