Investors Abandon Ray Dalio’s Famed Trade as Performance Falters

Investors Abandon Ray Dalio’s Famed Trade as Performance Falters

(Bloomberg) — It was a compelling pitch. Give us your money, said executives at Ray Dalio’s Bridgewater Associates and other hedge funds, and we’ll put it toward a safe, profitable long-term strategy. But now, after five years of mediocre returns, many institutional investors who invested large sums in risk parity funds, as they are called, are demanding repayment.

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Investors, including public pension funds in New Mexico, Oregon and Ohio, have withdrawn their cash, reducing the size of the funds by about $70 billion from their peak in three years ago. For many, business demands for more time – that the next decade in markets is unlikely to look like the last – ring hollow.

“It’s been disappointing for a long time,” said Eileen Neill, managing director of Verus Investments, adviser to the roughly $17 billion New Mexico Public Employees’ Pension Fund, which eliminated its risk parity allocation in December . “The only time risk parity was really successful was during the Great Financial Crisis and that was really its peak.”

The lackluster ride of post-pandemic ups and downs has shaken confidence in an allocation method pioneered by Dalio, which made Bridgewater the world’s largest hedge fund. The strategy focuses on diversifying assets based on the volatility of each and often uses leverage to maximize returns relative to the risks taken.

It thrived after the 2008 financial crisis, as investors looked for a way to protect themselves from the next big cataclysm. But as investors reinvested in stocks, they fell behind the bull years. Then, when markets crashed in 2022 – hitting safe assets like U.S. Treasuries – they were hit even harder.

Overall, risk parity funds have lagged global 60/40 funds every year since 2019, according to a broad industry index.

This caused investors to withdraw cash, reducing the amount of such funds to around $90 billion by the end of 2023, from a peak of around $160 billion in 2021, according to Verus estimates compiled at from eVestment data.

First launched in 1996 to manage Dalio’s trust assets, it was presented as a way to use in-depth economic research to create the best possible portfolio, instead of trying to predict the next big thing.

Rather than accumulating risk to seek large returns, the strategy generally involves diversifying a wider range of assets, such as commodities and bonds, and making each of them an equal factor in the volatility of the wallet. To maintain the balance of risks, exposures can be increased or decreased depending on the magnitude of price swings, making this strategy Wall Street’s favorite scapegoat in the event of a selloff.

A difficult environment

For proponents of the strategy, the decision to bail out the country just as stock prices were hitting new record highs reflects a classic investment mistake.

“It’s really a reasoning from the last decade, which I would call the most exceptional,” said Otto van Hemert, director of core strategies at Man AHL, which manages about $15 billion in risk parity.

This period was marked by low rates which, most of the time, caused stocks and bonds to rise. Risk parity generated positive returns but, almost by default, not as much as simple portfolios investing more in stocks. Then, when the Federal Reserve began raising interest rates in 2022, bonds fell before most models could react. Many funds have seen volatility exceed their target levels or even peaks seen during the last financial crisis, according to Markov Processes International, an analytics firm.

In a September presentation to the Indiana Public Retirement System, Bridgewater, the largest risk parity manager, acknowledged that its All Weather fund had fallen below its expected returns. But the company said it remains an effective way to allocate cash over a 10-year horizon, especially given the risk that stock market gains may stop.

“The important secular forces that helped create the great run on stocks are fading,” according to slides released by Indiana, which retained its 20% allocation to risk parity.

The most popular iteration of All Weather, which targets 10% volatility, has lost 22% in 2022, the slides show, lagging most of its peers. This appears to be because it is less responsive to short-term market fluctuations and correlation changes, according to Michael Markov of Markov Processes.

Bridgewater declined to comment.

Fund managers began to revamp the strategy away from its origins and make it an almost passive, long-term approach. Fidelity Investments launched a risk parity fund in 2022 that can actively trade to exploit market dislocations and also takes market regime into account when adjusting exposures, says Christopher Kelliher, co- portfolio manager.

At Man AHL, where the Target Risk fund has beaten the HFR index – a measure of its peers – every year since its inception in 2014, van Hemert says the key is to be more responsive to changing market risks . This means increasing exposures further when markets are calm and even holding primarily cash in more difficult times.

“The sworn enemy of diversification”

Despite this, risk parity faces stiff competition from other sectors of Wall Street, such as private credit funds and superstar hedge funds that have generated consistent returns year after year.

“If I’m going to put 6 or 8 percent of my portfolio in something else, I’d rather something else be a collection of high-performing hedge funds,” said Michael Shackelford, chief investment officer at Retired Public Employees. New Mexico Association, which reduced its risk parity allocation in December.

In Oregon, the state investment council reached a similar conclusion. As of July 2020, it had moved more than $1 billion to risk parity funds managed by Bridgewater, Man Group and PanAgora Asset Management. But in late 2022, it reversed course, eliminating its investments in risk parity after the category lost about 6% annually. PanAgora did not respond to requests for comment.

For proponents of the strategy, the move could prove shortsighted given the high valuations of stocks while bonds offer the highest returns in years.

“The nemesis of diversification is FOMO: By definition, you will always have regrets,” said Jordan Brooks of AQR Capital Management, which manages $13.7 billion in risk parity investments. “Ultimately, investors’ job is not to look back but rather to determine what is the best portfolio to get through the next decade.”

–With help from Katherine Burton and Sam Potter.

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