Joel Kranc discusses the rationale for a gradual shift to the risk parity model with Bill Estabrook, executive director with Ohio Police & Fire Pension Fund
IPE: When did you first move to a risk parity approach?
Bill Estabrook: The board, staff and consultant (Wilshire Associates) began discussing the approach in early 2009. Wilshire wove the risk parity concept into the total fund asset allocation plan that arose out of an asset liability study Ohio Police & Fire (OP&F) was conducting throughout the better part of 2009.
In February 2010, the board formally adopted a new asset allocation plan, which incorporated risk parity. The new plan reduces equity exposures, while increasing fixed income (some strategies on a levered basis) and alternatives (adding timber and commodities while increasing real estate and private markets). The new plan called for the total portfolio to be levered 1.2 times.
IPE: What prompted that decision?
BE: Coming out of the painful experiences of 2008, the board, staff and consultant began looking for ways to reduce the portfolio's overall risk level and to provide a better balance of risk without sacrificing too much expected return. Staff asked Bridgewater Associates to discuss its All Weather strategy with the board and this risk parity approach struck a chord with all concerned, as did Bridgewater's view of the developed world being in an atypical, prolonged deleveraging cycle.
IPE: Who advises you or manages your assets according to this approach?
BE: Wilshire Associates has, and continues, to provide a key advisory role in the process. As for managing the assets according to the approach, all of OP&F's managers play a role (the vast majority are unchanged), but the one already implemented mandate that stands out as different from our prior approach is a two-times levered global inflation protected securities mandate. Bridgewater was already managing our global inflation protected securities mandate prior to our risk parity decision and afterwards, over a multi-quarter period, moved the mandate to a two-times levered position.
IPE: Describe your risk parity approach.
BE: Risk parity is being implemented at the total plan level as opposed to simply investing in a risk parity product. Admittedly, our plan does not use the amount of leverage required to fully balance all asset classes by risk. Still, we believe that adopting risk parity at the total fund level has a much greater impact than investing in a product. Wilshire did analyse allocating differing percentages of the fund to a risk parity product but found that approach offered only limited risk diversification unless the investment was a very significant portion of total assets.
IPE: You have described how the portfolio is not fully balanced. Otherwise, does it follow the ‘textbook' approach, or does it incorporate some other risk management strategies?
BE: A risk parity, or risk balanced, approach is intended to provide just that, balance; thus, these ‘hundred-year' type events causing chaos in one or more parts of the portfolio should benefit other portions of the portfolio.
IPE: Bond risk looked asymmetric a year ago. Now it arguably looks even more asymmetric. Does that make you think again about the strategy?
BE: The level of interest rates, their probable direction and the potential impact on the portfolio have been an ongoing topic of discussion as it relates to a levered long duration mandate that has yet to be implemented. Still, there are numerous risks - market, economic and geopolitical - whose outcomes are unknowable, resulting in a huge range of potential outcomes for investment portfolios. In this context, a risk-balanced approach still looks quite appealing over the long-term.
IPE: How satisfied have you been with the parts of the approach that have already been implemented - and what changes have you found necessary to implement, if any?
BE: The entire plan has not yet been implemented, but a levered global inflation protected securities mandate has been in place for nearly two years (fully two-times levered for over a year) and has performed exceptionally well. Meanwhile, equities are slowly being reduced, while existing private markets and real estate allocations are growing. Our first timber managers have been selected and are close to making their initial investments, while staff and consultant are discussing how to proceed in the commodities.