Quants Fire Back at Paul Tudor Jones After His Attack on Risk ParityBy
Macro manager sees strategy as driver for next stock selloff
Risk parity didn’t dump all stocks in last correction: AQR
Paul Tudor Jones says automated trading strategies are poised to blow up the market when volatility returns. That’s not going over well at one of the biggest quant shops on Wall Street.
Speaking at a closed-door Goldman Sachs Asset Management conference earlier this month, the billionaire hedge fund investor said that a portfolio strategy known as risk parity will eventually act as “the hammer on the downside” when turmoil returns to equity markets.
For AQR Capital Management LLC, a giant in the risk parity field, the concerns are overblown, with any selling forced by the strategy having an “utterly trivial” impact on the $23 trillion U.S. equity market.
“There are scenarios in which risk parity funds sell equities, but the possible magnitude of that is very small,” said Michael Mendelson, a risk-parity portfolio manager at AQR.“Some reports have grossly exaggerated the potential impact.”
Jones, who oversees $10 billion in his Greenwich, Connecticut-based Tudor Investment hedge fund, is the latest active asset manager to whip up fears surrounding the automated strategies that were a favorite target of bank researchers during the selloffs in August 2015 and early 2016. The strategy has less than $150 billion invested in it, according to data provider eVestment, most of at AQR and Bridgewater Associates’ All Weather Fund.
That’s significantly lower than the roughly $500 billion that some have estimated. And of that total, only around a third is investing in equities, Mendelson said. That compares to the nearly $2 trillion in market value that evaporated from U.S. equities during the last stock market correction.
“Even on a sharp move in the stock market, the positioning changes would be utterly trivial and would have about zero impact,” Mendelson said.
A spokesman for Paul Tudor Jones did not immediately respond to an email request seeking comment.
Risk parity bases its allocations to different asset classes on risk rather than capital, as in the typical 60-40 stock-bond fund. So, for example, U.S. Treasures and international government bonds often play a larger role in risk parity funds than in other asset pools, while stocks usually take up a smaller slice.
In addition, money has fled risk parity funds in seven of the past nine quarters, for net outflows of more than $16 billion among funds tracked by eVestment.
But even in the scenario that Jones lays out, the funds wouldn’t dump their stock holdings for a variety of reasons, according to Edward Qian, who’s credited with coining the term risk parity. Because of the safer asset concentration, the strategy performs relatively better when stocks tumble and wouldn’t need to sell as much as a traditional 60-40 portfolio, Qian said.
“They’re always focused on the equity portion of risk parity, saying that equities might have a terrible time and other scary fear mongering things,” Qian said. “Even if someone has a stop loss or equity reduction program, it can’t be a significant player in those time periods.”
Take August 2015, when JPMorgan Chase & Co. analyst Marko Kolanovic shot to fame after attributing the correction in the S&P 500 Index to automated selling from quant funds such as risk parity.
However, while the main equity gauge tumbled 11 percent in just five days, a risk parity strategy fell just half as much, as tracked by the Salient Risk Parity index. Not only did managers just sell a portion of their exposure, they didn’t all sell at once, AQR said at the time.
It’s true that under the risk parity framework most programs gobble up equities when volatility subsides. However, Qian says that stock holdings in his fund and others likely are hovering near their average levels, since they use multi-year measurements to calculate riskiness. Mendelson believes the funds may be reducing their equity exposure to keep up with their diversification models. And because their time horizon is long, it’ll take more than a few days of volatility to prompt selling, Qian said.
Still, the quants don’t expect the finger pointing to stop.
“First you had Leon Cooperman and now it’s a hedge fund guy,” said Qian. “Any time performance isn’t doing well, they just blame risk parity.”
— With assistance by Katia Porzecanski, and Katherine Burton