An $80 billion portfolio managed by hedge fund titan Ray Dalio's Bridgewater Associates and widely held by many pension funds slumped in August and some investors blame the strategy of such funds for the eruption in volatility that slammed stocks and commodities.
Bridgewater's "All Weather Fund" fell 4.2 percent in August and is down 3.76 percent so far this year, according to three people familiar with the fund's performance on Thursday.
Equity markets worldwide stumbled in recent weeks, driven lower by concerns about China's growth and worries that the U.S. Federal Reserve will soon raise rates. The moves, coupled with weakness in commodities and bonds, wreaked havoc on hedge funds that use risk-parity strategies, which are supposed to make money for investors if bonds or stocks sell off, though not if both markets fall at the same time.
Investors, including Leon Cooperman's and Steven Einhorn's Omega Advisors plus some other hedge fund managers, are blaming risk-parity strategies for the market's recent volatility and the forced selling that drove stocks down 10 percent in five sessions near the end of August. Omega's funds fell between 9 percent and 11 percent last month.
However, analysts note that so-called risk-parity funds such as Bridgewater oversee about $500 billion, a small fraction of the $3 trillion managed by hedge funds. Bridgewater, the world's largest hedge fund, manages $162 billion in assets and the All Weather Fund is one of its two big portfolios.
Besides Bridgewater, the big players in the risk-parity space include Cliff Asness' AQR Capital Management and Invesco.
Risk parity is a popular investment option for many pension funds and has been marketed by Bridgewater and Wall Street banks as way to hedge market turmoil.
Risk-parity strategies are designed for low volatility and generally allocate more toward bonds than equities. Often, though, clients want additional volatility, so a manager applies leverage through borrowing.
Chintan Kotecha, an equity-linked analyst at Bank of America, said that these types of portfolios have been known to add what is known as a "volatility control" component, a mechanism that responds to changes in market volatility by leveraging or deleveraging.
In the last several days, the equity market fell sharply and investors did not rush to buy up safe-haven bonds, causing the bond market to decline modestly as well.
The lack of bond buying caused a big spike in volatility in these funds - more than investors wanted - so they responded with a dramatic level of selling, particularly in equities.
In a Sept. 1 letter to their investors, Cooperman and Einhorn of Omega said the magnitude and velocity of the decline in the equity markets in August "can be attributed to systemic/technical investors that are price-insensitive and largely indifferent to fundamentals. Such investors include risk-parity funds, derivative hedgers, trend-following CTA's, and insurance variable-annuity programs."
Thursday, Bank of America discussed the topic with institutional investors on a conference call to educate clients.
Separately, several risk-parity managers said that they were being made into scapegoats for a sell-off they did not cause.
Their reasons? In total, they do not have enough money under management to cause such ructions and they generally do not adjust their positions so quickly.
"Risk-parity managers don't typically adjust their net exposure to equities by a significant amount on an intramonth basis," said Lee Partridge, chief investment officer at Salient Partners, which offers a $500 million risk-parity fund.
Analysts at JPMorgan Chase estimate that varying types of funds, including these funds, have completed about half of their selling as a result of the market's moves and are expected to sell another $100 billion.
"We expect elevated volatility and downside price risk to persist. In our view, the risk/reward for equity investors remains in favor of waiting, rather than being fully invested until there is more clarity from macro data and central banks," JPMorgan wrote.
The Salient Risk Parity Index, which is being used by the market as a benchmark, has fallen 5.78 percent this year but since the start of 2014 it shows an annualized return of 2.56 percent.