Given what we’ve seen this week in terms of DM yields spiking and that spilling over into equities, this is probably a good time to remind you that the 800-pound gorilla in the room is risk parity and the potential for a deleveraging episode.
As I’ve noted on several previous occasions, the gorilla analogy probably isn’t the best when it comes to the risk parity crowd because in that analogy, the gorilla’s weight is known.
One of the biggest problems with risk parity is that no one knows exactly what we’re talking about in terms of size, although we do know it’s somewhere between a half trillion and a trillion dollars.
Of course when it comes to deleveraging, the extent to which it will be “beautiful” (to quote the risk parity “zen master” himself) as opposed to “hideous” depends on a number of unknowns. Here’s how BofAML put it earlier this year:
As with CTAs, estimating potential equity selling pressure from risk parity and equity vol control funds requires first knowing how much of their assets are purely rules-based and second modelling how they could operate in a stress event. However, relative to CTAs there is much less transparency on the total size of assets in risk parity and equity vol control strategies let alone the subset of which is completely rules-based.
All of this is contingent on rates and equity vol. sustaining a spike, and it goes without saying that sustainable spikes in vol. are to come by these days.
Whatever the case, do keep in mind that the unwind does indeed appear to be underway – if only in a mild, and orderly fashion:
Take that for what it’s worth and here’s Cameron Crise to tell you why “it’s probably nothing”…
Via Bloomberg
Asset Prices Fall, But Don’t Worry About Risk Parity: Macro Man
The coincident decline in stocks and bonds over the past couple of weeks has started to ignite concerns about potential selling from risk-parity funds. The notion of a large and disorderly liquidation of asset holdings is an enticing one for macro traders — and a frightening one for long-only investors. However, the reality is that markets would likely have to fall substantially further before risk-parity funds become a legitimate market factor.
