July 20, 2012
--- Risk
parity is used by defined benefit plans to protect against downside risk, but “there’s
no reason DC sponsors shouldn’t use it,” Invesco noted. ---
In a Webcast hosted by PLANSPONSOR
and its sister publication aiCIO, David Glutch, client portfolio manager, Global Asset Allocation at
Invesco, explained that risk parity is an alternative form of portfolio
management that allocates capital based on the underlying risk of asset
classes, rather than anticipated returns. Risk parity will balance asset
classes so that no class dominates; investors win by not losing, he
added.
Risk parity is an important consideration for defined
contribution (DC) plans because target-date funds (TDFs) are predicted to
become the largest recipient of DC contributions and assets from investors in
general. The “to” versus “through” retirement debate is important, but it is
not the core issue, Glutch contended. The issue should be the asset-allocation
framework and embedded assumptions; equity dependence is still an issue. TDFs
struggled in 2008 because of an over-reliance on equity exposure. Near-date
TDFs are highly sensitive to equity drawdowns, but there is also still a lot of
equity in later-date TDFs.
Some argue that participants who continued investing in TDFs
are now back to even, but being back to even is not a good thing, Glutch said.
This assumes that TDF investors are young enough to take that risk, and it
assumes no disruption in income.
With TDFs, the industry needs to think of a better way to
construct asset allocation to address the downside risk. The objective for a
TDF should be to preserve value in any economic environment as well as
outperform cash at all times; this has significant ramifications for choosing
asset allocation, Glutch contended. One must understand how asset classes
behave in three economic environments: recession, inflation, non-inflationary
growth.