Sunday, 1 May 2016
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Aug 20 2013 | 11:31am ET
With the Federal Reserve mulling how and when to begin to cut back on its bond-buying program, Bridgewater Associates had an unsettling realization: It's famed risk-parity strategy was altogether too risky.
The hedge-fund giant spent months researching the issue, and found that its All Weather strategy was too vulnerable to interest-rate volatility, it told clients last month. So it began to sell Treasuries and Treasury Inflation Protected Securities to mitigate that risk, eventually cutting its holdings of highly-rate-sensitive assets by $37 billion, Bloomberg News reports.
The moves didn't save All Weather from an 8.4% loss in the second quarter, almost all of it due to declines in inflation-linked debt. But the moves, which primarily occurred prior to rates beginning to rise in May, save the fund from a further 1.5% loss.
The changes to All Weather's model are the first major alterations to the strategy since its debut in 1996.
Paradoxically, it was All Weather's outperformance between 2010 and 2012 that prompted the changes. The strategy aims to return between 5% and 7% above cash per year—but averaged returns of 16% over the past three. Bridgewater began to do research earlier this year on why the fund was doing so much better than expected, finding that the model did not properly account for the interest-rate-sensitivity of many assets.