State manages risk

Ken Skarbeck’s [Nov. 19] column addressed a new strategy the Indiana Public Retirement System is using to diversify its portfolio. The strategy, known as risk parity, has been around for over 20 years and will eventually compose 10 percent of INPRS assets.

Since the financial crisis of 2008, INPRS has dedicated significant time and resources to improve its risk management infrastructure. The decision to move a portion of the assets into risk parity—which seeks to diversify risk, rather than merely diversify asset classes—is one direct outcome of the new risk management program.

Risk parity attempts to balance risk across equities, bonds, commodities and inflation-linked bonds. It recognizes the distinct performance characteristics of these assets during periods of robust or slow growth, for instance, or high or low inflation. For any given rate of return target, risk can be mitigated. Likewise, for a given risk appetite, returns can be improved.

Nothing is a sure bet, but risk parity strategies have achieved robust returns while minimizing risk over most time periods.

Skarbeck makes a good point that historical volatility does not measure all types of risk. We heartily agree.

Skarbeck thinks stocks are a good bet right now. He may be correct. INPRS owns billions of dollars of equities and works with investment managers who have strong views, perhaps similar to Skarbeck’s, about the direction of stocks, bonds and other assets. But as an entity charged with funding the retirements of 500,000 Hoosier workers and retirees, INPRS as a whole should not make overly concentrated bets.

Truly balanced portfolios recognize that neither INPRS nor anyone else knows with certainty what the global economy has in store. Committing to a concentrated asset mix because of a particular view on equities would represent the very type of risk Skarbeck warns against.

Fortunately, risk parity has performed well in all environments—from low-inflation, high-growth periods where stocks might outperform to high-inflation periods where commodities and TIPS might do better. That’s the point of the strategy: Seek healthy returns sufficient to fund the retirements of INPRS members while minimizing downside risk.

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Bret T. Swanson
Trustee and Investment Committee Member