Leon Cooperman of Omega Advisors, points to strategies such as “risk parity” for having worsened the troubles experienced by equity markets over the last month, joining a number of industry observers who have the same opinion. According to a report from CNBC, Cooperman and Omega Advisors’ Vice Chairman Steven Einhorn said in a letter to investors on September 1 that “the magnitude and velocity of the decline” of markets in August could not have been influenced only by troubles in China and concerns about interest rates in the U.S. As such, there were other forces that contributed to the tumult, and Omega Advisors’ losses by extension, and these are “systemic or technical investors” including risk parity funds, which grew in popularity after the success of Ray Dalio’s Bridgewater Associates, as well as momentum investors, which are also known as CTAs.
The problem with risk parity funds, CTAs, and “smart beta” investors is the speed at which they rebalance their portfolios in reaction to controlling risk, the letter suggests. Often, funds that utilize these strategies are controlled by algorithms, and when markets move towards volatility, sell-offs may be initiated. As sell-offs are started, it may trigger further sell-offs, and the cycle may be self-reinforcing, as other industry observers like AllianceBernstein, JPMorgan, and Pimco note. Among these strategies, risk parity is in the spotlight the CNBC report notes, as around $600 billion in investments are managed now using this strategy, and that is excluding leverage, which makes the strategy even more prominent. Unlike traditional portfolio allocation methods, risk parity aims to balance the allocation of risk and volatility over components. The strategy can be very effective, as evidenced by Bridgewater Associates’ success, but in turbulent times it can negatively affect markets and institutions such as Omega Advisors.
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According to the investor letter, Omega’s funds concentrated in equity investments tumbled by between 9% and 11% in August, dragging them down to dips of 6% and 11% year-to-date. These figures are consistent with Leon Cooperman’s top stock picks’ decline during August. Omega Advisors’ top stock picks at the end of June were Allergan PLC (NYSE:AGN), AerCap Holdings N.V. (NYSE:AER), and Sunedison Inc (NYSE:SUNE), which fell by 8.27%, 10.25%, and a massive 55.32%, respectively, over the course of August. The poor performance of Omega Advisors last month can partly be attributed to it vacating short positions more and more, in light of the recent U.S. bull market. In August, the S&P 500 lost 6.25% while the Dow Jones lost 6.57%, weighing down on Omega Advisors’ equity-focused funds.
The down market, which may have been influenced by risk parity, is not only affecting firms like Omega Advisors. Activist investors like Bill Ackman’s Pershing Square and Barry Rosenstein’s JANA Partners have also been hit hard in August. According to people briefed on these funds’ performance, Pershing Square lost 9.2% while JANA Partners tumbled by 4.3% in August. Activists generally hold long positions for the longer term while trying to influence unlocking of more shareholder value through reforms.
Nonetheless, Leon Cooperman is not downtrodden about the future of the markets. In the letter, he says that he thinks the end of 2015 will see U.S stocks climb. He says that Omega Advisors believes “that the bulk of U.S. equity market damage has been done.” If the bull market has ended, this would be the “oddest ending to a bull market in the postwar period,” the letter notes.
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