Leon Cooperman Blames Risk Parity For Market Chaos

Last week JPMorgan Chase & Co. (NYSE:JPM) Chase & Co. warned its clients that Volatility Target strategies, CTAs and Risk Parity portfolios could sell a combined total of $150 billion to $300 billion of equities during the next few weeks as momentum drives selling (Concerns Over Risk Parity Grow [Cont.])

The report from JPMorgan came a few days after the Financial Times published an article on the risks that Risk Parity strategies posed to the global bond market. The Financial Times cited a new report from AllianceBernstein (Introduction to Tail Risk Parity an old copy of the paper can be found here), which estimates that risk parity is now a $400 billion industry. Assuming an average leverage ratio of 355%, these funds control around $1.4 trillion in assets.

Risk Parity strategy

Leon Cooperman on risk parity

Reports from the Financial Times, AllianceBernstein and JPMorgan all imply that Risk Parity is a disaster waiting to happen. And Leon Cooperman, the founder of Omega Advisors just joined the party.

Within his August letter to investors, Cooperman blamed Omega's poor returns (year to date Omega's funds are down between 6% and 11% according to Omega's letter to investors reviewed by ValueWalk) on "price-insensitive" investors.

Our investment process, grounded in fundamental company research, with a capital marketr overview designed to help us gauge appropriate risk asset exposure, has served us well since our inception 23 years ago, and we believe in its continued effectiveness. The firm has virtually no debit balance, and we like what we own.

With respect to the investment outlook, we believe that shares in the U.S. will end the year higher. A slowing in China's economic growth, the surprise devaluation of the yuan in August, continued weak oil and commodity prices, and uncertainty as to the timing of the first Federal Reserve rate hike, all contributed to an initial weakness in U.S. and global equity markets in late August. However, these factors, we believe, cannot fully explain the maenitude and velocity of the decline in equity markets last month. We think that much of that decline can Ix attributed to systematic/technical investors that are price-insensitive and largely indifferent to fundamentals. Such investors include risk-parity funds, derivative hedgers, trend-following CTA's, and insurance variable-annuity programs.

The month of August was a bad one for global risk markets and a bad one for Omega. The S&P 500 dropped 6%, its worst monthly decline in over three years. Our various investment funds, excluding our Credit Opportunity Fund which eased just 1.4% last month, declined by between 9% and 11% in August. Year to date, our equity-focused funds are down between 6% and 11%; differential returns among our funds reflect different investment mandates. The Credit Opportunity Fund has a total return of 9% year-to-date.

We are very disappointed in our performance. Prior to the August decline in U.S share prices, we were of the view that our equity market was in a zone of fair to full value and had moderate upside potential to year-end. The swift and severe correction in U.S. and global equity markets took us by surprise, as our analysis of the fundamentals did not signal noteworthy equity-marks vulnerability. Be assured that everyone at Omega is committed to reversing our 2015 year-to-date experience. Our investment process, grounded in fundamental company research, with a capital marketr overview designed to help us gauge appropriate risk asset exposure, has served us well since our inception 23 years ago, and we believe in its continued effectiveness. The firm has virtually no debit balance, and we like what we own.

With respect to the investment outlook, we believe that shares in the U.S. will end the year higher. A slowing in China's economic growth, the surprise aevaluation of the yuan in August, continued weak oil and commodity prices, and uncertainty as to the timing of the first Federal Reserve rate hike, all contributed to an initial weakness in U.S. and global equity markets in late August. However, these factors, we believe, cannot fully explain the magnitude and velocity of the decline in equity markets last month. We think that much of that decline can 3e attributed to systematic/technical investors that are price-insensitive and largely indifferent to fundamentals. Such investors include risk-parity funds, derivative hedgers, trend-following CTA's, and insurance variable-annuity programs.

While it is obviously difficult to estimate when these systematic/technical investors will stop roiling the markets, we do believe that the conditions for a further sustained decline in share prices are not in-place and that shares should trend higher over the coming year. Put simply, the end of an equity bull market has almost always required the following: significant acceleration in wage and consumer price inflation; tight monetary policy as represented by declining year-over-year growth in real money supply; the expectation of recession; investor exuberance; speculative aggregate market valuation; and net purchases of equities by individuals. None of these precursors to a bear market are evident today nor do we expect their arrival any time soon. Further, the large percentage of stocks in the S&P 500 down year-to-date, and the significant percentage of stocks down in excess of 15% year-to-date, both signal that substantial damage to shares has already been incurred. Based on these observations, if the U.S. equity bull market is over, it will be the oddest ending to a bull market in the post-war period.

RBC: Selling slows

While Leon Cooperman and others are blaming Risk Parity strategies for the market panic caused at the end of last month, in a note to clients this week RBC Capital reported that there's been a sizeable slowdown in the exposure cutting of leveraged trading strategies this week.

RBC's traders have reported a "strong bid into the back part of the SPX cash session 4 of the past 5 days." However, according to the note to clients, the bank reports that a number of different buy-side sources have estimated anywhere from $75 billion to $100 billion apiece of S&P futures selling from leveraged vol target / risk-parity / systematic quant strategies over the past 10 days -- an estimated $275 billion of futures supply against estimates from some around $300 billion of exposure cutting to do.