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Eight decades of risk parity investing

eight decades of risk parity investing

The investment approach for Risk Parity Portfolios 6 They include eight asset classes: U.S. large‑cap equity, U.S. small‑cap. The lower risk portfolio offers investors double-digit annual returns and is significantly safer, less volatile than treasuries, a strong. October 11, PM Updated 4 years ago Risk-parity funds refer to a set of rule-based investment strategies that combine stocks, bonds and other. FOOTBALL BETTING PREDICTIONS PREMIERSHIP TRANSFERS

SPX marked its biggest one-day fall since February on Wednesday and added to losses the day after. The order of events, rising bond yields followed by a stock market selloff, recalled a similar event in February and also placed the focus on mechanical investment strategies sensitive to volatility, including risk-parity funds. Risk-parity funds refer to a set of rule-based investment strategies that combine stocks, bonds and other financial assets.

They are a counterweight to traditional portfolio investment strategies where investors are split between equities and bonds but equities end up carrying more of the risk. The formula is based on historical research on how each asset performs and relates to the other groups over time. Said portfolio might look as follows. Risk parity seems to work, in theory at least. During the most recent bear market, early , the risk parity portfolio would have performed well.

Treasury gains would have been twice as high as equity losses. Equity gains would have outpaced treasury losses. This is the essence of risk parity: the two different asset classes having equal risks and returns. Risk parity seems to work, in theory, and in practice. Risk parity takes the same concepts, analysis, and mathematics behind the above, and expands them into other asset classes and economic environments. It is much more than just equities and treasuries, but the logic is the same.

A summary of these follows. Source: BridgeWater The different quadrants show which asset classes perform particularly well during a specific market condition. When growth is high, upper left quadrant, the portfolio performs well due to its investments in equities, commodities, corporate credit, and EM credit. When inflation is high, upper right quadrant, the portfolio performs well due to its investments in inflation-linked bonds IL bonds , commodities, and EM credit.

Same idea for the other quadrants. The process behind choosing the asset classes and their weights is the same as the one in my example, just more complicated. From the above, it seems clear that a proper risk parity portfolio should perform well during bear markets, bull markets, inflationary and deflationary environments, as well as other adverse economic and market conditions.

With the above in mind, let's create a real risk parity portfolio, with all the bells and whistles. Risk Parity Model Portfolios Risk parity portfolio funds were selected taking into consideration their investment strategy, holdings, and use of leverage.

I knew how the portfolio as a whole was meant to look, and selected funds which coincided with my expectations for the portfolio. I settled on the following three funds. These same securities also have reasonably strong long-term expected returns, at least when analyzed as a whole, and taking into consideration their use of leverage. In theory, these securities could be used to construct a portfolio with strong, consistent returns.

Finally, I calculated fund weights to equalize risk across the four different scenarios as well as I could. Results are as follows, data from May to May Source: Portfolio Visualizer - Chart by author As can be seen above, the model portfolio performs, well, exceedingly well. It is stronger than more traditional balanced portfolios in all relevant metrics, including returns, risk and volatility, and downturns. The fund is about as safe as treasuries, but boasting double-digit annual returns since inception.

Importantly, the portfolio performs quite well during most relevant market conditions. Before the pandemic, from May to January , growth was rising while inflation and rates were falling. Portfolio returns equaled 6. Data by YCharts At the start of the pandemic, from January to April , we had falling growth, inflation, and rates.

DBC, however, significantly underperformed. Returns were effectively zero, technically positive at 0. Data by YCharts Afterwards, from April 1st, to May 31st, , we have been under a period of rising growth, inflation, and rates. All funds are supposed to perform well under these conditions, especially DBC, as has been the case. Portfolio returns equaled During said time period, all major asset classes were down, including U. When everything is down, IVOL's interest rate options are supposed to pick up the slack.

They mostly did, but the timing was a bit off. IVOL's price spiked on the 31st of August, and so it was technically down during the time period in question. IVOL traded with an uncharacteristic premium that day, quite rare for an ETF, and usually caused by the aforementioned reason. In any case, the portfolio's largest drawdown doesn't look too bad. The portfolio has suffered other losses, none of which lasted more than one month. As mentioned previously, these are outstanding results.

Commodities, TIPs, and interest rate options should perform well as inflation increases, so expect strong returns from IVOL and DCB, and for the portfolio as a whole, during stagflation. Weights and results are as follows: The higher risk portfolio is, well, riskier, but also achieves slightly stronger returns.

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What is risk parity? - FT Markets

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