The simple risk parity approach is a long-only equal risk-weighted allocation across equity, bonds, credit, and commodities. The portfolio will have a targeted volatility which may require leverage. This portfolio will usually have a higher dollar allocation to bonds given the relatively low volatility versus equity. There are different rebalancing approaches that will impact returns, but the overall strategy will be have a similar framework.
Risk parity funds were down between 3.5 and 5% as measured by the HFR risk parity indices through the end of February.
The asset class returns, except for rates, are all negative for March. There was little diversification benefit across asset classes beyond sovereign rates; however, the real problem was the volatility and correlation shock to these strategies. Bonds have seen an increase in volatility this year of 3.5 times while stock volatility has increased 6.5 times since the beginning of the 2020. The volatility numbers have doubled this month. At the same time, correlations across asset classes have also more than doubled.
Leverage has hurt these strategies and volatility targeting has forced selling into the market across all asset classes. Loses have been booked for larger positions and de-risking will not allow for future gains. Being short volatility has helped accelerate overall market loses.
The component ideas behind risk parity make sense, accounting for volatility and correlation contribution, volatility targeting, and systematic rebalancing; however, without a mechanism for adjusting asset allocation, investors are subject to sharp declines in return.
Risk parity funds were down between 3.5 and 5% as measured by the HFR risk parity indices through the end of February.
The asset class returns, except for rates, are all negative for March. There was little diversification benefit across asset classes beyond sovereign rates; however, the real problem was the volatility and correlation shock to these strategies. Bonds have seen an increase in volatility this year of 3.5 times while stock volatility has increased 6.5 times since the beginning of the 2020. The volatility numbers have doubled this month. At the same time, correlations across asset classes have also more than doubled.
Leverage has hurt these strategies and volatility targeting has forced selling into the market across all asset classes. Loses have been booked for larger positions and de-risking will not allow for future gains. Being short volatility has helped accelerate overall market loses.
The component ideas behind risk parity make sense, accounting for volatility and correlation contribution, volatility targeting, and systematic rebalancing; however, without a mechanism for adjusting asset allocation, investors are subject to sharp declines in return.
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