risk parity

“Risk parity strategies – designed to withstand all economic circumstances – have been tested in recent times by the triple threat of unfavourable rates, spiked inflation and asset correlation breakdowns. Few managers in the field were above water through most of 2023; some saw increased portfolio risk exacerbated by leverage and untamed volatility, says a study by Markov Processes International.” – writes Luke Clancy in his Risk.net article “Can risk parity ride out the storm of correlated asset chaos?” The article extensively quotes MPI’s original research.

“Quant funds that employed risk parity saw their riskiness as measured by realized volatility levels surging 50% to 80% higher than their stated targets, according to a study from Markov Processes International obtained by Bloomberg based on results through November… Markov found that majority of the 10 popular risk-parity strategies it reviewed saw record levels of volatility, with a “staggering” gap between the winners and losers.” – writes Bloomberg’s Isabelle Lee and senior editor John Authers in his column discussing results of MPI’s research Risk Parity Not Performing? Blame the Weather.

Many high profile funds with set risk targets exhibit levels of volatility last seen only during the Global Financial Crisis. This and the disparity of results between funds in the category is the subject of this post.

2022 has been a challenging year for some of the largest risk-parity funds. RISK.net’s Luke Clancy covers MPI research “Is 2022 All Bad Weather For Risk Parity?” in his article Keep risk parity simple, stupid – Risk.net (subscription required)

Risk parity strategies can look very different from each other in implementation.  They may have different risk budgets, risk targets, asset class buckets or even different definitions of risk. In this particular period, however, the disparity in performance is staggering.

RIABiz article  “Wealthfront CEO Andy Rachleff oversaw the insertion of leverage, hence risk into portfolios, which has been unrewarding in this market“ covers MPI’s risk parity research and  interviews Megan Woods, MPI’s research director.

“Estimates of daily changes in leverage at risk parity mutual funds, one group of volatility-targeting investors pinpointed as contributors to deleveraging last month, suggest some funds cut leverage sharply but others didn’t“, writes Faye Kilburn about MPI’s research in her Risk.net article. 

How have risk parity funds actually acted (or reacted) during the current crisis? We use our Stylus Pro system to estimate changes in allocations and leverage levels.

2017 Yale endowment report rebuts Warren Buffett’s 2016 Berkshire Hathaway investor letter that “financial ‘elites’”, including endowments, are better off investing in low fee index products and not “wasting” money on active managers’ hefty fees. We did our own calculations and here’s what we found…

Four of the other five fund families with holdings vs. returns-based discrepancies are of a similar nature in that they have investments in derivatives, leveraged funds or absolute return funds, which affect the holdings tally. In each of these cases, DSA provides a much closer estimate to the intended systematic exposure.