Risk parity

The objective of the Risk Parity strategy is to maximize risk adjusted returns by generating long-term returns from an efficient beta portfolio that is constructed through risk allocation. Risk Parity portfolios target equal risk contribution thus limiting the impact of the components on the total portfolio and providing better downside protection.

It is based on two underlying principles. The first is to achieve true portfolio diversification by targeting equal long-term risk contribution among various financial assets. Research shows traditional asset allocation through capital allocations often leads to skewed risk allocation and skewed risk allocation causes substantial total portfolio losses when components of the portfolio suffer large losses. The second principle is dynamic risk allocation. While long-term various financial assets have comparable risk-adjusted returns, return/risk ratios of financial assets often deviate from the long-term equilibrium, due to human bias with under- and over-reaction to market and economic events. Dynamic risk allocation uses quantitative techniques to forecast relative return/risk ratios of financial assets and adjusts risk allocation accordingly, thus generating additional returns for the Risk Parity portfolios.

The Risk Parity strategy is applied to the asset allocation as well as to the subcomponents of the portfolio (commodity, equity, and bond).