Risk Parity – From the 1990’s to today
Risk Parity strategies have been effective and popular strategies since the early 1990’s as diversification benefits enabled risk parity strategies to make money in most environments. However, the tide may be going out for risk parity strategies as rising interest rate environments impact their ability to use leverage to boost returns.
While investors wonder if this is the ebb of risk parity strategies, the number of alternative mutual funds and ETF/ETNs continues to rise. This raises the following question. If both risk parity and alternative funds provide diversification and downside protection, can allocation to alternative funds provide risk parity like returns? In other words, are alternative funds the new risk parity strategies?
Historically, as shown by the MSCI Barra graph above, risk parity strategies have weathered market downturns and delivered returns above a standard 60% equity/40 % bond market portfolio. However, as interest rates have risen starting in 2Q2013, risk parity strategies have been hit hard. The graph below shows two risk parity strategies, one managed by AQR and the second managed by Invesco. Both funds have taken significant hits since May 2013 with the funds down 6.45% and 3.21% YTD respectively.