Alternative Investing
Risk Parity: A Supplement to Traditional Portfolios, Not Their Replacement
January 1, 2012
Topics - Alternative Investing Risk Parity
Investments and Pensions Europe
It is often said that long-term investors can rely on equity returns since they can withstand short-term periods of underperformance and still survive to realize the benefits in the long-term. In this article, the authors contend that in the past 40 years stocks have had no better risk-adjusted returns than bonds or commodities (and if you study the narrower, but longer data histories since the 1920s, risk-adjusted returns on equities actually have been slightly lower than bonds).
Regardless of whether or not an investor believes they have a long or short investment horizon, this empirical observation leads to a surprising fact: not only would a risk-diversified portfolio managed to similar risk levels have had more muted drawdowns than the traditional, equity-dominated portfolio, it also would have had higher returns. That is, despite the conventional wisdom, in the long run an equity-oriented portfolio did not deliver the highest returns, and certainly not the highest risk-adjusted returns.
The benefits of risk parity should not, however, be oversold. As we have demonstrated, Sharpe Ratios of risk parity portfolios should be a bit higher than that of traditional allocations, but investors should not expect steadily higher returns.
The authors write that risk parity is not a “silver bullet,” but say they believe that within the larger context of a traditional allocation, it is a useful strategy that raises portfolio risk-adjusted return while reducing concentration in equities.
This document is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and AQR Capital Management, LLC (“AQR”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
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