Alternative Investing

Risk Parity, Risk Management and the Real World

Topics - Alternative Investing Risk Parity Portfolio Risk and Performance

Read Time - 10 mins

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Risk Parity, Risk Management and the Real World

AQR White Paper

At the heart of risk parity, there is risk management.

Risk parity’s core benefit — improved portfolio diversification — ultimately is a product of how well risk is assessed and managed. For investment managers, the practical considerations are important.

Risk parity strategies share two common elements: (1) balanced risk exposures, which usually mean less capital exposure to stocks than traditional portfolios (and more exposure to everything else); and (2) the use of leverage to scale the portfolio risk to about the level of traditional portfolios.

The goal of risk parity strategies is for everything in the portfolio to matter, but for nothing to matter too much. Implicit is the assumption that risk parity managers can make reasonable assessments of risk, and make those assessments in a constantly changing market environment.

In this paper, we conclude that risk parity portfolios require dynamic management; their holdings need to be regularly adjusted to reflect the dynamics of underlying market risk. Further, we conclude that risk parity portfolios should incorporate a planned capital-preservation strategy to try to avoid significant disruptions in a crisis.

At its core, risk parity is an argument about the importance of diversification — across time and across asset classes. In the long term, we think the best risk parity portfolios will be those that both adopt a dynamic approach to risk management and have a plan to preserve capital in a crisis.

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information 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. Past performance is not a guarantee of future results.

 

Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. Hypothetical performance results are presented for illustrative purposes only.

 

Diversification does not eliminate the risk of experiencing investment loss.

 

Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.