If you’re still hawking the story that the original results of Fama and French, Jegadeesh and Titman, Lakonishok, Vishny and Shleifer — and even yours truly and others — were the result of data mining, you have been completely defeated on the field of financial battle, and you must stop.
The risk parity-versus-60/40 argument has always been about strategic long term — not tactical short term — asset allocation. Here I argue that, when viewed strategically, the empirical work on risk parity, including some of our own, understates its potential advantages. Moreover, all you need is basic finance theory to see it.
The idea that corporate management should focus on maximizing shareholder value is under attack, often in hyperbolic terms, with this idea blamed for great and varied harm (e.g., underinvestment, inefficiency, inequality and the failure of people to appreciate the film Ishtar). Recently, James Montier of the esteemed, including by me, money manager Grantham, Mayo, Van Otterloo & Co., voicing the views of many, wrote a piece calling it “The World’s Dumbest Idea.” Luckily for markets and the economy, this is not the world’s dumbest idea — not close. It’s imperfect, as all things are, but it’s not even a little bit “dumb.”
First, I must issue a disclaimer. This is for wonks already immersed in the factor literature. There's lots of inside baseball, assumed terminology, etc., in this one. I explain what I’m doing along the way, but rarely from scratch. If this stuff is brand new to you and you still understand it all you are way smarter than me (you are allowed to find that to be faint praise). There’s nothing more mathematical here than a regression model but there is lots of shop talk. So, if "factor wonk" doesn't describe you, you probably have friends and a social life, so that’s nice, but this piece won't make much sense (consider it even).
Critics seeking to attack risk parity don't have to go all tin-foil-hat crazy — blaming the strategy for the exceptional market volatility last summer. Instead, they could just do what people usually do, attack recent performance, because risk parity has undeniably been through a tough relative performance period of late. But we still believe in it as an alternative long-term strategic asset allocation that’s typically used to diversify a more traditional equity-dominated allocation.