Alternative Investing
Risk Parity, Risk Management and the Real World
April 1, 2011
Topics - Alternative Investing Risk Parity Portfolio Risk and Performance
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.
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.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.