Risk Parity

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tradri
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sat Apr 24, 2021 5:43 pm
Personally, I'm more interested in DIY Risk Parity than any of the packaged offerings.

A simple example just using retail ETF/mutual funds:

Portfolio 1: Standard 60/40

60% VTSMX Total Stock (99% risk contribution)
40% VBMFX Total Bond (1% risk contribution)

vs

Portfolio 2: Lazy Risk Parity

45% VTSMX Total Stock (50% risk contribution)
55% UST 3x 7-10 YR Tr (50% risk contribution)

In this backtest, the Lazy Risk Parity slightly beats the Standard 60/40 on performance, loses a bit on fees, and crushes standard 60/40 on max drawdown.

https://www.portfoliovisualizer.com/bac ... tion3_2=55
That's a beautiful use case for leveraged ETFs in a portfolio. :beer
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Re: Risk Parity

Post by nisiprius »

watchnerd wrote: Sat Apr 24, 2021 12:06 pm
JamesDean44 wrote: Sat Apr 24, 2021 11:52 am I never claimed that risk parity funds outperformed a 60/40 in the recent past. Leveraging a diversified portfolio rather than just increasing equity exposure to obtain a desired targeted return makes sense to me and is supported by investing principles and research.

I'll add that psldx could be viewed as a risk parity type approach, but without the inflation/commodities and with only US equities. It has obviously performed very well in the recent past.
Also:

Raw outperformance isn't the point of risk parity, anyway.
Risk parity isn't supposed to outperform 100% stocks, but it is supposed to be comparable to 60/40. If we look at, say, CRAAX, their own chosen benchmark is 60% MSCI ACWI, 40% Bloomberg-Barclay's Aggregate Index. Morningstar benchmarks them to a "Moderate Target Risk" portfolio which is 60% stocks, 40% bonds+"other".

The whole premise is that you can do better with risk parity than you can simply by adding unleveraged bonds, because you get more low-correlation benefit from the leverage, and because the other asset categories willhelp in times when both bonds and stocks lag.

Those funds would have underperformed on return without substantially reducing risk. The risk measures come out roughly the same. It should be clear enough visually that the risk characteristics of the risk parity funds was roughly the same as for the 60/40 fund. On the actual number it turns out they would have had slightly lower risk than 60/40, so to make the failure of the risk parity funds perfectly clear, I'll compare them with the Vanguard LifeStrategy Conservative Growth, 40/60. When we do this, we see that not only would they not have beaten 60/40, they wouldn't even have beaten 40/60... and yet they would have had more volatility (StDev), and deeper drawdowns than 40/60. Less return with more risk.

[url=https://www.portfoliovisualizer.com/fun ... mark=VSCGX]

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Last edited by nisiprius on Sat Apr 24, 2021 6:20 pm, edited 4 times in total.
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watchnerd
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sat Apr 24, 2021 6:02 pm
watchnerd wrote: Sat Apr 24, 2021 12:06 pm
JamesDean44 wrote: Sat Apr 24, 2021 11:52 am I never claimed that risk parity funds outperformed a 60/40 in the recent past. Leveraging a diversified portfolio rather than just increasing equity exposure to obtain a desired targeted return makes sense to me and is supported by investing principles and research.

I'll add that psldx could be viewed as a risk parity type approach, but without the inflation/commodities and with only US equities. It has obviously performed very well in the recent past.
Also:

Raw outperformance isn't the point of risk parity, anyway.
Risk parity isn't support to outperform 100% stocks, but it is supposed to be comparable to 60/40. The whole argument is that you can do better with risk parity than you can simply by adding bonds.
See the Lazy Risk Parity example I gave right upthread. ^^^^^

It ties on performance, handily beats vanilla 60/40 on risk.
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watchnerd
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sat Apr 24, 2021 5:48 pm
watchnerd wrote: Sat Apr 24, 2021 5:43 pm
Personally, I'm more interested in DIY Risk Parity than any of the packaged offerings.

A simple example just using retail ETF/mutual funds:

Portfolio 1: Standard 60/40

60% VTSMX Total Stock (99% risk contribution)
40% VBMFX Total Bond (1% risk contribution)

vs

Portfolio 2: Lazy Risk Parity

45% VTSMX Total Stock (50% risk contribution)
55% UST 3x 7-10 YR Tr (50% risk contribution)

In this backtest, the Lazy Risk Parity slightly beats the Standard 60/40 on performance, loses a bit on fees, and crushes standard 60/40 on max drawdown.

https://www.portfoliovisualizer.com/bac ... tion3_2=55
That's a beautiful use case for leveraged ETFs in a portfolio. :beer
Thanks!

:beer

I'm not wild about the fees, though.

0.59 fee across the whole port isn't awful compared to active funds, but it's .08 bps more than RPAR. You might be able to DIY roll your own with Treasury futures contracts, but that becomes a bit of a maintenance hassle, too.
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sat Apr 24, 2021 6:02 pm I'll compare them with the Vanguard LifeStrategy Conservative Growth, 40/60.
Oh, and the Lazy Risk Parity in the tested time period beat Vanguard LifeStrategy Cnsrv Gr Inv (VSCGX) on:

CAGR
Max Drawdown

StdDev was within 65 bps of each other.

https://www.portfoliovisualizer.com/bac ... ion4_3=100

The real win for VSCGX is cost.
Last edited by watchnerd on Sat Apr 24, 2021 6:18 pm, edited 3 times in total.
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nisiprius
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Re: Risk Parity

Post by nisiprius »

watchnerd wrote: Sat Apr 24, 2021 6:04 pm See the Lazy Risk Parity example I gave right upthread. ^^^^^

It ties on performance, handily beats vanilla 60/40 on risk.
You're right. Although I wish you'd use the past tense, "Over the time period shown, Jan 2011 - Mar 2021, it would have ..."
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sat Apr 24, 2021 6:17 pm
watchnerd wrote: Sat Apr 24, 2021 6:04 pm See the Lazy Risk Parity example I gave right upthread. ^^^^^

It ties on performance, handily beats vanilla 60/40 on risk.
You're right. Although I wish you'd use the past tense, "Over the time period shown, Jan 2011 - Mar 2021, it would have ..."
Yes, sometimes I remember to write for the past tense, sometimes I forget.

Good catch.
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Re: Risk Parity

Post by nisiprius »

watchnerd wrote: Sat Apr 24, 2021 6:18 pm
nisiprius wrote: Sat Apr 24, 2021 6:17 pm
watchnerd wrote: Sat Apr 24, 2021 6:04 pm See the Lazy Risk Parity example I gave right upthread. ^^^^^

It ties on performance, handily beats vanilla 60/40 on risk.
You're right. Although I wish you'd use the past tense, "Over the time period shown, Jan 2011 - Mar 2021, it would have ..."
Yes, sometimes I remember to write for the past tense, sometimes I forget.

Good catch.
I just went back and checked my own posting and made a couple of verb tense adjustments, too.
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Re: Risk Parity

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Ocean77 wrote: Fri Apr 23, 2021 12:49 am I thought Ray Dalio originally came up with this, used it until last year, and then abandoned it? Reason being the essential element in it (long term bonds) had come down to such low interest rates that it no longer offered the returns it had for previous years and decades.
Risk Parity worked great with falling rates due to it's large allocation to long bonds. Now, not so much.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: Risk Parity

Post by watchnerd »

GaryA505 wrote: Sat Apr 24, 2021 6:27 pm
Ocean77 wrote: Fri Apr 23, 2021 12:49 am I thought Ray Dalio originally came up with this, used it until last year, and then abandoned it? Reason being the essential element in it (long term bonds) had come down to such low interest rates that it no longer offered the returns it had for previous years and decades.
Risk Parity worked great with falling rates due to it's large allocation to long bonds. Now, not so much.
You can use Long Bonds in standard MPT contexts without it being Risk Parity; for example, I don't think my usage of Long Treasuries qualifies as Risk Parity.

And you can use Risk Parity without Long Bonds.

They're not synonymous.

Levering up Intermediate bonds can give them a volatility similar to Long.
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Re: Risk Parity

Post by watchnerd »

55% EDV / 45% BIL was a pretty decent simulation of UST's 2x 7-10 YR:

https://www.portfoliovisualizer.com/bac ... ion3_2=100

And much cheaper.
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Re: Risk Parity

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GaryA505 wrote: Sat Apr 24, 2021 6:27 pm
Ocean77 wrote: Fri Apr 23, 2021 12:49 am I thought Ray Dalio originally came up with this, used it until last year, and then abandoned it? Reason being the essential element in it (long term bonds) had come down to such low interest rates that it no longer offered the returns it had for previous years and decades.
Risk Parity worked great with falling rates due to it's large allocation to long bonds. Now, not so much.
Indeed. I think one of the attractions of this strategy was that you would get almost stock like returns, but with much lower risk. Only a small portion of the portfolio consisted of stocks, so the usual stock volatility did not have much effect on the portfolio. And the big allocation to long term bonds lowered the risk but still gave this great return. There isn't really any such option anymore. Sure we can still find low risk investments, but they are usually also low return. The low risk / high return we had with long term bonds was probably a once in a lifetime effect that won't recur.
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Re: Risk Parity

Post by nisiprius »

GaryA505 wrote: Sat Apr 24, 2021 6:27 pm
Ocean77 wrote: Fri Apr 23, 2021 12:49 am I thought Ray Dalio originally came up with this, used it until last year, and then abandoned it? Reason being the essential element in it (long term bonds) had come down to such low interest rates that it no longer offered the returns it had for previous years and decades.
Risk Parity worked great with falling rates due to it's large allocation to long bonds. Now, not so much.
But let's be clear. The claims made for Dalio's risk parity strategy are unequivocal.

The strategy as described by Bridgewater is not supposed to depend on long bonds having a decent return, nor on their being negatively correlated with stocks. The paper says explicitly that beyond core principles,
Anything else (asset class returns, correlations, or even precise volatilities) is an attempt to predict the future.
It is supposed to be based on
the timeless and universal relationships that both explain economic outcomes and repeat throughout history.
The principles behind All Weather relate to answering a deceptively straightforward question explored by Ray with co-Chief Investment Officer Bob Prince and other early colleagues at Bridgewater—what kind of investment portfolio would you hold that would perform well across all environments, be it a devaluation or something completely different?
It is supposed to perform well in all environments including the unanticipated.
After decades of study Ray, Bob, Greg Jensen, Dan Bernstein and others at Bridgewater created an investment strategy structured to be indifferent to shifts in discounted economic conditions.... It is predicated on the notion that asset classes react in understandable ways based on the relationship of their cash flows to the economic environment. By balancing assets based on these structural characteristics the impact of economic surprises can be minimized.
It is not supposed to be undone by surprises like changes in interest rates.
Market participants might be surprised by inflation shifts or a growth bust and All Weather would chug along, providing attractive, relatively stable returns.
And finally:
If you can’t predict the future with much certainty and you don’t know which particular economic conditions will unfold, then it seems reasonable to hold a mix of assets that can perform well across all different types of economic environments.
ALL different types.
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sun Apr 25, 2021 7:02 am
GaryA505 wrote: Sat Apr 24, 2021 6:27 pm
Ocean77 wrote: Fri Apr 23, 2021 12:49 am I thought Ray Dalio originally came up with this, used it until last year, and then abandoned it? Reason being the essential element in it (long term bonds) had come down to such low interest rates that it no longer offered the returns it had for previous years and decades.
Risk Parity worked great with falling rates due to it's large allocation to long bonds. Now, not so much.
But let's be clear. The claims made for Dalio's risk parity strategy are unequivocal.

The strategy as described by Bridgewater is not supposed to depend on long bonds having a decent return, nor on their being negatively correlated with stocks.
As a reminder...

"All Weather" != Risk Parity

Qian's work doesn't focus on Long Treasuries, either.

https://www.panagora.com/assets/PanAgor ... cation.pdf

To quote:
Using the Risk Parity Portfolios

Risk Parity Portfolios can be used as stand-alone beta
products. They can also be combined with alpha strategies
to further increase returns. As a beta strategy, Risk Parity
Portfolios can be used in the following three ways:

• An unleveraged version with 4%–5% risk, similar to that
of the Lehman Aggregate Bond Index

• A leveraged version with a leverage ratio of about 2:1
and a risk target of around 8%–10%, similar to that of
domestic or global balanced portfolios

• A global macro strategy with 16%–20% risk and leverage
of 4:1, similar to that of a typical hedge fund
I have to get credit to Dalio, though, for doing enough public speaking to make himself synonymous with the concept in the mind of the lay person.

And Dalio recently moans a lot about how horrible bonds are, of all durations.
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Re: Risk Parity

Post by nisiprius »

Also notable, particularly if you are using AQR as an educational resource on risk parity:

Cliff Asness, June 1, 2015: Risk Parity Is Even Better Than We Thought

Bloomberg, 12/7/2018 (disable Javascript) AQR Strips Risk Parity Name from Mutual Fund After RedemptionsMoney manager will rebrand the fund as a multi-asset pool

AQR Capital Management’s flagship risk parity mutual fund, which has suffered big outflows, will no longer be billed as a risk parity fund.

The firm, which helped popularize the investing style, is changing the name and tweaking the strategy for its $344 million AQR Risk Parity Fund, according to a November regulatory filing. The rebranded AQR Multi-Asset Fund will have more leeway to bet against stocks and bonds, among other changes, which may help it navigate volatile markets.[/quote]

I don't think Cliff Asness has posted anything about risk parity since the rebranding; the last piece of his on risk parity was in early 2018, saying that people should not be blaming stock market turmoil on the use of risk parity strategies.

Source

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Last edited by nisiprius on Sun Apr 25, 2021 10:44 am, edited 3 times in total.
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Re: Risk Parity

Post by nisiprius »

First, to acknowledge again, watchnerd posted, above, a simple portfolio of stocks and leveraged bond (and no other assets) that backtests beautifully, beating a number of mutual funds that claim to be following risk parity strategies. Not sure where the HEDGEFUNDIE strategy fits in the taxonomy.
watchnerd wrote: Sun Apr 25, 2021 9:50 amAs a reminder...

"All Weather" != Risk Parity
That's a cultural question and open to legitimate discussion. Wikipedia says something reasonable: Risk parity
Risk parity (or risk premia parity) is an approach to investment management which focuses on allocation of risk, usually defined as volatility, rather than allocation of capital....

Some of its theoretical components were developed in the 1950s and 1960s but the first risk parity fund, called the All Weather fund, was pioneered in 1996. In recent years many investment companies have begun offering risk parity funds to their clients. The term, risk parity, came into use in 2005, coined by Edward Qian, of PanAgora Asset Management, and was then adopted by the asset management industry. Risk parity can be seen as either a passive or active management strategy.
One of the problems with risk parity, in my opinion, is that it is not well defined and thus always open to "no true Scotsman" objections. I note, for example, that Bridgewater said in 2012 and earlier that
The strategy was and is passive,
yet on according to a Bloomberg story in 2020, Bridgewater's Risk Parity Shift Jolts a $400 Billion Quant Trade, Bridgewater said in July 2020 that
Our balanced approach to beta has never been about a particular asset allocation, nor has it ever been reliant on any particular asset class.
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Re: Risk Parity

Post by tradri »

I think there is no true "risk parity" portfolio, because the risk/reward characteristics of different assets are always changing, as well as the correlation between those assets.

I think the main idea behind risk parity is to include uncorrelated assets, which is a valuable lesson in my opinion.
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sun Apr 25, 2021 10:45 am I think there is no true "risk parity" portfolio, because the risk/reward characteristics of different assets are always changing, as well as the correlation between those assets.
Yes, very true.

The Lazy Risk Parity port I posted above is pretty close to 50 stock / 50 bond risk exposure through the long period, but in any given year, it can shift pretty dramatically in terms of risk drift.

So true risk equalization may be a bit of a unicorn.

And that's not even getting into cost drag...
tradri wrote: Sun Apr 25, 2021 10:45 am
I think the main idea behind risk parity is to include uncorrelated assets, which is a valuable lesson in my opinion.
To me, that's just basic MPT.

MPT predates Risk Parity by many decades.
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Re: Risk Parity

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watchnerd wrote: Sun Apr 25, 2021 11:31 am
To me, that's just basic MPT.

MPT predates Risk Parity by many decades.
Ok. I just heard the concept from Ray Dalio first, so I equated those two. https://youtu.be/Nu4lHaSh7D4
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sun Apr 25, 2021 11:35 am
watchnerd wrote: Sun Apr 25, 2021 11:31 am
To me, that's just basic MPT.

MPT predates Risk Parity by many decades.
Ok. I just heard the concept first from Ray Dalio, so I equated those two. https://youtu.be/Nu4lHaSh7D4
Oh lordy.

Please don't let Dalio steal credit for this.

Harry Markowitz got the Nobel Prize for his work on MPT.

He first published the concept in 1952.

Learn the history, young blood. ;)
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sun Apr 25, 2021 11:53 am
Oh lordy.

Please don't let Dalio steal credit for this.

Harry Markowitz got the Nobel Prize for his work on MPT.

He first published the concept in 1952.

Learn the history, young blood. ;)
Thanks, didn't know that.

Was it then Ray Dalio who came up with the idea of leveraging a portfolio of uncorrelated assets, or is he just a marketer who popularized these ideas?
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sun Apr 25, 2021 11:57 am
Thanks, didn't know that.

Was it then Ray Dalio who came up with the idea of leveraging a portfolio of uncorrelated assets, or is he just a marketer who popularized these ideas?
That's murkier.

There were papers published after Markowitz in the 1950s and 1960s discussing applying leverage to uncorrelated assets.

So I don't think Bridgewater can be credited with inventing the concept.

They might have been the first to actually execute on it, though, at any kind of scale.

It was pretty hard to actually implement Risk Parity in a real world portfolio before the invention of computers and modern electronic trading.
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sun Apr 25, 2021 12:03 pm
That's murkier.

There were papers published after Markowitz in the 1950s and 1960s discussing applying leverage to uncorrelated assets.

So I don't think Bridgewater can be credited with inventing the concept.

They might have been the first to actually execute on it, though, at any kind of scale.

It was pretty hard to actually implement Risk Parity in a real world portfolio before the invention of computers and modern electronic trading.
Interesting, thx.
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Re: Risk Parity

Post by nisiprius »

According to Bridgewater's presentation (i.e. not at all objective or disinterested), the idea originated as a portfolio for institutional investors, and got its start because the tech crash made institutional investors more receptive to ideas for defensive strategies.
Around that time, Bob [Prince] began talking with Britt Harris, then CIO of a major corporate pension fund, which was a client of Bridgewater’s... Bob told Britt, “Let me tell you what I would do if I were in your shoes.” The portfolio he described and they built for Britt’s pension plan—as you might expect—was All Weather. It was so unorthodox that Britt insisted on a massive due diligence process...
Reading between the lines, pension funds were leery of leverage.
Gradually objections surrounding All Weather eased. As investors grew accustomed to looking at leverage in a less black-and-white way — “no leverage is good and any leverage is bad” — many have come to understand that a moderately-levered, highly-diversified portfolio is less risky than an unleveraged, un-diversified portfolio.
And they constantly talk about institutional investors and pension funds. That seems to be whom the pitch is directed at.

So my mental sketch of the history, subject to learning more, is that regardless of what things might have been proposed theoretically, there was a big hangup over the use of leverage in pension funds, and it just wasn't being done, until Bridgewater made the big breakthrough in implementing and selling the concept.
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sun Apr 25, 2021 12:22 pm According to Bridgewater's presentation (i.e. not at all objective or disinterested), the idea originated as a portfolio for institutional investors, and got its start because the tech crash made institutional investors more receptive to ideas for defensive strategies.
I thought All Weather started in 1996?

Which would be before the tech crash.
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Re: Risk Parity

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Here are my personal notes on Risk Parity, documented for public testimony should I backslide and decide to implement RP in the future:

--Risk Parity is intellectually interesting and learning about it enhances understanding of Modern Portfolio Theory, efficient frontiers, and Sharpe ratios.

--Implementing at the retail level using currently available leveraged ETFs is expensive. The 'Lazy Risk Parity' portfolio above has an ER of about .50. On a $1M+ plus risk portfolio, that's a minimum of $5K a year in cost drag.

--Existing retail packaged products (e.g. RPAR) have similar costs, or higher.

--DIY buying your own Treasury futures (for example) is not only a maintenance headache and learning curve, the minimum buy-in is high. Ultra 10 Future delivery at maturity are $100K.

--Good margin rates are still 1.01% on $1.5M, which is problematic if bonds are the levered asset, given current real yields.

--I'm not a pension fund and have other ways to deal with stability of income than micro-managing Std Dev vs outflows

--I already have a LMP portfolio of blended TIPS and nominal laddered bonds to provide an income floor far cheaper than the cost of implementing risk parity as a means to regulate total liquid portfolio volatility

--If your investment strategy pairs a LMP portfolio with a Risk Portfolio, there is not much strategic purpose in paying the extra cost to push maximal capital efficiency of the Risk Portfolio by using leverage to drive up the Sharpe Ratio to increase returns per unit of risk; you're already paying for risk reduction by moving capital from the Risk Portfolio into the LMP -- you don't need to buy the same insurance twice.
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sun Apr 25, 2021 1:16 pm Here are my personal notes on Risk Parity, documented for public testimony should I backslide and decide to implement RP in the future:

--Risk Parity is intellectually interesting and learning about it enhances understanding of Modern Portfolio Theory, efficient frontiers, and Sharpe ratios.

--Implementing at the retail level using currently available leveraged ETFs is expensive. The 'Lazy Risk Parity' portfolio above has an ER of about .50. On a $1M+ plus risk portfolio, that's a minimum of $5K a year in cost drag.

--DIY buying your own Treasury futures (for example) is not only a maintenance headache and learning curve, the minimum buy-in is high. Ultra 10 Future delivery at maturity are $100K.

--Good margin rates are still 1.01% on $1.5M, which is problematic if bonds are the levered asset, given current real yields.

--I'm not a pension fund and have other ways to deal with stability of income than micro-managing Std Dev vs outflows

--I already have a LMP portfolio with blended TIPS and nominal laddered bonds to provide an income floor far cheaper than the cost of implementing risk parity as a means to regulate total liquid portfolio volatility

--If your investment strategy pairs a LMP portfolio with a Risk Portfolio, there is not much strategic purpose in paying the extra cost to push maximal capital efficiency of the Risk Portfolio by using leverage to drive up the Sharpe Ratio to maximize returns per unit of risk; you're already paying for risk reduction by moving capital from the Risk Portfolio into the LMP -- you don't need to buy the same insurance twice.
Thanks for sharing.

The thing that got me really interested in the risk parity concept, is the fact that the same principles apply when optimizing for the highest returns. The more leverage one uses, the more efficient the portfolio has to become in order to get those higher returns.

Implementing a leveraged strategy sucks (Ben Felix acknowledges this in his podcast: https://www.youtube.com/watch?v=AlgaIyjK3Qc at minute 50) but I think leveraged ETFs are the most straightforward way of actually doing it.
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sun Apr 25, 2021 1:36 pm

Thanks for sharing.

The thing that got me really interested in the risk parity concept, is the fact that the same principles apply when optimizing for the highest returns. The more leverage one uses, the more efficient the portfolio has to become in order to get those higher returns.

Implementing a leveraged strategy sucks (Ben Felix acknowledges this in his podcast: https://www.youtube.com/watch?v=AlgaIyjK3Qc at minute 50) but I think leveraged ETFs are the most straightforward way of actually doing it.
Implementing leverage to increase returns by increasing aggregate portfolio risk / beta exposure is a different animal with different goals.
Last edited by watchnerd on Sun Apr 25, 2021 1:43 pm, edited 1 time in total.
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Re: Risk Parity

Post by nisiprius »

watchnerd wrote: Sun Apr 25, 2021 1:16 pm...--If your investment strategy pairs a LMP portfolio with a Risk Portfolio, there is not much strategic purpose in paying the extra cost to push maximal capital efficiency of the Risk Portfolio by using leverage to drive up the Sharpe Ratio to maximize returns per unit of risk; you're already paying for risk reduction by moving capital from the Risk Portfolio into the LMP -- you don't need to buy the same insurance twice...
And there's a certain disconnect there, because it is the traditional MPT tangency portfolio that maximizes the Sharpe ratio.* The Wikipedia article says "The risk parity approach asserts that when asset allocations are adjusted (leveraged or deleveraged) to the same risk level, the risk parity portfolio can achieve a higher Sharpe ratio... than the traditional portfolio," but that can't be correct. Risk parity does not maximize the Sharpe ratio. As a matter of fact, applying leverage, if you can borrow at the riskless rate, does not change the Sharpe ratio.

So it is not clear to me what risk parity is maximizing--if there is a mathematical basis to it, it must be involving replacing the traditional Sharpe ratio with some other measure of risk and risk-adjusted return.

*maximizes the Sharpe ratio for some specific past time period, and of course past Sharpe ratio is no sure indicator of future Sharpe ratio.
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sun Apr 25, 2021 1:42 pm
Implementing leverage to increase returns by increasing aggregate portfolio risk / beta exposure is a different animal with different goals.
Yes, they have different goals, but if you increase leverage enough, optimizing for Sharpe and highest returns become synonymous.
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Re: Risk Parity

Post by watchnerd »

nisiprius wrote: Sun Apr 25, 2021 1:42 pm
watchnerd wrote: Sun Apr 25, 2021 1:16 pm...--If your investment strategy pairs a LMP portfolio with a Risk Portfolio, there is not much strategic purpose in paying the extra cost to push maximal capital efficiency of the Risk Portfolio by using leverage to drive up the Sharpe Ratio to maximize returns per unit of risk; you're already paying for risk reduction by moving capital from the Risk Portfolio into the LMP -- you don't need to buy the same insurance twice...
And there's a certain disconnect there, because it is the traditional MPT tangency portfolio that maximizes the Sharpe ratio.* The Wikipedia article says "The risk parity approach asserts that when asset allocations are adjusted (leveraged or deleveraged) to the same risk level, the risk parity portfolio can achieve a higher Sharpe ratio... than the traditional portfolio," but that can't be correct. Risk parity does not maximize the Sharpe ratio. As a matter of fact, applying leverage, if you can borrow at the riskless rate, does not change the Sharpe ratio.

So it is not clear to me what risk parity is maximizing--if there is a mathematical basis to it, it must be involving replacing the traditional Sharpe ratio with some other measure of risk and risk-adjusted return.

*maximizes the Sharpe ratio for some specific past time period, and of course past Sharpe ratio is no sure indicator of future Sharpe ratio.
I believe, mathematically, it's because you're supposed to be applying leverage to the negatively correlated asset(s).

Which should increase the Sharpe ratio, as long as those negatively correlated assets have sufficient positive return.
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Re: Risk Parity

Post by watchnerd »

tradri wrote: Sun Apr 25, 2021 1:46 pm
watchnerd wrote: Sun Apr 25, 2021 1:42 pm
Implementing leverage to increase returns by increasing aggregate portfolio risk / beta exposure is a different animal with different goals.
Yes, they have different goals, but if you increase leverage enough, optimizing for Sharpe and highest returns become synonymous.
That's too broad and a massive blending of different goals.

The purpose of Risk Parity is to maximize returns within a given target volatility.

Risk Parity has never touted, even by Dalio, as a way to jack up raw CAGR, regardless of volatility.

So to recap:

--MPT concepts of diversification are not synonymous with Risk Parity and predate RP by decades

--The generic use of leverage to increase returns, absent volatility limits, is not synonymous with the stated goals of Risk Parity, according to those who wrote the papers and promote the concept
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Re: Risk Parity

Post by tradri »

watchnerd wrote: Sun Apr 25, 2021 1:52 pm
That's too broad and a massive blending of different goals.

The purpose of Risk Parity is to maximize returns within a given target volatility.

Risk Parity has never touted, even by Dalio, as a way to jack up raw CAGR.

So to recap:

--MPT concepts of diversification are not synonymous with Risk Parity and predate RP by decades

--The generic use of leverage to increase returns, absent volatility limits, is not synonymous with the stated goals of Risk Parity, according to those who wrote the papers and promote the concept
You're right. I just wanted to say that learning about risk parity has helped me immensely to understand the HEDGEFUNDIE strategy and why it works the way it works.
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Re: Risk Parity

Post by watchnerd »

slowandsteadywins wrote: Sat Apr 24, 2021 11:06 am

The Wealthfront Risk Parity Mutual Fund. It did under perform March 2020 (COVID-19 pandemic) because the leveraged bonds in the volatility diversification both dropped and rose, which of course, was not the anticipated correlation between the assets in the risk balancing strategy of the risk parity fund.

https://support.wealthfront.com/hc/en-u ... sk-Parity- (General documents: reports, prospectus summary/full, etc.)

https://www.wealthfront.com/static/docu ... report.pdf (Fund Manager speaks to the March 2020 and COVID-19 drop and slow rebound)

The more I read, the more I like it and feel comfortable with Wealthfront adding 20% of my overall portfolio to this fund. Otherwise, it is a balanced low cost ETF, with some direct stock holdings representing a portion of the US Stock allocation to allow for more nuanced tax loss harvesting.

I'd love to hear your thoughts on their risk parity fund strategy and choice of assets, since you have some background and familiarity with risk parity and Boglehead philosophy. If you choose to, thanks so much!
Well, since you asked for input....

So if I read their statement:
Performance of the Wealthfront Risk Parity Fund (“the Fund”) in the fiscal year of 2020 (November
1, 2019 to October 31, 2020) was poor. Over this period, the Fund returned -12.94%, while the
Fund’s benchmark (a 60/40 blend of MSCI World Equity Index (Net) and the Bloomberg-Barclays
Global Aggregate Bond Index) returned 5.39%. The disappointing performance was driven by a
sharp decline in equity markets caused by the onset of the COVID-19 crisis and a temporary
positive correlation in the performance of equities and bonds, which were exacerbated by
leverage in the Fund’s exposures.
The rationale is a little puzzling.

The Treasuries I hold were not positively correlated with equities during the Covid crash.

In fact, the Long Treasuries in my port were wonderfully negatively correlated.

So what kind of bonds were they leveraging up?
"The Fund seeks equal risk contributions from six asset classes: US, non-US Developed Markets, and
Emerging Markets Equities; US and Emerging Markets Bonds; and Real Estate. ...To achieve an adequate level of absolute return, the Fund applies leverage to its positions seeking to achieve a target 12% annualized volatility. Total leverage applied is usually between
two and three times the Fund’s assets
, although total exposure may be higher or lower at any
given time."
Okay, so if they were using 2x - 3x on US corp, US high yield, and EM bonds.....yeah, those might normally be 'low' correlation assets, but they're not negatively correlated.

And, as was shown, that correlation often increases in bad times.

What, specifically, are they holding?

I'm having a hard time finding out the AA of the fund. This was listed in the 'underlying assets' section:

AGG: 157%
EMB: 60%
SPY: 95%
VEA: 131%
VWO: 76%
VNQ: 33%

Total: ~5.5X

I'm suspicious that this is the AA, as this would be a lot more than 2-3x gearing; Morningstar says it uses a 2x gearing.

Morningstar gives WFRPX a "Negative" rating:

https://www.morningstar.com/funds/xnas/wfrpx/quote
"Wealthfront Risk Parity W earns a Morningstar Quantitative Rating of Negative because of negative contributors including a weak portfolio-management team and a questionable investment process."
Although Wealthfront Risk Parity Fund was incepted in January 2018, the fund's long-term track record is largely no longer applicable, as its portfolio management team has turned over completely. Since the new regime's current strategy is not necessarily representative of the past, it is difficult to compare them. The new team took the reins in February 2020 and looking at their new performance record, they have posted disappointing results. For the most recent one-year period, the strategy earned a -7.8% return through month-end, lagging behind its category peers' 13.8% and trailing the Morningstar Global Allocation Index’s 19.5% return. And taking risk into account, over the past year, the strategy had an elevated standard deviation relative to the benchmark.
I also think it's a real stretch to call it a "risk parity" fund when it holds so many highly correlated assets -- the methodology seems to be just to lever up everything.

Personally, I don't have a reason to invest in this kind of fund.

My portfolio (in my sig) costs 50% less in fees and gave almost 1.8x the performance over the life of the fund, about half the volatility, and half the draw down:

https://www.portfoliovisualizer.com/bac ... tion5_2=60
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Re: Risk Parity

Post by slowandsteadywins »

watchnerd wrote: Sun Apr 25, 2021 3:36 pm
Okay, so if they were using 2x - 3x on US corp, US high yield, and EM bonds.....yeah, those might normally be 'low' correlation assets, but they're not negatively correlated.

And, as was shown, that correlation often increases in bad times.

What, specifically, are they holding?
This is the correlation assumptions that I understand Wealthfront is utilizing, from their overall Investment Methodology Whitepaper (https://research.wealthfront.com/whitep ... thodology/)

Image
We use the estimates from the variance-covariance matrix of asset class returns, and the net-of-fee, after-tax expected returns for each asset class as inputs to the mean-variance optimization to determine the optimal portfolio for each level of risk. Additionally, we enforce minimum and maximum allocation constraints for each asset class that are displayed in Table 6. Unless otherwise noted, the minimum allocation constraints are set at zero in order to ensure that the optimized portfolios are long-only (i.e. do not involve any short position). The only asset classes we require in taxable portfolios are US Stocks, Foreign Developed Stocks, Emerging Market Stocks, and Municipal Bonds. These asset classes form the foundation of Target Date Funds (TDFs). However, most TDFs utilize general Government Bonds rather than municipal securities, resulting in portfolios that are less tax efficient, particularly for investors in higher tax brackets. Finally, we exclude REITs from taxable portfolios, as tax forms distributed by REIT ETFs are commonly restated or distributed late, complicating tax filings for investors.

We selected 35% as the maximum allocation for each asset class to ensure sufficient diversification. Other respected sources (including Swensen, 2005) recommend similar maximum asset class allocations. We limit the allocation to Risk Parity in taxable accounts to 20%. We use a relatively more conservative limit for Risk Parity because its portfolio allocation will not be able to participate in Tax Loss Harvesting, due to the lack of a suitable alternate fund. Furthermore, accounts under $100k are ineligible to invest in Risk Parity, as they do not have access to Direct Indexing, which enhances the tax efficiency of the Risk Parity allocation in taxable accounts. Aside from these constraints we allow the optimizer to freely assemble portfolios from the complete set of asset classes.
Image

Full WF Risk Parity Prospectus (March 2021): https://www.wealthfront.com/static/docu ... pectus.pdf
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Re: Risk Parity

Post by watchnerd »

slowandsteadywins wrote: Sun Apr 25, 2021 4:14 pm
watchnerd wrote: Sun Apr 25, 2021 3:36 pm
Okay, so if they were using 2x - 3x on US corp, US high yield, and EM bonds.....yeah, those might normally be 'low' correlation assets, but they're not negatively correlated.

And, as was shown, that correlation often increases in bad times.

What, specifically, are they holding?
This is the correlation assumptions that I understand Wealthfront is utilizing, from their overall Investment Methodology Whitepaper (https://research.wealthfront.com/whitep ... thodology/)

Image
We use the estimates from the variance-covariance matrix of asset class returns, and the net-of-fee, after-tax expected returns for each asset class as inputs to the mean-variance optimization to determine the optimal portfolio for each level of risk. Additionally, we enforce minimum and maximum allocation constraints for each asset class that are displayed in Table 6. Unless otherwise noted, the minimum allocation constraints are set at zero in order to ensure that the optimized portfolios are long-only (i.e. do not involve any short position). The only asset classes we require in taxable portfolios are US Stocks, Foreign Developed Stocks, Emerging Market Stocks, and Municipal Bonds. These asset classes form the foundation of Target Date Funds (TDFs). However, most TDFs utilize general Government Bonds rather than municipal securities, resulting in portfolios that are less tax efficient, particularly for investors in higher tax brackets. Finally, we exclude REITs from taxable portfolios, as tax forms distributed by REIT ETFs are commonly restated or distributed late, complicating tax filings for investors.

We selected 35% as the maximum allocation for each asset class to ensure sufficient diversification. Other respected sources (including Swensen, 2005) recommend similar maximum asset class allocations. We limit the allocation to Risk Parity in taxable accounts to 20%. We use a relatively more conservative limit for Risk Parity because its portfolio allocation will not be able to participate in Tax Loss Harvesting, due to the lack of a suitable alternate fund. Furthermore, accounts under $100k are ineligible to invest in Risk Parity, as they do not have access to Direct Indexing, which enhances the tax efficiency of the Risk Parity allocation in taxable accounts. Aside from these constraints we allow the optimizer to freely assemble portfolios from the complete set of asset classes.
Image

Full WF Risk Parity Prospectus (March 2021): https://www.wealthfront.com/static/docu ... pectus.pdf

Well, that correlation chart only partially maps to the ETFs they seem to hold.

Because they can go to 0 in a bunch of them.

At least from what I can tell.

It shouldn't be this hard to tell what's in a fund's portfolio....

The algorithm behind the Robo Advisor doesn't seem to be pulling off a magic trick to beat the market.
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Re: Risk Parity

Post by slowandsteadywins »

Regarding the poor performance of wealth front’s Risk Parity fund during COVID-19, they responded:
We don't yet have any published data for 2020 but I'm happy to provide some context into the performance of Risk Parity last year.

In the long-term, stocks and bonds are diversifying - they tend to move in opposite directions when investors rebalance from one asset class to the other. Because bonds are normally a low-risk asset class, our fund employs leverage to equalize the amount of risk coming from bonds with the amount of risk coming from stocks. Risk Parity often performs better in normal market downdrafts, as it did in the first two months of 2020. However, it will perform badly in short term shocks when bonds and stocks both go down.The market experienced extreme volatility last year during the onset of the global pandemic and both stocks and bonds moved sharply downward together. This caused the performance of Risk Parity to move downward as well.

It's unusual for both asset classes to move in the same direction, and we don't expect this to continue over the long-term. The good news is these environments normalize which leads to more expected risk parity behavior.

Hope this helps. Let us know if you have further questions.
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Re: Risk Parity

Post by watchnerd »

slowandsteadywins wrote: Mon Apr 26, 2021 10:20 am Regarding the poor performance of wealth front’s Risk Parity fund during COVID-19, they responded:
We don't yet have any published data for 2020 but I'm happy to provide some context into the performance of Risk Parity last year.

In the long-term, stocks and bonds are diversifying - they tend to move in opposite directions when investors rebalance from one asset class to the other. Because bonds are normally a low-risk asset class, our fund employs leverage to equalize the amount of risk coming from bonds with the amount of risk coming from stocks. Risk Parity often performs better in normal market downdrafts, as it did in the first two months of 2020. However, it will perform badly in short term shocks when bonds and stocks both go down.The market experienced extreme volatility last year during the onset of the global pandemic and both stocks and bonds moved sharply downward together. This caused the performance of Risk Parity to move downward as well.

It's unusual for both asset classes to move in the same direction, and we don't expect this to continue over the long-term. The good news is these environments normalize which leads to more expected risk parity behavior.

Hope this helps. Let us know if you have further questions.
That's a pretty misleading answer.

They're obscuring the issue by lumping all bonds together.

The issue is that the algorithm / managers picked the wrong kind of bonds.

EM bonds provide very little protection in a crash.

And broad TBM (with corp, high yield) provide less than Treasuries.

This is clear from their own correlation matrix.
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Re: Risk Parity

Post by nisiprius »

slowandsteadywins wrote: Mon Apr 26, 2021 10:20 am(Wealthfront replied) "It's unusual for both asset classes to move in the same direction." ...
Only if you have an unusual definition of "unusual."

Here, I looked only at 1/2000 through 2/2021, a restricted period of time that I chose because I knew that stocks and long-term Treasuries did show negative correlation over that time period (unlike the 35 preceding years).

There is negative correlation, yes; in fact ρ = -0.301. But that does not mean they mostly moved in opposite directions.

The monthly returns of the Vanguard Total Stock and Long-term Treasury Funds moved in the same direction 117 times out of 253 or 46% of the time. I don't consider something that happens 46% of the time to be "unusual."

Image
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Re: Risk Parity

Post by slowandsteadywins »

Thanks all.

- I don’t understand the risk parity fund.
- The funds manager may not have either?
- I’ll stick with tax loss harvesting features for now

:D
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Re: Risk Parity

Post by MarkRoulo »

watchnerd wrote: Sun Apr 25, 2021 12:26 pm
nisiprius wrote: Sun Apr 25, 2021 12:22 pm According to Bridgewater's presentation (i.e. not at all objective or disinterested), the idea originated as a portfolio for institutional investors, and got its start because the tech crash made institutional investors more receptive to ideas for defensive strategies.
I thought All Weather started in 1996?

Which would be before the tech crash.
It did. It got popular with outside investors after the tech crash.
The fully formed All Weather emerged in 1996 as Ray, Bob and by this point the third CIO, Greg Jensen, who had joined Bridgewater out of college, sought to distill decades of learning into a single portfolio.
...
Ray described creating the portfolio “like inventing a plane that’s never flown before.” It looked right, but would it fly? He started running a pilot with his assets, and it was someone’s part-time job to rebalance the portfolio from time to time. The portfolio flew the way Bridgewater expected, but it remained purely for Ray’s trusts. All Weather was never envisaged as a product. It was profound enough that no one was doing it but at the same time so straightforward that anyone could seemingly do it for themselves. While US equities were in the early stages of the tech bubble, Ray and others began propounding the concepts of balance, initially to rather indifferent interest.

The crash of 2000 changed that. With the bursting of the bubble came the realization that equities were by no means a “sure thing.” The tech bubble implosion shifted the mindset of the average investor, reminiscent of the disruptions of Bretton Woods, the oil shocks and the 1987 stock market crash. Many money managers began shifting towards alpha (tactical bets) as a way to cope with what they perceived as a now-unstable stock market.

Around that time, Bob began talking with Britt Harris, then CIO of a major corporate pension fund, which was a client of Bridgewater’s. Bob and Britt knew each other from coaching their children together and their children’s common nursery school. Britt called Bob up one Sunday and asked about inflation-linked bonds and how they would fit into an investment portfolio. Bob told Britt, “Let me tell you what I would do if I were in your shoes.” The portfolio he described and they built for Britt’s pension plan—as you might expect—was All Weather. It was so unorthodox that Britt insisted on a massive due diligence process, which further helped codify the principles underlying the All Weather approach. As Bob recounts, “Britt said, ‘when the regulators come and ask me the question, I want to be able to pull the book off the shelf and show them all the work we did to show that this makes sense.’” The pension fund started with a $200mm allocation.

The second large client to adopt the All Weather approach was a major automobile company. They had just issued pension obligation bonds because they were severely underfunded in the aftermath of the 2001 stock market crash. The CIO wanted to manage this “new money” from the bond issuance in a “new way.” The CIO sent out perhaps 30 letters to the top institutional money managers in the world and ended up hiring five to manage his “new money”; Bridgewater was one of them.

https://www.bridgewater.com/research-an ... ther-story
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Re: Risk Parity

Post by watchnerd »

slowandsteadywins wrote: Mon Apr 26, 2021 11:42 am
- The funds manager may not have either?
This may be true.

Going back to the Morningstar comment:
its portfolio management team has turned over completely. Since the new regime's current strategy is not necessarily representative of the past, it is difficult to compare them. The new team took the reins in February 2020
I can understand the politics ("sorry guys, bad luck, but we need to improve the optics, so you're all being removed from the project"), but isn't the point of a robo advisor to remove manager risk?
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Re: Risk Parity

Post by slowandsteadywins »

I would presume the rules based system would work well as long as the rules and data entered (such as appropriately correlated holding types) is correct.
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Re: Risk Parity

Post by KirklandCoug »

If you're looking for a podcast, search for Risk Parity Radio.
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Re: Risk Parity

Post by slowandsteadywins »

watchnerd wrote: Mon Apr 26, 2021 11:48 am
slowandsteadywins wrote: Mon Apr 26, 2021 11:42 am
- The funds manager may not have either?
This may be true.

Going back to the Morningstar comment:
its portfolio management team has turned over completely. Since the new regime's current strategy is not necessarily representative of the past, it is difficult to compare them. The new team took the reins in February 2020
I can understand the politics ("sorry guys, bad luck, but we need to improve the optics, so you're all being removed from the project"), but isn't the point of a robo advisor to remove manager risk?
https://www.wealthfront.com/static/docu ... report.pdf
This is the latest annual report.
Page 5 shows the holdings and asset details as of October 2020.

The beginning has commentary from the Manager of the Fund on the poor March 2020 performance:
Manager Discussion of Fund Performance

Performance of the Wealthfront Risk Parity Fund (“the Fund”) in the fiscal year of 2020 (November 1, 2019 to October 31, 2020) was poor.
Over this period, the Fund returned -12.94%, while the Fund’s benchmark (a 60/40 blend of
MSCI World Equity Index (Net) and the Bloomberg-Barclays Global Aggregate Bond Index) returned 5.39%. The disappointing performance was driven by a
sharp decline in equity markets caused by the onset of the COVID-19 crisis and a temporary positive correlation in the performance of equities and bonds, which were exacerbated by leverage in the Fund’s exposures.

The Fund’s strategy is premised on low or negative correlation between bonds and equities. The
Fund seeks equal risk contributions from six asset classes: US, non-US Developed Markets, and
Emerging Markets Equities; US and Emerging Markets Bonds; and Real Estate. We believe this
risk-balanced approach has the ability to result in a portfolio with an expected risk-adjusted return
superior to any single asset class, and superior to that of a typical 60/40 equities/bonds portfolio.
However, the allocation by risk, rather than capital, historically tends to result in a portfolio with a
high allocation to lower-risk (lower volatility) and lower-return asset classes, such as high-quality
bonds. To achieve an adequate level of absolute return, the Fund applies leverage to its positions
seeking to achieve a target 12% annualized volatility. Total leverage applied is usually between
two and three times the Fund’s assets, although total exposure may be higher or lower at any
given time.

While low/negative correlation between bonds and equities is the typical case in the long-run, the
correlation can turn sharply positive for short periods of time in exceptional circumstances. This
is what the Fund experienced in March. As concern about the COVID-19 virus grew, both equities
and bonds experienced large negative returns as investors abandoned risky assets. These
returns were magnified by the Fund’s leverage and led to very poor performance in the month of
March.

Since March, the Fund’s performance has begun to rebound, with a return of 11.93% from April
1 through November 10, the time of writing. While positive in absolute terms, the recovery of the
Fund has trailed that of its benchmark. Following the extreme volatility beginning in March, the
leverage of the Fund was automatically reduced significantly to maintain its annual volatility target
of 12%, and as a result, the Fund has not bounced back as quickly as some individual asset
classes.

The Adviser of the Fund, Wealthfront Strategies LLC, does not adjust the portfolio’s allocations or leverage based on discretionary views on the absolute or relative expected performance of the underlying asset classes. We believe this process leads to better outcomes in the long-run, though not over every time period.

We stress that this strategy is intended for clients with an investment horizon of at least three to five years and it may not be appropriate for clients with a shorter-term horizon.

The chart below shows the growth of a $10,000 investment in the Fund, the blended index benchmark, and the two components of the benchmark. The chart shows two drawdowns since the inception of the Fund, with a less drastic one occurring in 2018. This was another period where equities, particularly foreign markets, performed poorly and bonds failed to compensate. Following 2018, the Fund experienced a period of exceptional performance, outperforming its benchmark by 13.36% and earning a total return of 32.51% in 2019, while also pulling ahead of the benchmark in terms of total return since inception. The relative outperformance continued into 2020, with the Fund beating the benchmark by 1.95% through the end of February, which is indicated by the dotted black line in the chart.
We believe that periods of underperformance are inevitable and temporary, and that the core tenets of the Fund’s strategy are sound. We maintain our belief that, although there are no guarantees, the diversification achieved through a risk-balanced portfolio, implemented systematically at a low fee, has the ability to yield superior performance in the long term.
"Nothing in this world can take the place of persistence; Persistence and determination alone are omnipotent." | -Calvin Coolidge
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watchnerd
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Re: Risk Parity

Post by watchnerd »

slowandsteadywins wrote: Mon Apr 26, 2021 1:28 pm

The beginning has commentary from the Manager of the Fund on the poor March 2020 performance:
Yes, I read the whole thing over the weekend.

It lies by omission.

Treasuries *were* negatively correlated with stocks during the Covid crash.

They levered up on risky bonds instead of safer bonds, presumably to juice returns before the crash happened.
Global stocks, IG/HY bonds, gold & digital assets at market weights 75% / 19% / 6% || LMP: TIPS ladder
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slowandsteadywins
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Re: Risk Parity

Post by slowandsteadywins »

watchnerd wrote: Mon Apr 26, 2021 1:34 pm
slowandsteadywins wrote: Mon Apr 26, 2021 1:28 pm

The beginning has commentary from the Manager of the Fund on the poor March 2020 performance:
Yes, I read the whole thing over the weekend.

It lies by omission.

Treasuries *were* negatively correlated with stocks during the Covid crash.

They levered up on risky bonds instead of safer bonds, presumably to juice returns before the crash happened.
I appreciate you for reading and providing this feedback. I tried calling the Fund per the prospective and I got a transfer agent. Haha. Well, going to avoid this one for now until I have a better grasp of the strategy and can understand it enough to analyze if they get their ducks in a row.
"Nothing in this world can take the place of persistence; Persistence and determination alone are omnipotent." | -Calvin Coolidge
Hydromod
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Re: Risk Parity

Post by Hydromod »

To my mind, a good use for risk parity is for assigning allocations to long-only funds in order to balance volatility. My goal is to maintain a relatively smooth return over a few years; the moving 3-year CAGR is about the right duration.

The figure below is my attempt at developing a risk parity portfolio. It's basically minimum variance except that the risk assigned to equities is 60 percent in aggregate and to LTT is 40 percent. Each month the portfolio weights are recalculated with a two-month lookback for the correlation matrix. Note that the average weight for LTT is roughly 50 percent, but it bounced around considerably.

Image

I have 4 equities (S&P 500, NASDAQ, utilities, and real estate) plus long-term treasuries.
  • The top plot shows the portfolio value, adjusted to 1 at the start, and the components adjusted to their fraction of the portfolio.
  • The second plot shows the moving 3-year CAGR.
  • The third plot shows the allocation for each fund.
  • The fourth plot shows the ulcer index for the components and the portfolio.
The portfolio only roughly follows the components; it does not track the peak performer. However, it does back down the allocations of components that are not doing well. Over this period the CAGR was 10 percent.

Exactly the same method is used for 2x LETFs in the next figure. The early part of some LETFs are synthetic, based on leveraging the corresponding fund in the first figure, and may be optimistic with respect to expenses. None of the LETFs start after 2/2007.

Image

The key here is that the funds again balanced out very nicely, even though some of the individual 2x funds had bad patches. The calculated CAGR for the period was 19 percent, again probably a bit optimistic from the first few years. The portfolio oscillations are a bit bigger than the unleveraged version.

I find that the 3x version also behaved nearly as smoothly, but all funds all synthetic prior to 2009 and the synthetic versions are probably quite optimistic so I'm not showing it. The CAGR from 2009 on was roughly 25-30 percent.

This is the type of strategy that I will be following with my HEDGEFUNDIE adventure going forward. It's only practical in tax protected, because of the monthly rebalancing.
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Adenovir
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Re: Risk Parity

Post by Adenovir »

KirklandCoug wrote: Mon Apr 26, 2021 1:08 pm If you're looking for a podcast, search for Risk Parity Radio.
I just came here to second the recommendation for the Risk Parity Radio podcast. It's really changed how I look at investing, especially during the distribution phase.

https://www.riskparityradio.com
"Investing is simple but not easy." ~Warren Buffett
prioritarian
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Re: Risk Parity

Post by prioritarian »

nisiprius wrote: Mon Apr 26, 2021 11:23 am
slowandsteadywins wrote: Mon Apr 26, 2021 10:20 am(Wealthfront replied) "It's unusual for both asset classes to move in the same direction." ...
Only if you have an unusual definition of "unusual."

Here, I looked only at 1/2000 through 2/2021, a restricted period of time that I chose because I knew that stocks and long-term Treasuries did show negative correlation over that time period (unlike the 35 preceding years).

There is negative correlation, yes; in fact ρ = -0.301. But that does not mean they mostly moved in opposite directions.

The monthly returns of the Vanguard Total Stock and Long-term Treasury Funds moved in the same direction 117 times out of 253 or 46% of the time. I don't consider something that happens 46% of the time to be "unusual."

Image

Treasuries are often positively correlated with stocks so wealthfront is talking their book. However, the premise of risk parity is not that stocks and bonds are always negatively correlated but rather that during periods of market panic longer duration treasury bonds show extreme negative correlation with stocks. There is a large economic literature on this flight to liquidity and some examples can be found by searching my comments.
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