Risk Parity Resources: Lee et al. (2013)

"Understanding Risk Parity"

Easy to read, short, and highly accessible introduction to Risk Parity. Great resource for newcomers to risk parity, though concepts are covered elsewhere so this paper can be skipped by those already familiar with RP.

Read the original:

Important Points for the RP Investor:

Pages 1-4: Discussion of RP in simple terms. Covers the insights of modern portfolio theory at just the right level for beginners.

Page 3: Discussion of what I think of as the two paths of RP. Authors note that “a risk parity strategy can target any level of portfolio risk and thus excess return.” An investor with a long time horizon could use the RP approach to target a higher level of risk; an investor with a shorter time horizon could target a lower level.

Page 4-5: One truism of RP is that there is no one single approach to RP, as different academics and practitioners can interpret the broad mandate to balance risk in different ways. Authors here make the point that the differences are often based on the time frame people use to analyze risk in a portfolio, and there is no single, standard methodology. People can disagree on the timeframes to measure risk, thereby resulting in very different asset class allocations as well as rebalancing timeframes.

Pages 6-7: Common Criticisms of Risk Parity. Another refutation of RP’s common criticisms, namely that it is dependent on falling yields, and then that the use of leverage is problematic.

Pages 7-8: Risk Parity in Practice. Authors break down their firm’s (Clifton Group) approach to RP, using eight different asset classes: global equities, global real estate, global credit spreads, diversified commodities, global nominal bonds, global inflation-protected bonds, precious metals, and a volatility hedge. Exact weights aren’t given, nor are the exact assets used, so adapting this for the individual investor would be difficult.

The authors are Thomas Lee, Andrew Spellar, and Paul Bouchey, all of whom were affiliated with the Clifton Group, which has since been acquired by Parametric Portfolio Associates.