Analysis by the Cass Centre for Asset Management Research shows that an annually-rebalanced, risk parity-allocated portfolio of five asset classes – developed and emerging market equities; developed world bonds, commodities, and commercial property – would have produced a yearly return almost identical to that of a simple buy-and-hold, equally-weighted strategy, between 1993 and 2011.
Nevertheless, an equal risk approach may benefit multi-asset portfolios, by reducing overall downside volatility, the study finds. Indeed, a risk parity-allocated strategy would have suffered a maximum drawdown of just 20% over the period, compared with 47% for buy-and-hold.
In contrast, risk parity can increase drawdown when applied within single asset classes – notably in developed world sovereign bonds and equities – but with improved returns. In emerging market equities, risk parity would have returned 9.58% per year, compared with 5.48% for buy-and-hold.
In a blog for the City University London website, Andrew Clare, professor of asset management at Cass and a former researcher at the Bank of England, writes that “risk parity does appear to offer something to investors, although it may not be the investment panacea that its proponents claim.”
Andrew Clare’s blog is available here, while a copy of research paper The Trend is Our Friend: Risk Parity, Momentum and Trend Following in Global Asset Allocation can be downloaded here.