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.”