just finished my Friday night backtests - risk parity does seem to perform pretty well a lot of the times. So when does it not?
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A few thoughts I have about risk parity (disclaimer, I don’t manage a risk parity strat except for a very simple one in my PA so I am likely missing some things).
The hardest bit to get right is inflation exposure. It’s tempting to ignore this since you haven’t needed it for the last 30 years and stocks + levered bonds have done really well. But look at the performance of stocks + levered bonds from 1970-1985 to see how bad it could get.
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You get inflation exposure two ways — inflation linked assets (TIPS, gilt linkers, inflation swaps) and commodities. TIPS/linkers should in theory do we in a risk off environment (diversifying stocks) but in practice it’s trickier than that since risk off environments can be
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passing out now will come back to this tom - thanks for sharing :)
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on the curve i think people get a few things mixed-up: utes: nom rate driven staples: inflation-driven + disco rate (some real) insurance: real-rates-driven banks: nom yield curve driven discretionary: real-growth driven commodities (equity): pure real growth + inflation
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I honestly have not put much thought into how your sector exposure contributes/detracts from your exposure to credit/nominal/real rates so these are useful starting points, thanks!
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