Risk Parity
Risk parity is an investment strategy that allocates capital across a portfolio based on the risk contribution of each asset rather than the traditional method of capital allocation. The goal is to equalize the risk across all assets, ensuring that no single asset or asset class dominates the overall risk of the portfolio. This approach aims to optimize the risk-adjusted return by balancing risk among equities, bonds, commodities, and other asset classes, often using leverage to achieve desired returns.
Example
In a risk parity portfolio, equities, bonds, and commodities are allocated in such a way that they contribute equally to the portfolio's overall risk, reducing the dominance of more volatile assets like stocks.
Key points
• Allocates capital based on risk contribution, not dollar amount.
• Aims to balance risk across asset classes for better risk-adjusted returns.
• Often uses leverage to achieve higher returns while maintaining balanced risk.
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