Risk Parity

AAA

DEFINITION of 'Risk Parity'

A portfolio allocation strategy based on targeting risk levels across the various components of an investment portfolio. The risk parity approach to asset allocation allows investors to target specific levels of risk and to divide that risk equally across the entire investment portfolio in order to achieve optimal portfolio diversification for each individual investor. Risk parity strategies are in contrast to traditional allocation methods that are based on holding a certain percentage of investment classes, such as 60% stocks and 40% bonds, within one's investment portfolio.

INVESTOPEDIA EXPLAINS 'Risk Parity'

The risk parity approach to portfolio asset allocation focuses on the amount of risk in each component rather than the specific dollar amounts invested in each component. In other words, risk parity focuses not on the allocation of capital (like traditional allocation models), but on the allocation of risk. Risk parity considers four different components: equities, credit, interest rates and commodities, and attempts to spread risk evenly across the asset classes. The goal of risk parity investing is to earn the same level of return with less volatility and risk, or to realize better returns with an equal amount of risk and volatility (versus traditional asset allocation strategies).

A traditional 60/40 portfolio can attribute 80 to 90% of its risk allocation to equities. As a result, the portfolio's returns will be dependent upon the returns of the equity markets. Proponents of the risk parity strategy state that while the 60/40 approach performs well during bull markets and periods of economic growth, it tends to fail during bear markets and economic slumps. The risk parity approach attempts to balance the portfolio to perform well under a variety of economic and market conditions.

Several risk parity-specific products, including mutual funds, are available, and investors can also build their own risk parity portfolios through careful research or by working with a qualified financial professional. The first risk parity fund, the All Weather hedge fund, was introduced by Bridgewater Associates in 1996.

RELATED TERMS
  1. Strategic Asset Allocation

    A portfolio strategy that involves setting target allocations ...
  2. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  3. Portfolio

    A grouping of financial assets such as stocks, bonds and cash ...
  4. Risk

    The chance that an investment's actual return will be different ...
  5. Diversification

    A risk management technique that mixes a wide variety of investments ...
  6. Losses and Loss-Adjustment Expense

    The portion of an insurance company’s reserves set aside for ...
Related Articles
  1. The Illusion Of Diversification: The ...
    Fundamental Analysis

    The Illusion Of Diversification: The ...

  2. Asset Allocation: The First Step Toward ...
    Investing Basics

    Asset Allocation: The First Step Toward ...

  3. Diversify Your Strategies, Not Your ...
    Investing Basics

    Diversify Your Strategies, Not Your ...

  4. Financial Advice With Zero Return
    Mutual Funds & ETFs

    Financial Advice With Zero Return

Hot Definitions
  1. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  2. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
  3. Leading Indicator

    A measurable economic factor that changes before the economy starts to follow a particular pattern or trend. Leading indicators ...
  4. Wage-Price Spiral

    A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. ...
  5. Accelerated Depreciation

    Any method of depreciation used for accounting or income tax purposes that allows greater deductions in the earlier years ...
  6. Call Risk

    The risk, faced by a holder of a callable bond, that a bond issuer will take advantage of the callable bond feature and redeem ...
Trading Center