This article points out that while the investment strategy known as risk parity typically is available only to institutional investors, there are a couple of offerings available to individual investors and more likely are on the way. Unlike many articles on the subject, it actually is a good explanation of risk parity and explains both its advantages and potential pitfalls.
Fans of risk parity say it solves a problem plaguing traditional diversified portfolios. Namely, they’re diversified in name only. Consider the iconic 60/40 portfolio of U.S. stocks and bonds. It may seem well balanced, but stocks dominate.
Here’s why. The volatility of the S&P 500 Index — a common proxy for risk that’s expressed as standard deviation — was 14.7 percent from 1976 through June, while that of the Bloomberg Barclays U.S. Aggregate Bond Index was just 5.3 percent, the longest overlapping period for both indexes. Because stocks are three times more volatile than bonds, they contribute far more than 60 percent of the volatility in a 60/40 portfolio. As the stock market goes, in other words, so goes the portfolio.