Risk Parity Portfolio vs. Other Asset Allocation Heuristic Portfolios

In this paper, we conduct a horse race between representative Risk Parity portfolios and other asset allocation strategies, including equal weighting, minimum-variance, mean-variance optimization, and the classic 60/40 equity/bond portfolio. We find that the traditional Risk Parity portfolio construction does not consistently outperform on a risk-adjusted basis the equal weighting or a model pension fund portfolio anchored to the 60/40 equity/bond portfolio structure. However, it does significantly outperform optimized allocation strategies such as minimum-variance and mean-variance efficient portfolios on a consistent basis. Over the past 30 years, the Sharpe Ratios of the Risk Parity and the equal weighting portfolio have been much more stable across decade-long sub-periods than either the 60/40 portfolio or the optimized portfolios. Although Risk Parity performs on par with equal weighting, it does provide better diversification in terms of risk allocation and, thus, warrants further consideration as an asset allocation strategy. However, we show that the Risk Parity strategy’s performance can be highly dependent on the investment universe. Thus, to execute on Risk Parity successfully, careful selection of asset classes is very critical and, for the time being, remains an art rather than a science.