risk parity
Will My Risk Parity Strategy Outperform?
Robert M. Anderson∗
University of California at Berkeley
Stephen W. Bianchi†
University of California at Berkeley
Lisa R. Goldberg‡
MSCI and University of California at Berkeley
November 10, 2011§
Abstract
We gauge the return-generating potential and risk inherent in four investment strategies: value weighted, fixed mix, and levered and unlevered risk parity, over an
85-year horizon. There are three essential conclusions from our study. First, even over periods lasting decades, the specific start and end dates of a backtest can have a material effect on the results; second, transaction costs can negate apparent outperformance; third, statistical significance of findings needs to be assessed.
Key words: Risk parity, value weighted, leverage, turnover, trading costs, market frictions, statistical significance
∗
Department of Economics, 530 Evans Hall #3880, University of California, Berkeley, CA 94720-3880,
USA, email: anderson@econ.berkeley.edu.
†
Department of Economics, 530 Evans Hall #3880, University of California, Berkeley, CA 94720-3880,
USA, email: swbianchi@berkeley.edu.
‡
2100 Milvia Street, Berkeley, CA 94704-1113, USA, email: lisa.goldberg@msci.com.
§
We thank Rodney Sullivan for stimulating conversations about risk parity, leverage and strategy evaluation. 1
1
Past Performance is Not a Guarantee of Future
Returns
This familiar disclaimer highlights the fact that a particular investment strategy may work well in some periods and poorly in other periods, limiting the inference that can be drawn from past returns.
The concern is heightened when a proposed investment strategy is backtested using historic data. Consider an investment strategy that can be pursued today using readily available securities. If those securities were not available in the past, then the strategy has no true antecedent. Backtesting must be done using proxies for the securities, and the choice of proxies can have a material effect on
Robert M. Anderson∗
University of California at Berkeley
Stephen W. Bianchi†
University of California at Berkeley
Lisa R. Goldberg‡
MSCI and University of California at Berkeley
November 10, 2011§
Abstract
We gauge the return-generating potential and risk inherent in four investment strategies: value weighted, fixed mix, and levered and unlevered risk parity, over an
85-year horizon. There are three essential conclusions from our study. First, even over periods lasting decades, the specific start and end dates of a backtest can have a material effect on the results; second, transaction costs can negate apparent outperformance; third, statistical significance of findings needs to be assessed.
Key words: Risk parity, value weighted, leverage, turnover, trading costs, market frictions, statistical significance
∗
Department of Economics, 530 Evans Hall #3880, University of California, Berkeley, CA 94720-3880,
USA, email: anderson@econ.berkeley.edu.
†
Department of Economics, 530 Evans Hall #3880, University of California, Berkeley, CA 94720-3880,
USA, email: swbianchi@berkeley.edu.
‡
2100 Milvia Street, Berkeley, CA 94704-1113, USA, email: lisa.goldberg@msci.com.
§
We thank Rodney Sullivan for stimulating conversations about risk parity, leverage and strategy evaluation. 1
1
Past Performance is Not a Guarantee of Future
Returns
This familiar disclaimer highlights the fact that a particular investment strategy may work well in some periods and poorly in other periods, limiting the inference that can be drawn from past returns.
The concern is heightened when a proposed investment strategy is backtested using historic data. Consider an investment strategy that can be pursued today using readily available securities. If those securities were not available in the past, then the strategy has no true antecedent. Backtesting must be done using proxies for the securities, and the choice of proxies can have a material effect on
References: Clifford Asness, Andrea Frazzini and Lasse Heje Pedersen. Leverage Aversion and Risk Parity, 2011 Andrea Frazzini and Lasse Heje Pedersen. Betting Against Beta, 2010. Working Paper, AQR Capital Management, New York University and NBER Working Paper 16601. Lorenzo Naranjo. Implied Interest Rates in a Market with Frictions, 2009. Working paper, New York University. Rodney Sullivan. Speculative Leverage: A False Cure for Pension Woes. Financial Analysts Jouranl, 66(3):6–8, 2010.