Methodology for the Construction and Enhancement of Risk-Parity Portfolios

The investment capital of a Risk-Parity (RP) portfolio is allocated in such a way that all portfolio constituents should contribute equally to the total “risk” of the portfolio. This is in contrast to more conventional asset management, such as equally weighted funds, in which capital (rather than risk) is distributed equally. While the RP concept is straight-forward, the implementation is less so, and is described here in detail. The economic rationale behind Risk-Parity is to enforce diversification, with the goal of increasing risk adjusted return on capital invested. Our RP construction, when applied to a managed futures portfolio, demonstrates improvement upon equal weighted allocation and other suitable benchmarks. Performance can be significantly enhanced by the overlay of market views on the asset allocator, a key innovation over conventional RP-Funds, which we name Active Risk-Parity (ARP).