Just spotted a survey from aiCIO that refers to risk parity as an “innovative but unproven” allocation strategy.
The word “unproven” is pejorative and unduly presumptive. Proof of what? Compared to what? Has aiCIO identified examples of “proven” allocation strategies? All allocation strategies of which I’m aware involve investing in assets that entail risk of loss. Did someone “prove” some strategies when I wasn’t paying attention? Which ones? What’s the proof supposed to be? Who decides when a strategy is proven?
Risk parity means you equal weight the portfolio contribution to risk. That’s it. That is a reasonable allocation strategy when:
- You’re allocating among assets that don’t have a meaningful equilibrium market cap, such as commodities
- You seek more risk than in a minimum variance portfolio but think a cap-weighted allocation is too concentrated in volatile assets
- You’re uncertain what returns to expect among the assets in your allocation, so you minimize your regret by allocating among their risk equally
What does it mean for an allocation strategy to be “proven?” Does the Surgeon General have to issue a statement? Homeland Security? The FDA?
Calling it “unproven” presupposes that some day the proof could come in. What is the proof? What are the criteria for a strategy to be “proven?”
Risk parity is simply a way to allocate portfolio risk. It is an optimistic1 skeptic’s alternative to a maximum Sharpe ratio allocation.
1I assume a pessimistic skeptic would stick either to cash or to minimum variance portfolios.