How to ride out market volatility: Risk Parity Approach

What went wrong with our expectations? This is the very big question that links the last crisis we experienced in 2008 to the one we are facing now. Although we cannot yet provide an economic answer to the Covid-19 one (whose root cause must be sought in the healthcare emergency), we can for sure provide an answer to the other one: what today is clear is that investors underestimated risk. This is the reason why it is time to talk about risk parity again.

After the 2008 crisis investors started looking for investment strategies that could perform well even during market turmoil. This was the context in which emerged the “All Weather” portfolio based on the assumption that, identifying clearly where the risk comes from and how much it weighs, allows diversification, creating more stable portfolios in order to face unexpected events. Even before Covid-19 outbreak, we were already experiencing a fragile global growth and very high stock valuations, thus a stock market correction would have been inevitable in any case.

The persistence of low level of interest rates has led investors all over the world to take more and more risk within their portfolios by increasing their exposure to risky assets (e.g. stocks and high yield bonds). The prices of these activities have thus risen. The slump was therefore so abrupt because the prices were excessive. However, this traditional equity-driven approach has been working during the last decade but, is it still capable of generating value?