120914_Reshaping_As_Well_As Balancing_Risk_in_Essential_Beta_ADV_new.indd

Past performance is no guarantee of future results. Potential for profi t is accompanied by possibility of loss. Commodities trading involves substantial risk of loss. Introduction First Quadrant has been using a “risk parity” approach for some time as a component of our Essential Beta strategy. The methodology used to balance risk has been previously described in several articles. However, we have never set risk parity as the goal of the portfolio, but rather as a means to an end. The goal is to produce hedged global economic growth by reducing the risks which could impede that growth and so generate an equity-like return at lower volatility. The standard risk parity approach allocates risk equally across stocks and bonds by leveraging bonds so they have equal risk to equities. The leveraged bonds is expected to naturally hedge against economic decline, deflation and equity downside risk commonly referred to as “tail-risk.” Equities, REITS, TIPS and commodities hedge against normal inflationary pressures. So risk parity presents a theoretically ideal method for achieving our goal, since it is designed to achieve true risk diversification and provides growth in different market environments.