If Risk Parity is Fallible, What’s the Sharpe Option Now?

What a difference three months makes—risk parity’s wobble has deposed the strategy’s winning long-term risk-adjusted return.

(July 18, 2013) — High yield bonds on either side of the Atlantic have toppled risk parity as the strategy that has offered investors the best risk-adjusted returns over a one and three-year period, latest figures have shown.

A quarterly report by London-based investment consultants Redington showed European high yield made a 15.9% return in the 12 months to the end of June, while risk parity strategies could only manage 3.6%. Despite its relatively higher risk profile, the high yield portfolio actually managed a much better Sharpe Ratio than the supposedly more balanced risk parity strategy: 3.38 for European high yield vs 0.32 for risk parity.

Over the last three months a range of fixed-income strategies and even developed market equities moved ahead of risk parity-on an overall returns and Sharpe Ratio basis.

At the end of March, risk parity was far and away the best performing strategy in terms of overall returns and Sharpe Ratios, Redington’s research showed. It made excess returns of 15.54%, which beat the closest contender—high yield European debt—by almost four and a half percentage points with a Sharpe Ratio of 3.32.

On a three-year basis, the story has had the same twist. Three months ago, risk parity led the three-year chart for total and risk-adjusted returns. By the end of June, US high yield debt was at the head of the pack on a Sharpe Ratio basis, with a score of 1.48 and total return of 10.1%. Edging out this asset class on a total return basis was developed market equities with a 10.9% performance, but 0.7 Sharpe Ratio.

Risk parity showed an 8.9% return overall with a Sharpe Ratio of 0.97 over the three-year period.

Over five years, UK government debt topped the leader board for its Sharpe Ratio of 0.82, beating US high yield—at 0.69—by some margin, leaving risk parity in sixth place with an 0.47 rating.

This month, aiCIO looked into the recent wobbles within the risk parity strategy. To find out the main protagonists’ reasons behind the recent disappointment read Risk Parity: What Happened? and for news on what they plan to do to stop it happening again, read Risk Parity: What’s Next?

If you are an asset owner who loves, loathes or is not even interested in risk parity, please take five minutes to fill out our survey on the strategy by clicking here.

To read Redington’s full quarterly paper, click here

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