Will My Risk Parity Strategy Outperform?

Abstract

We gauge the return-generating potential of four investment strategies: value weighted, 60/40 fixed mix, unlevered and levered risk parity. We have three main findings. First, even over periods lasting decades, the start and end dates of a backtest can have a material effect on results; second, transaction costs can reverse ranking, especially when leverage is employed; third, a statistically significant return premium does not guarantee outperformance over reasonable investment horizons.

Keywords: Risk parity, value weighting, fixed mix, leverage, turnover, trading costs, borrowing costs, market frictions, statistical significance, outperformance, Sharpe ratio

JEL Classification: C10, C12, C13, C15, C22