Active Risk Budgeting: A Portfolio Construction Methodology for Futures Strategies

Abstract

We present a portfolio construction methodology for futures strategies that incorporates active trading and also borrows salient features from the risk-parity methodology. We document the evolution of expected risk and return based portfolio construction methodologies and propose a new methodology which corrects the crucial assumption in risk parity that all investments have similar risk adjusted returns and improves on Grinold and Kahn’s position sizing methodology by using a optimization based framework. We demonstrate a baseline implementation of active risk budgeting that improves upon both mean variance optimization and risk budgeting and document the challenges associated with its implementation for futures trading.

Keywords: Portfolio Construction, Position Sizing, Managed Futures, Portfolio Optimization, Risk Budgeting, Risk Parity

JEL Classification: C00, C10, C45, C50, G00, G11