Risk Parity
A portfolio construction approach that allocates capital so each asset class contributes equally to total portfolio risk.
What is Risk Parity?
Risk parity is a portfolio construction strategy that allocates capital based on risk contributions rather than dollar amounts, with the goal of achieving equal risk contribution from each asset class. In a traditional 60% stocks / 40% bonds portfolio, equities are much more volatile than bonds and therefore dominate portfolio risk — often contributing 85–90% of total volatility despite representing only 60% of capital. Risk parity corrects this imbalance by over-weighting lower-volatility assets (bonds, commodities) and under-weighting higher-volatility assets (equities), frequently using leverage to bring lower-volatility assets up to a target total portfolio risk level. The strategy was pioneered by Bridgewater Associates and its 'All Weather' fund. Risk parity performs well when asset class risks are fairly rewarded and correlations are stable; it can underperform when bonds and stocks become positively correlated (as in 2022) and when the cost of leverage exceeds the yield spread of lower-risk assets.
Example
A risk parity fund targets 10% portfolio volatility. Equities (15% volatility) and bonds (5% volatility) must contribute equally. To achieve parity, bonds receive a much larger capital allocation than equities, often 2–3× on a dollar basis, brought to the target volatility through leverage. In 2022, rising rates caused both stocks and bonds to fall simultaneously, and leverage amplified losses — one of risk parity's worst environments.