Risk Parity and Equal-Weighted Strategies
Allocating risk instead of capital — the All Weather framework and what 2022 revealed about its assumptions
Imagine a portfolio of $1 million invested 60% in U.S. equities and 40% in U.
S. Treasuries. By capital allocation, the equity portion is 1.
5 times the bond portion. By risk allocation, the equity portion is something like 5-7 times the bond portion — equities have roughly three times the volatility of long-duration Treasuries, so the equity contribution to portfolio variance dwarfs the bond contribution. A 60/40 portfolio is approximately 90% equity-risk and 10% bond-risk, which is not what the capital weights suggest.
Bridgewater Associates' Ray Dalio and his colleagues confronted this asymmetry in the 1990s and built a framework — the All Weather portfolio portfolio — that allocated risk equally across asset classes by leveraging the lower-volatility legs. Risk parity, as the broader framework became known, reframed the asset-allocation question from 'what fraction of capital goes to each asset class?' to 'what fraction of total portfolio risk comes from each asset class?
That is the opening. Finishing a lesson is where it stops being interesting and starts being useful: the full lesson runs to 8 sections and ends with 6 practice questions. A free account is what opens the rest, and the other 255 lessons in the Academy with it. No card.
What this lesson covers
- 1Why equal risk contribution is mathematically elegant
- 2What 2022 revealed about risk parity
- 3Risk Parity vs 60/40 Comparator
- 4Equal risk contribution formulation
- 5Risk parity vs 60/40 — illustrative weight comparison and risk contributions
- 6Bridgewater All Weather and the 2022 stress test
- 7Where to see this on the platform
- 8Summary