How do folks feel about risk parity strategies? How about the retail implementation through leveraged ETFs? It's been a tough start to the year for RP with high volatility and stocks and bonds both in the red.

My thoughts on risk parity from a recent blog:

My test of how well I understand a topic is to try explaining it to my friends. They’ll listen patiently and ask questions as I’m explaining the concept. As I talk, I often begin to realize that my narrative is unraveling in the face of their questions, and I am repeating the same lines over and over (at a louder and louder volume).

Ugh. Clearly, I don’t know enough to explain the topic simply and therefore I don’t really understand it all. My thoughts aren’t translating to my mouth, and in the case of this blog, won’t translate onto the page. This happened recently with risk parity.

I know. I know. Some of you are yelling at your screen. “It’s intuitive! Balance risk not dollars! Use some leverage! Ray Dalio!” Others may not have heard of risk parity and you’ve already forgiven me. Thank you.

But, for retail investors the practical application of a theoretical risk parity portfolio is a bit more complicated. And, I think a strong understanding of risk parity and the challenges facing retail investors is essential before diving in.

I would also say many of us, myself included, have a long relationship with adding equities to increase expected returns. While we may “get” risk parity, it could take some time to get comfortable building portfolios in a different way.

‍Back to school: Finance 101

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Bear with me a minute while I get finance-y. As simply as I can say it, to create a risk parity portfolio, investors weigh assets by risk (volatility) instead of dollar amounts. Traditional portfolio construction looks at expected returns and volatility (risk) and creates a portfolio that minimizes risks for a desired return. An investor may end up with a portfolio that is 60% equities and 40% bonds (i.e., weighted by dollars).

However, if we assume volatility of 15% for stocks and 5% for bonds and a correlation of 0.2, then stocks will account for over 90% of the risk in a 60 40 portfolio. SeekingAlpha crunched the numbers from 2000 - 2017 and found the risk contribution was actually greater than 100%! This concentration of risk is what risk parity seeks to address.