and eventually published my findings in my first book, Balanced Asset Allocation: How to Profit in Any Economic Climate, which was published by Wiley in 2014. Ray and Bridgewater were strongly supportive of the project and instrumental in providing me with the required data to back my findings.
Damien called me after my first meeting with Ray to let me know that Ray enjoyed our encounter and hoped that I would join Bridgewater. I managed to flip the discussion by explaining to Damien why I loved my career and my position of helping my clients, and I would never consider a change. That led to an ongoing dialogue about possibly working together at some point in the future. Over time, we realized that we were completely aligned in our mission to strive to continually improve client portfolios and our belief about how an ideal business should be managed. Six years later Damien got married and decided it was time to move back to California to be closer to his family and to raise a family of his own. He left Bridgewater in 2013 after a successful nine‐year career and took 10 months off to travel to 23 countries on an extended honeymoon. Damien joined me when I departed Merrill Lynch after 15 years, and we launched our own firm, Advanced Research Investment Solutions (ARIS), in 2014. This marked another major inflection point in my career.
ARIS managed over $12 billion in client assets for many years and was consistently ranked among the top advisory firms in the country by Barron’s.1 We implemented the investment framework, which was described in my first book, across our client portfolios. Five years after founding ARIS, we created the Advanced Research Risk Parity Index as a proxy for the investment approach. This allowed us to back test and publish the results over a long period of time through shifting economic environments.
This brings us to the present. The reason I wrote this book is to describe the thought process that has led our journey to risk parity. My goal is to memorialize our learning over the past 15 years in simple‐to‐understand, nontechnical language that anyone who is interested in investing can absorb. I begin with bigger‐picture topics and work my way down to the details. For those who enjoyed my first book, this may essentially be viewed as a second, more refined edition that is tailored for the specific risk parity index that we created. I strive to present this information to you so you can objectively decide for yourself whether the framework is sound.
The book is divided into the following chapters:
Chapter 1 describes the conceptual framework for risk parity. I will explain what it means to be well balanced and why the conventional portfolio is surprisingly poorly balanced.
Chapter 2 gets into the two required steps to build balance: (1) selecting the right asset classes, and (2) structuring each to have similar returns.
Chapters 3–7 dive into the major asset classes used in our risk parity model. I explain what they are, how they perform in different economic environments, and their role in a balanced mix of assets.
Chapter 8 lays out the details of our risk parity portfolio, including the desired weighting to each asset class and, most important, the rationale for the specific allocation.The Risk Parity Portfolio25% global equities25% commodities (15% commodity producer equities, 10% gold)35% long‐term Treasuries35% long‐term TIPS
Chapter 9 provides a long‐term historical return series to show how the risk parity portfolio would have performed through varying market environments.
Chapter 10 covers the timeliness of the risk parity approach. Given the wide range of potential economic outcomes looking forward, today appears to be a prudent time for investors to maintain strong balance.
Chapter 11 gets into the “rebalancing boost,” which refers to the increase in returns that comes from a repeated process of buying low and selling high.
Chapter 12 covers implementation strategies to put the concepts into practice.
Chapter 13 points out the unique environments during which the risk parity portfolio may be expected to perform poorly. I think of this chapter as a “Break in Case of Emergency” warning. It serves as a reminder to adopters of risk parity to read this section if tempted to abandon the strategy.
Chapter 14 summarizes my responses to the most commonly raised questions and objections I've heard about risk parity over the past 15 years.
Chapter 15 offers some concluding remarks.
NOTE
1 1 The Barron's Top RIA Firms rankings are based on data provided by over 4,000 of the nation's most productive advisors. Factors used in the rankings include: assets under management, revenue produced for the firm, regulatory record, technology spending, staff diversity, succession planning, quality of practice, and philanthropic work. Investment performance isn't an explicit component because not all advisors have audited results and because performance figures often are influenced more by clients' risk tolerance than by an advisor's investment‐picking abilities. Barron's is a registered trademark of Dow Jones & Company, L.P. All rights reserved.
CHAPTER ONE
Ray Dalio, Bob Prince and their team at Bridgewater pioneered most of the concepts presented in this book about 30 years ago and have been successfully refining and implementing the strategy ever since. Our risk parity mix uses the same overall framework as Bridgewater's, although the specific asset classes and allocation represent a simplified version. Our approach also differs slightly as it is designed for a wide range of investors, many of whom are subject to paying taxes, as opposed to being tailored for the largest tax‐exempt institutions in the world. This also represents our best thinking as of this writing. As previously stated, we hope to continue to evolve our understanding and make improvements in future iterations.
RISK PARITY IS ALL ABOUT BALANCE
The ultimate goal of a risk parity portfolio is to earn attractive equity‐like returns while taking less risk than equities. Both objectives are important. We want good absolute returns (competitive with equities) over the long run since that is the main purpose behind investing capital. Controlling risk is also paramount because losses are painful and can be difficult to recover from, both mathematically and emotionally. A portfolio that achieves attractive returns while minimizing risk can be constructed with a well‐balanced allocation that invests in public market securities, which will be the focus here.
The operative term is balance. Webster's dictionary defines balance as a “state in which different things have an equal or proper amount of importance.”
