Risk parity can help investors diversify their portfolios, even if they have a typical portfolio in which 60% of their assets are invested in stocks and 40% are invested in bonds, according to the financial services firm SEI.
Risk parity is a “strategy to get you closer to an optimal portfolio,” J. Womack, managing director for Investment Solutions in SEI’s Independent Advisor Solutions group, told ThinkAdvisor on Thursday.
He and other SEI executives also touted the benefits of risk parity during a recent webinar, “Risk Parity Explained: Addressing the Top 5 Questions We Get On Risk Parity,” that Womack said was targeted at advisors.
Explaining what risk parity is exactly, the SEI executives noted it’s an investment strategy designed to balance the sources of risk in an investor’s portfolio, answering the most obvious question that SEI tends to hear from advisors.
Another common question that the firm gets asked by RIAs and other advisors is where the idea of risk parity comes from, according to SEI.
“Bridgewater was the first major institutional group to outline the strategy,” Womack pointed out. During the webinar, Jim Smigiel, CIO of nontraditional strategies at SEI, provided more details on the history of the strategy.
Another question advisors ask SEI about risk parity is what’s wrong with traditional allocation versus risk-based allocation, according to the firm. Another: How does risk parity compare to a traditional 60/40 strategy?
“On a risk-based allocation perspective, 92% of the risk” in a client’s portfolio tends to come from equity versus 8% for fixed income, Womack told ThinkAdvisor. Therefore, while a traditional portfolio is 60/40, “from a notional or dollar value perspective, it’s approximately 90/10 from a risk perspective” actually, he explained. “So, if what you’re trying to implement is a diversified portfolio, the classic 60/40 doesn’t quite get there from a risk perspective,” he said, adding, “risk is ultimately what drives the vast majority of variation in portfolio returns.”
The fifth most common question about risk parity that SEI gets asked is why the firm includes risk parity in its strategies, according to the firm.