The major selling point of “risk parity” funds is they are designed to make money in most environments. These funds typically have their assets evenly divided into three broad categories: stocks, bonds, and commodities. Risk parity funds use leverage to increase returns on bonds so that the bonds have returns similar to stocks.
Since 2008, “these funds have consistently outperformed traditional strategies and have soared in popularity ($200 billion),” according to a June 2013 WSJ article. During June 2013, when stocks and bonds both dropped, commodities and inflation-protected securities also suffered heavy losses due to receding inflationary expectations.
According to Morningstar, risk parity mutual funds lost 6.8% for the first six months of 2013 while a 60/40 (stock/bond) mix was up 6.8%. Advocates of risk parity funds believe their strategy should beat a so-called 60/40 portfolio of stocks and bonds (S&P 500 + Barclays U.S. Aggregate Bond Index).
The risk parity strategy was first adopted by hedge funds and is now offered by a handful of mutual funds. Since its 1996 inception, the Bridgewater “All Weather” hedge fund (which uses a risk parity approach) has returned an average of 9.5% a year; the fund did suffer a loss during the 2008 financial crisis.
Investors often worry about market volatility. One hedging strategy is to look for investments that increase in value when markets decline.