Quiver Quantitative - The hawkish turn in monetary policy is shaking the foundations of risk-parity quantitative investors as assets across the board decline in value. Following the recent Federal Reserve meeting, a joint slump was observed in stocks, bonds, and many commodities, causing significant distress to the risk-parity investing approach. This method, popularized by Bridgewater Associates' Ray Dalio, divides investments across assets based on each asset's perceived risk. The strategy is often reliant on government debt to counterbalance equity downturns, making it vulnerable during broad market selloffs.
The RPAR Risk Parity ETF (RPAR) experienced its most significant downturn since December, reaching its lowest in ten months. Following the Fed's decision to maintain rates, expectations rose with 12 out of 19 officials projecting another rate increase in 2023. This development poses a dual challenge in the markets: it not only hampers economic activity but also reduces the current valuation of numerous assets. In response to these events, the RPAR Ultra Risk Parity ETF (UPAR) had its steepest decline since November. This ETF, which employs more leverage than its counterpart, aims to amplify returns.
US stocks experienced their most significant drop since March post the Fed meeting, and the yield on 10-year Treasuries saw its largest jump in three weeks. George Cipolloni of Penn Mutual Asset Management commented on the current situation, stating that the downturn is essentially a reversal of the "Everything Bubble" seen in 2021, where everything seemed to rally.
Various forms of risk parity strategies exist, but a common trait among them is targeting a specific volatility level. As such, these strategies are inclined to liquidate positions during turbulent times, potentially intensifying price fluctuations. Recent data indicates that risk parity positioning across stocks and bonds has diminished. Parag Thatte from Deutsche Bank (ETR:DBKGn) (DB) suggested that a lasting increase in volatility might prompt systematic strategies, including risk parity funds, to further decrease their exposure to both stocks and bonds.
This article was originally published on Quiver Quantitative