Risk Parity. Alex Shahidi
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country over the past 200 years has suffered massive wealth destruction at one time or another, meaning a decline in real purchasing power of 50% to 80% within the course of a decade. Even cash is a very risky asset when you view it through the lens of inflation‐adjusted returns. Today, cash and bonds are particularly risky, because policy makers have pushed real interest rates into negative territory and are holding them there as a means of reducing the burdens on debtors, shifting that burden to the retirements of savers and asset holders.
In recognition of the risks, we at Bridgewater believe that the most reliable solution is a balanced portfolio. By balanced I mean a portfolio whose risk allocation is distributed across a set of asset classes which have offsetting exposures to shifts in the economic environment. Shifts in economic growth and inflation exert a dominant influence on asset returns. Therefore, you want a mix of assets that neutralizes these influences on returns.
At Bridgewater we refer to this as the All Weather approach: a portfolio that is balanced to the influences of economic growth and inflation, enabling performance across all environments. Many of us have applied this All Weather approach for decades to our own personal portfolios and for the largest and most sophisticated institutional investors in the world. In time, the approach has become known as Risk Parity, and a number of professional asset managers developed their own way of doing it. There are significant differences, but what they all have in common is a balanced allocation of risk across complementary asset classes.
What Alex is doing in this book is making this balanced approach available to anyone who wants reliability of investment returns over time, regardless of how economic conditions transpire. There is no fluff or bluster in the book. Each chapter is a relevant building block toward a well‐balanced whole. This is not a book of empty assertions or unproven theories. It is backed up by research and logic, which he presents in each chapter. The research and logic have been borne out through time.
We at Bridgewater have known Alex for a very long time and can attest to the thoughtfulness and thoroughness of his approach. He describes his journey; we watched it unfold first‐hand. There is legitimacy and authenticity to what follows. I hope that you take it seriously and put it into action.
Bob Prince
Co‐CIO, Bridgewater Associates
Preface
A fundamental question all investors face is whether they want their portfolio to be balanced or imbalanced. Framing the decision in this simple way leads to an obvious answer. Why would anyone not desire good balance, particularly when a portfolio can be easily diversified without sacrificing long‐term returns?
Surprisingly, nearly every portfolio that I have observed over the past couple of decades has been poorly balanced. These portfolios are overly sensitive to shifting economic environments, performing brilliantly during good times and underperforming the rest of the time. In fact, it seems that investors have become accustomed to their portfolios rising and falling along with the stock market's wild swings. We cheer on bull markets and suffer through the inevitable downturns as we are all in the market together. Investors have been conditioned to believe that attractive long‐term returns can only be attained by allocating a large percentage of their portfolio to stocks, which can be highly volatile. Those who can't stomach the ride should not participate.
I wrote this book with the aim of debunking this widely held myth. I introduce an easy‐to‐follow conceptual framework that allows for strong balance while targeting long‐term returns competitive with equities. This is not an approach that involves market timing, a sophisticated trading strategy, or the use of esoteric investment vehicles. A simple, fixed allocation across a diversified mix of major asset classes is all that is needed to achieve the objective.
The investment strategy, commonly termed “Risk Parity,” is not something new and untested. Some of the world's most sophisticated institutions have adopted and successfully implemented this approach for several decades. Bridgewater Associates, the largest hedge fund in the world, developed the concepts presented in this book over 25 years ago and has been running a risk parity strategy for its giant institutional portfolios ever since.
It seems that investors' portfolios are not only imbalanced, but that investors don't have a full understanding of what it means to be balanced. I want to share these insights that I have gleaned from the smartest minds in the industry because every investor, large and small, deserves to know. In this book, I attempt to describe the framework in a language that anyone interested in investing will understand regardless of their investment acumen and experience. Over the years, I have had the opportunity to walk through the concepts with a wide variety of investors and investment professionals. With repetition comes an appreciation of the points that resonate and a refined narrative for more complex topics.
Moreover, I feel strongly that investors need more balance today than perhaps at any point in our lifetimes. The potential range of economic outcomes is exceedingly broad, and the odds of extreme results only seem to increase over time. My goal is to equip investors with the knowledge and tools they need to build smarter portfolios and avoid taking unnecessary risk.
Acknowledgments
The author is not the sole writer of a book. The ideas presented were likely sparked by someone else. The manner in which the concepts are described was probably polished from constructive feedback from the audience. One of the greatest challenges writers face is appropriately zooming out to ensure the overall message is clear when we are deeply immersed in the current paragraph that we strive to perfect. Thoughtful feedback from friends, family, and colleagues who offered a fresh perspective of the big picture enabled me to stay on course.
Damien Bisserier, my business partner since 2014 and close friend long before then, has not only taught me the intricate details of the risk parity approach but also how to tell the story. Damien worked at Bridgewater Associates for nearly a decade, so he was steeped in these concepts and was trained by the most sophisticated proponents of the strategy to effectively convey the concepts. I have immensely benefited from his hard work and brilliance for many years and would like to acknowledge his contribution.
Michael Marco, a valued colleague of mine at Evoke Advisors and former Investment Associate at Bridgewater, provided extremely insightful feedback throughout this process. His unique background and time commitment to carefully read the entire manuscript was an invaluable asset in this journey. Thank you Michael.
My deepest gratitude goes to the entire Bridgewater organization, particularly to Jim Haskel, Ray Dalio, Bob Prince, and Greg Jensen, all of whom were integral in familiarizing me with the concepts presented in this book many years ago. Without my connection to Bridgewater and their support to write this book (and my previous book), none of this would have made it to print.
Brendan Corcoran and Aman Ahluwalia, who work with me at Evoke, took the time to read every word and offer valuable comments. I recognize that they both had little time to spare, so I appreciate their commitment to help. I am also thankful for the contributions of the following partners at Evoke: David Hou, Mark Sear, Kim Ip, Darell Krasnoff, Andrew Palmer, and Eric Bright. I appreciate your interest on the subject and input into the process.
Eric Schwartz, Abigail Johnson, Mike Miller, Diane Mirowski, Corey Barash, Aaron Iba, and Andrew Gwozdz dove in and thoughtfully shared their views. Each comes from a very different background, which provides a unique perspective that helped shape how the book was written.
The team at Wiley deserves recognition for the countless hours spent on this project. It all started with Bill Falloon, who gave me an opportunity to publish my first book seven years ago. Thank you for taking a chance on an inexperienced author and for trusting me to write a second one. Purvi Patel and Samantha Enders, your professionalism and dedication to develop my manuscript into the final product is greatly appreciated. It has been an absolute joy working with all of you.
Finally, I am thankful for my soulmate of over 20 years, Danielle, and our precious children, Michael and Bella, for their continued support throughout. Their persistent