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Cliff Asness is correct: Leverage Aversion and Risk Parity

Many have complained that gearing into bonds in a rising interest rate environment will lead to disaster. Not so says Cliff Asness and I wholeheartedly agree with him.

Can Risk Parity Outperform If Yields Rise?

I have spent many an hour looking at market data going back for centuries. To 1650 in the case of the UK (courtesy of the Bank of England).  Without going into boring details my endless research leads me to similar views. The vast proportion of bond return is from coupon not price. Provided the rise in interest rates is not too violent, funds can re-invest at higher coupons as rates rise which in time will overcome short term price loss. Calculate a long term Constant Maturity Bond Index yourself (with data from the Fed or the Bank of England) and you will come to the same conclusion.

For what its worth you will find links below to spreadsheets taken from Robert Schiller and the Bank of England containing data for bonds and stocks going back centuries. I have added constant maturity bond indices (which you can chart) which show the relative UNIMPORTANCE over time of price. Coupon is all.  You will, I hope excuse any idiocies or mistakes I have made. I have not looked at these spreadsheets for a while.

Schiller Spreadsheet

Bank of England Spreadsheet


I set out below a simple back test of a very simple risk parity 2 instrument portfolio: S&P 500 TR and 2.5x leverage on the 10 Yr US Treasury bond calculated from futures prices (understated since no interest on capital is included). Yes, AQR and Bridgewater are far more sophisticated and of course include commodities and well as different stock markets and bonds (maturities, currencies and so forth).  The lookback to calculate volatility used was 3 months.

Perhaps the information below might be of help to those looking at the concept for the first time.  Similar volatility, far higher R Sq of equity curve and lower drawdown for the bond/equity/ risk parity scheme.  Will it continue this way? Who knows but it seems a reasonable way to invest.

Stat                 Inverse Volatility    S&P 500 TR
-------------------  --------------------  -----------
Start                1988-04-04            1988-04-04
End                  2016-12-20            2016-12-20
Risk-free rate       0.00%                 0.00%

Total Return         1677.08%              1578.16%
Daily Sharpe         1.02                  0.65
CAGR                 10.54%                10.32%
Max Drawdown         -20.34%               -55.25%
Monthly Mean (ann.)  10.58%                10.83%



Portfolio Weightings


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