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Improving traditional risk parity strategies by considering more appropriate risk measures than historical volatility
Lyxor – Improving traditional risk parity strategies by considering more appropriate risk measures than historical volatility
Risk parity is a generic term used by the asset management industry to designate portfolio construction methodologies based on risk budgeting. Whereas the standard approach to risk parity is used to design a well-diversified strategy, a new generation of risk parity strategies is emerging that considers more sophisticated risk measures.
WHAT IS THE ORIGINAL RISK PARITY STRATEGY?
Since 2008, risk parity is a popular approach to building well-diversified portfolios placing risk management at the heart of the portfolio construction process. This explains why an increasing number of pension funds and other institutional investors are now using this approach both within asset classes, and notably for the development of smart beta equity and bond benchmarks, and across asset classes, that is for the redefinition of their long-term investment policy portfolios.
This methodology ensures that the risk contributions will be identical for all constituent assets of the portfolio. The attractive performance of such strategies in recent years undoubtedly explains the success of risk parity diversified funds based on equities, bonds and commodities. For instance, Invesco manages about USD 22 billion using a risk parity strategy. Another commercial success is Bridgewater’s “All Weather Fund”, which is one of the largest hedge funds in the world.
TRADITIONAL RISK PARITY STRATEGIES SUFFER FROM A NUMBER OF SHORTCOMINGS
A risk parity portfolio is typically defined by considering volatility as the risk measure. However, these strategies also suffer from a number of shortcomings.
Standard approaches to risk parity are based on portfolio volatility as the risk measure, implying that upside risk is penalized as much as downside risk in obvious contradiction with investors’ preferences.
Moreover it is not obvious indeed that historical volatility of market returns has the same meaning for equities, sovereign bonds, corporate bonds, inflation-linked bonds, commodities, etc. In particular, market volatility does not fully reflect the risk taken by an investor when investing in bonds, because it only partially incorporates default risk. For example, the recent crisis in the Eurozone sovereign bond markets has not been accompanied by a massive increase in the historical market volatility.
Typical risk parity strategies inevitably involve a substantial overweighting of bonds with respect to equities, which might be a problem in a low bond yield environment, with mean-reversion implying that a drop in long-term bond prices might be more likely than a further increase in bond prices. More generally, risk parity strategies do not take into account changing economic environments and in particular time-varying risk premia.
Perhaps as a consequence of these shortcomings, the performance of risk parity funds has been disappointing overall in 2013. Indeed, most of them posted negative or flat performances in a context of strong equity returns. Moreover, dispersion among their performances was high, with as much as a 20% difference between the best and worst performers.
RISK PARITY NEW GENERATION: WHY DIRECTIONAL RISKS MATTER
A new generation of risk parity strategies – sometimes known as conditional risk parity strategies to emphasize their higher degree of reactivity to changes in market conditions – introduces a new dimension, which is the directional risk, as reflected in particular in the first moment (expected return) and third moment (skewness) of asset return distributions, in addition to volatility.
This new approach recognizes that risk cannot only be summarized as the daily fluctuations of prices. In Exhibit 1, the prices of three assets are reported with the same 20% volatility, For the standard risk parity approach, there is no difference between the three assets because they present the same volatility patterns. For the conditional risk parity approach, the three assets may not present the same risk patterns because they do not have, for instance, the same directional risks as can be seen by the very different trends.
For instance, if we consider a standard risk parity portfolio of equities and bonds, we notice that the allocation is the same in June 2008 and July 2013. This implies that these two periods present the same patterns in terms of relative levels of stock and bond volatility.. However, these two periods vastly differ in terms of directional risks as can be measured through valuation, trend, risk premium, economic condition, etc.
By reintroducing expected returns into the risk measure, the conditional risk parity strategy corrects one drawback of the traditional risk parity, which is its lack of sensitivity to yield levels. The use of conditional risk parity strategies avoid the sample dependency to the historical market volatility of bond returns and overweighting of bonds in a low interest rate environment. This new generation of risk parity strategies is therefore better equipped to deal with the rising interest rate challenge.
In this framework, risk parity becomes a robust active management model, which is less aggressive than the Markowitz model. This approach is therefore an interesting alternative to traditional active management approaches when portfolio managers want active management without concentrating their portfolios on a small number of aggressive bets. This explains why conditional risk parity strategies are also often called active risk parity strategies by the asset management industry.
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Michael Saylor’s bold Bitcoin bet and Strategy’s risk analysis
Strategy (formerly MicroStrategy) has amassed a staggering $43 billion in Bitcoin, positioning itself at the forefront of the corporate “reserve race.” Under the leadership of Bitcoin maximalist Michael Saylor, the company now boasts an $84 billion market cap. But with such an aggressive strategy, how sustainable is its approach—and what risks lie ahead? We break it down in today’s analysis.
Bitcoin price technical analysis: Where are the liquidation levels?
A drop below $72,000 could flush longs, while a breakout above $90,000 may squeeze shorts. One key positive indicator is that Bitcoin continues to print higher lows since March 10, which preserves a bullish market structure in our view. Dive into our technical analysis.
What are real-world assets and why do we need tokenization?
Imagine owning a slice of a skyscraper or a piece of fine art with just a few clicks. Tokenization, the act of converting ownership rights to real-world assets (RWAs) into tradable tokens, has surpassed $10 billion in on-chain value, unlocking global 24/7 access to once-exclusive markets with liquidity, efficiency, and yield. Find out how it works.
Research Newsletter
Each week the 21Shares Research team will publish our data-driven insights into the crypto asset world through this newsletter. Please direct any comments, questions, and words of feedback to research@21shares.com
Disclaimer
The information provided does not constitute a prospectus or other offering material and does not contain or constitute an offer to sell or a solicitation of any offer to buy securities in any jurisdiction. Some of the information published herein may contain forward-looking statements. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties and that actual results may differ materially from those in the forward-looking statements as a result of various factors. The information contained herein may not be considered as economic, legal, tax or other advice and users are cautioned to base investment decisions or other decisions solely on the content hereof.
Since President Trump appointed Mark Uyeda as acting SEC chair two months ago, many investigations into crypto businesses have been dropped, as the SEC moves away from regulation by enforcement and works to create a framework for digital assets. As regulations become clearer and news flow turns more positive, crypto prices—which dropped sharply this week—should begin to better reflect the new regulatory landscape in the US.
We believe this regulatory shift could ultimately help trigger the next leg of the current bull run, as investors better understand the significance of regulatory clarity and seek to acquire bitcoin and altcoins at what we believe are currently very favorable levels.
Market Highlights
SEC Dismisses Crypto Enforcement Actions
The SEC dropped its enforcement actions against crypto-related companies Kraken, Consensys, and Cumberland DRW.
This indicates a shift in SEC’s regulatory approach, favoring clearer guidelines over enforcement actions. Such a pivot could foster a more predictable environment, encouraging innovation within the sector.
Banks to Engage in Crypto Activities
The FDIC has rescinded previous guidelines which prevented financial institutions from engaging with crypto activities without prior sign-off.
By removing bureaucratic hurdles, banks may more readily offer crypto-related services, potentially leading to broader adoption and integration of digital assets.
Bitcoin ETFs Inflow Streak Surpassed $1 Billion
US spot Bitcoin ETFs have recorded a 10-day inflow streak exceeding $1 billion marking the longest such streak in 2025.
This underscores growing institutional and retail investor confidence in Bitcoin as an asset class that helps increase market stability and possibly paving the way for the approval of other crypto-based financial products.
Market Metrics
All NCITM constituents had negative performance last week, with XRP (-10.8%) and UNI (-10.7%) seeing the steepest declines. ETH also experienced a sharp drop (-9.1%), contributing to NCITM’s underperformance relative to BTC (-2.9%). The NCITM -4.2% decline reflects a broader risk-off sentiment in the crypto market, as investors reassess their positions amid ongoing macroeconomic uncertainties.
NCITM (-4.2%) extended its underperformance last week, deepening year-to-date losses. Traditional indices like the S&P 500 (-1.5%) and Nasdaq 100 (-2.4%) saw smaller declines. The gap between crypto and other risk assets continues to widen, while gold has emerged as the top performer in 2025, gaining nearly 20% amid ongoing macroeconomic uncertainties. This trend highlights a growing risk-off sentiment, with investors shifting toward defensive assets and away from high-volatility investments.
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