Some Clarity on Risk Parity

In our ongoing writing on the topic of investment sizing and portfolio choice, we recently published two articles that discuss the use of Sharpe Ratio in building portfolios with the highest expected risk-adjusted return. In the first note, Some Clarity on Risk Parity (Bloomberg Prophets), we showed how a levered Risk Parity portfolio and a Traditional unlevered equity/fixed income balanced portfolio could both be derived from the same basic expected utility maximization toolkit. We went on to show that a relatively small difference in investor risk and leverage preferences would tip the investor to preferring one versus the other type of portfolio.

In our second note, A Brief History of Sharpe Ratio and Beyond (SSRN), we dug deeper into the question of how much investors can rely on maximizing the Sharpe Ratio in choosing the investment portfolio best for them. As we discussed in our first note on Risk Parity, we explain why Sharpe Ratio isn’t enough for investors who have an aversion to leverage. We show why, and to what extent, investors should be willing to trade off a lower Sharpe Ratio versus a higher expected return on their portfolio.