The Impacts of Risk Parity Strategies

Ray Dalio’s Bridgewater is the latest celebrity investment management firm to opine that in a low-interest rate environment government bonds not only offer little in the way of value for investors, but that their ability to provide risk reduction during financial stress will be impaired as well. As this article from Bloomberg reports, Bridgewater is in the process of tweaking its “All Weather” investment strategy (a version of Risk Parity) to rotate away from government bonds and into other asset classes like gold and inflation-linked bonds. Without getting into granular detail of how Bridgewater’s All Weather strategy differs from other Risk Parity implementations and the overall merits of the Bloomberg headline, the article is an interesting discussion topic on whether bonds continue to serve a long-term purpose in investor portfolios during low yield environments – and this is not a conundrum unique to Bridgewater. The argument that bonds are overvalued and offer little in the way of downside protection has been a worry for many investors over the last decade, but that worry hasn’t stopped bond yields from continuing to move lower, flying in the face of those who decreed the death of bonds 10 years ago. One takeaway is that a more dynamic strategy will be needed in order to navigate this unprecedented environment, especially when historical returns for a static 60/40 portfolio should not be expected to continue indefinitely with equity valuations high and bond yields low. As discussed in the article, keeping an eye on inflation will be key in the coming years. Rising inflation that spurs tighter monetary policy is bad news for both stocks and nominal bonds and it is therefore important to consider how Risk Parity strategies, which include asset classes like commodities and inflation-linked bonds, could help provide additional diversification to traditional 60/40 portfolios.