Risk-based strategies are an alternative approach to multi-asset investing.For traditional asset-based strategies, such as a 60/40 equity/bond portfolio, asset weights drive risk characteristics. For risk-based multi-asset strategies, risk characteristics drive asset weights.
The objectives of multi-asset risk-based strategies are derived from different branches of portfolio theory can be defined as follows:
Minimum Variance: Aims to minimise the overall strategy volatility by using pairwise correlations and volatilities of stocks to provide a good proxy for the least risky portfolio in the Modern Portfolio Theory framework.
Risk Parity: Aims to achieve equal risk contribution from asset classes under the assumption of identical pair-wise correlations structures. The same as inverse volatility weighting.
Maximum Deconcentration: A naïve diversification strategy that aims at maximising the effective number of holdings, equivalent to minimising concentration.
Maximum Sharpe: Aims to combine assets to achieve a strategy with the highest risk-adjusted return in excess of the risk-free rate.
Maximum Decorrelation: Aims to minimise the volatility of a strategy assuming that individual volatilities are identical, thereby constructing the strategy based on correlation structure alone (solving for the least correlated strategy).
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Commercial interest: Elston Consulting is an index provider promoting indices that include multi-asset risk-based strategies. For more information see www.elstonetf.com/indices