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Enhancing Risk Parity: 7 Circles’ Approach

Today’s post explores articles on improving Risk Parity portfolios. I discovered this topic on Risk Parity Chronicles, which I found through the Risk Parity Radio podcast. Run by Justin, RPC might be taken down after a year. One interesting post from August 2022 is called “Thoughts on Picture Perfect’s 10 Improvements to an RP Portfolio” by Nomadic Samuel. Samuel advocates for Risk Parity portfolios and suggests they should be the go-to for long-term investing. However, there are implementation issues, especially in England, where property investments are common and tax shelters like ISAs and SIPPs are not RP-friendly. Samuel presents a conservative RP portfolio consisting of 20% stocks, 30% 10-year Treasuries, 30% Intermediate bonds, and 20% gold/commodities. The main problem with RP is that it focuses on risk rather than returns, resulting in a larger allocation to bonds than stocks and gold. Despite this, RP offers stable returns with low volatility. Samuel suggests several improvements for the RP portfolio. First, he proposes shifting from US stocks to a global equity portfolio. Then, he suggests swapping plain global equities for minimum volatility global equities to control volatility. Next, he recommends replacing intermediate Treasuries with long-term ones for more stability. Samuel also suggests replacing 10-Year Treasury bonds with TIPS for lower correlations. Additionally, he suggests adding leverage, trend as managed futures, systematic macro strategies, long-vol option strategies, REITs, market-neutral equity strategies, and various alternative strategies. Finally, Samuel presents his final leveraged portfolio, which differs significantly from the base. Justin, in Risk Parity Chronicles, agrees with some of Samuel’s changes, such as the move to global stocks and the use of minimum volatility. However, they would only use min vol as part of their stock allocation. Regarding long-term bonds, Justin suggests using Extended Duration Treasuries for even better results. They are skeptical about TIPS and their ability to protect against inflation. Justin concurs with Samuel that leverage could be beneficial but acknowledges the challenges of implementing it for individual investors. They also highlight the behavioral issues associated with leverage. Justin, unlike Samuel, uses leveraged ETFs in their portfolio.

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