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AQR On Risk Parity: The Dog That Did Not Bite

In August, Equity Selling in Risk Parity Was a Tiny Fraction of Market Volume

Following August equity market volatility, commentators have been lining up to blame risk parity as a driving force behind that volatility. As I’ve said before: I can’t define short-term silliness, but like Justice Stewart I can identify short-term silliness when I see it. This recent rush to use risk parity as a pin cushion is just another case of such silliness.

Some colleagues who lead our risk parity strategies here at AQR explain. Why isn't risk parity the cause? Well, we believe risk parity simply isn’t big enough to generate the level of trading necessary to create very large market gyrations and most certainly not to the degree witnessed recently.

A more parsimonious explanation, though I’d agree a far less newsworthy one, is simply that investors got more negative on economic fundamentals in August and re-priced assets and rebalanced their portfolios accordingly. I guess that’s a more boring story than “Risk parity man bites market”...

Over the past few weeks, some commentators have transformed risk parity from a widely used, modestly sized, slowly traded strategy that doesn’t hold a ton of equities into a giant investment paradigm managed by traders who whipsaw the markets, buying and selling huge quantities of stock with every tick in volatility.

Some reported estimates of assets managed in risk parity funds have run as high as $500 billion, and that 40% of its exposures are allocated to equities (so $400 billion, or 80% of invested capital after applying 2x leverage). While nobody knows the precise size, the authors cite eVestment and BarclayHedge data in asserting that they are much smaller. Risk parity funds use moderate leverage, but still hold equity exposures in the form of equity index futures or cash equities of only about 35% of invested capital, or a total of about $50 billion to $55 billion.

The authors contrast that to the $500 billion of volume traded daily in global equity index futures or the comparable volume traded daily in cash equities, based on AQR analysis of Bloomberg data. While they concede that markets would “move some” if every risk parity manager decided to sell all of his or her aggregated holdings in a single day, they point out that risk parity managers...