When executed well, risk parity was a strong performer in 2020. At SineCera Capital, we maintained a long-term view, stayed the course, and our All-Weather Core portfolio generated a double-digit return for the year. While one year is a small sample size, 2020 provides a compelling case study of how a risk parity portfolio can successfully navigate through a full market cycle. In such a short period, we saw a sharp downturn, swift recovery, and record highs across multiple stock indices. Staying the course was easier said than done.

In general, risk parity managers had a varied 2020. Several pension funds made notable moves by liquidating risk parity allocations when those managers failed to adequately protect capital as markets collapsed in Q1. Vulnerable to sharp increases in short-term volatility, the drawback of highly levered portfolios was evident as some funds were forced to reactively rebalance and raise cash. As equity markets embarked on one of the most notable V-shaped recoveries on record, underperformance only got worse.

Then, in September, Bridgewater Associates made headlines after announcing a significant departure from traditional risk parity by swapping out government bonds for alternative investments. With record-low yields in government bonds, Bridgewater now feels alternatives may better protect capital during stock market corrections. However, with all due respect to Bridgewater (the company’s Founder, Ray Dalio, is one of the inspirations for launching our All-Weather portfolio), we believe this type of market timing is the wrong approach, not to mention more expensive given the additional underlying fees tied to alternative asset managers.

Despite the volatility, we were not forced to rebalance to meet margin calls nor to maintain a fixed volatility target. Further, we did not implement any wholesale changes to the core components of our All-Weather strategy. Rather, we trusted our portfolio construction process which focuses on the long-term trends and correlations of the underlying asset classes. As a result, the overall portfolio generated balanced monthly returns relative to the volatility of the underlying investments’ performance. As represented in the chart below, it would have been very difficult to choose the winning asset classes from month to month, but using the strategy in aggregate (as shown in the dark blue) you are able to see the consistency and lower volatility of returns.

Going into the New Year, the criticisms around owning government bonds will likely continue. In response to Bridgewater’s move, Bloomberg quoted Edward Qian as saying, “You cannot just say because bond yields are low, they’re going to rise and let’s not invest in government bonds. That’s contradictory to the risk-parity approach.” We wholeheartedly agree with that statement. Government bonds, even in low-yield environments, have been a strong ballast during market selloffs. In our view, bonds (and equities) remain most vulnerable to a surge in inflation. However, this is precisely why a properly diversified strategy is invested in assets like gold and commodities (and importantly, why these inflation-hedging assets have roughly the same risk weighting as government bonds).

We will be the first to tell our investors that double-digit returns in an unlevered risk-parity strategy is rare. Further, it’s unlikely 2021 will see a repeat of 2020’s performance, especially since risk parity also did very well in 2019. Still, no matter where the markets are headed, the goal of risk parity is to be prepared for whatever may come. That is precisely why many, including us, call it “all weather.” Market timers take note. 

As always, if you have any questions, or would like to learn more about how SineCera Capital has helped clients during these complex times, please do not hesitate to contact us.

Best Regards,

Adam J. Packer, CFA®, CAIA®

Chief Analyst | SineCera Capital