Risk Parity and Inflation

This piece, written by Edward Qian, Ph.D., CFA, Chief Investment Officer and Head of Multi Asset Research, provides analysis of Risk Parity portfolios’ performance during the high inflation period of the 1970’s, which served as an ideal stress-testing environment for the Risk Parity approach to asset allocation.  Unlike traditional allocation, there are two aspects of a Risk Parity portfolio that aim to defend against inflation risk and generate real rates of return that are lacking in traditional asset allocation.

Here Dr. Qian shows that although rising inflation is potentially harmful to both fixed income and equity returns, a substantial allocation to real assets, such as those in the Risk Parity portfolios, remains necessary for both inflation hedging and the generation of long-term real returns. He also discusses PanAgora’s proprietary dynamic risk allocation process. Our research has shown that dynamic risk allocation is highly responsive to inflation cycles and provides an additional source of inflation hedging as it becomes necessary.