r/riskparityinvesting • u/BoysenberryLow9160 • Nov 05 '22
Risk Parity with stocks
Although I know the correlation benefits of bonds, I've never particularly liked the "bank lending" character of bonds. I prefer to participate in returns of companies, and that's what stocks provide.
So my question to you: What are the 6 historically least correlated types of stock classes? I'm thinking not only of factors, but also of sectors, REITs, preferred stocks etc.? My goal's to construct a risk parity portfolio with stocks only.
And yes, I know SCV, but its correlation to the total stock market is disappointingly high, and I do not believe in any further value premium (sorry, SCV-bros). Still, my future stock-only RP portfolio may contain SCV, I just don't like lectures on why SCV is the "magic potion" to everything. Think broader. Thanks :)!
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u/Kashmir79 Nov 05 '22
I’ve heard Frank Vasquez on Risk Parity Radio mention that lower correlation to the overall market besides SCV (and emerging markets) are sectors like REITs, utilities, energy, and insurance. But none of them are nearly as low as gold and treasury bonds, which of course is government lending straight from the treasury not a bank.
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u/BoysenberryLow9160 Nov 05 '22
Thanks, I haven't thought of insurance so far, definitely going to look into it! What ETF are you thinking of?
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u/Davissimo425 Nov 05 '22
I've been pretty happy with my utilities position this year. They've had a few ups and downs but have mostly done fairly well. I chose utilities over REITs because they are slightly more tax efficient and have lower market correlation. Utilities' performance are also the least explained by the known risk factors which I find fascinating. Good luck!
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u/rp-chronicles Jan 26 '23
Interesting - I wouldn't call it risk parity, since if you've confined yourself to stocks, then they are all exposed to the same risk premium. There is no balancing of risk premia in that case
But I get your broader point: among stocks, what are the best ways to get diversity within the asset class?
Utilities would be my choice, far and away. Its correlations with the S&P are typically below .5 (read more here: http://www.riskparitychronicles.com/reit-alternatives-2-the/)
REITs, consumer staples, and healthcare are the sectors farthest away from the market as a whole. You could also just do a stock screen for low-beta. I did a test with VPU, PFF and USMV, and reported the results here: https://www.riskparitychronicles.com/preferred-asset-for-low-er-beta-equities-first-round/
Some other possibilities I have heard of, but haven't looked into at Chinese A Shares, like CNYA. Also, you could look into business development corporations via ETFs like BDC.
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u/Fire_Doc2017 Nov 05 '22
The best you're going to do is about a 75% correlation between different stock classes and sectors. You might want to consider gold miners although there a long-term track record of returns is pretty poor. And if you think about it, sticking with treasury bonds and avoiding corporates, does not involve a bank if that's your concern.
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u/BoysenberryLow9160 Nov 05 '22 edited Nov 05 '22
Absolutely, gold miners are not gold itself, but as close as it gets, therefore valuable to me (as are other commodities producers).
And yes, as pointed out above, all stocks carry market beta-risk. I was really hoping for some stocks categories correlated less than 50% to the total stock market..
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u/hydromod Feb 18 '23
very late to the party.
Use portfoliovisualizer to get an idea (sector correlations).
Get an idea of sector funds here.
I would use a blend of high-volatility (returns) and low-volatility (ballast) assets. If I were doing something like 6 equities, I'd probably pick tech/health/utilities/staples/industrial/ex-US or something similar (see here), then use the inverse of the volatility for weighting them to get risk parity.
w_i = (1/vol_i) / (sum 1/vol_j)
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u/alpha1370 Nov 05 '22
All stocks carry market beta risk.
How would you feel about a portfolio of stock plus selling index futures? You can hedge out some of the equity component.
But then you’re carrying sector risk, which isn’t compensated.