History
Risk Parity emerged in institutional asset management during the 1980s and 1990s, but was most prominently developed and popularized by Ray Dalio and Bridgewater Associates. Traditional portfolios such as 60/40 allocate capital across assets, but in practice are dominated by equity risk because equities are much more volatile than bonds. Bridgewater’s insight was that a portfolio should not be balanced by dollars, but by risk contribution. This led to the construction of portfolios where low-volatility assets such as bonds are scaled up, sometimes using leverage in institutional settings, to match the risk contribution of equities. The result is a more evenly distributed exposure to economic drivers, particularly growth and inflation. Risk parity became widely discussed after the Global Financial Crisis, when diversification across risk factors gained renewed attention.
Philosophy
A dollar is not a unit of risk. Traditional portfolios concentrate risk in equities while appearing diversified. Risk parity instead balances the contribution of each asset to overall portfolio volatility. This typically requires higher allocations to lower-volatility assets such as bonds, and lower allocations to high-volatility assets such as equities. In institutional implementations, leverage may be used to scale the entire portfolio to a desired risk level. The objective is not to eliminate risk, but to distribute it more evenly across independent drivers such as growth, inflation and interest rates.