Risk Parity
Allocate risk, not dollars: equalize each asset’s contribution to volatility, then lever to taste.
Risk parity abandons return forecasts and allocates so that each asset contributes equally to portfolio volatility. Construction is nonlinear: each asset’s risk contribution is its weight times its marginal contribution to total risk, and equalizing these is solved iteratively. The payoff is stability, because weights lean on covariances, which are estimable, rather than expected returns, which are not. Equal risk in bonds delivers low volatility and low return, so the strategy leans on leverage to reach an equity-like risk budget: the Bridgewater All Weather idea that balanced risk can be geared up safely. The caveat is that correlations spike in crises, so parity holds only until it matters most.