Risk Parity and Trend-Following Approach on Asset Allocation

Abstract

The purpose of this paper is to investigate and analyse the performance of the trend-following -risk parity portfolio approach and to examine whether or not it can be expected to outperform the 60/40 portfolio and equal-weighted approaches. Performance and risk were measured using Sharpe Ratio, Sortino Ratio, Maximum Drawdown and the sensitivity to different market conditions were analysed- the change in interest rates and equity market volatility on portfolio returns. In the empirical study, it was found that the combination of trend-following -risk parity approach generates an acceptable expected return, when analysing the sample period from November 2000 to December 2020. The trend-following portfolios were found to significantly outperform the equal-weighted portfolio, the 60/40 portfolio and the naïve risk-parity for the investment universes but the trend-following risk parity provide a reasonable risk-adjusted return. The Sharpe ratio of the naïve risk parity & trend following was statistically significantly different from the Sharpe ratio of other passive strategies. Results of that the naïve risk parity & trend-following showed a positive sensitivity to the change in interest rates neither when decreasing or increasing. The naïve risk parity & trend-following portfolio also reduced the volatility, maximum drawdown and negative volatility of the portfolio than other portfolios.