Combining Trend Following and Risk Parity across Asset Classes
November 3, 2015 - Momentum Investing, Volatility Effects
Are trend following (intrinsic or time series momentum) and risk parity complementary multi-class portfolio construction approaches? In his October 2015 paper entitled “Trend-Following, Risk-Parity and the Influence of Correlations”, Nick Baltas compares performances of inverse volatility weighting and risk parity weighting as adapted to a long-short trend following strategy. Unlike volatility weighting, risk parity weighting incorporates asset return correlations, assigning higher (lower) weights to assets with lower (higher) average pairwise correlations with other assets. For both weighting schemes, portfolios are each month long (short) assets with positive (negative) past 12-month returns. Monthly inverse volatility weights derive from actual daily asset return volatilities over the past 90 trading days. Monthly risk parity weights derive from actual daily asset return volatilities and correlations over the past 90 trading days. Both weighting schemes target 10% portfolio volatility by each month applying overall leverage based on actual annualized volatility of an unleveraged trend following portfolio over the past 60 trading days divided by 10%. Using daily closing prices for the most liquid contract for each of 35 (6 energy, 10 commodity, 6 government bond, 6 currency exchange rate and 7 equity index) futures contract series as available during January 1987 through December 2013, he finds that: Keep Reading