Risk parity is a portfolio allocation strategy that uses risk calibration to determine balanced allocations across various components of an investment portfolio. Risk parity was pioneered by some of the largest hedge funds in the world, and has been used to manage and grow portfolios worth hundreds of billions of dollars with great success.
To translate a risk parity approach to crypto and DeFi, it is first essential to determine what factors underpin this strategy and whether and how they can be replicated in an algorithmic and decentralized fashion.
The most successful and well-known risk parity portfolio was designed by Ray Dalio, the founder and CIO of Bridgewater Associates, the largest hedge fund in the world. He called his fund All Weather because it’s designed to succeed in any circumstances.
All Weather was designed with the following fundamentals in mind:
Seek Risk-Balancing, not Yield-Maximizing Assets. Investment assets can be compared by calibrating how much yield each asset generates on a per unit of risk basis. You can then pair assets which are negatively correlated, i.e., which generate an overall positive yield, but in opposite market conditions. For example, the prices of stock and bonds are known to move in opposite directions in times of strong corporate growth.