The Engineering of Safety: Leveraged Risk Parity
The Engineering of Safety: Leveraged Risk Parity
Why the “60/40” portfolio is actually a “90/10” risk bet. How to use leverage to balance risk perfectly across Growth, Inflation, and Deflation.
Executive Summary
- The 60/40 Lie: In a traditional portfolio (60% Stocks / 40% Bonds), stocks are 3x more volatile than bonds. So, 90% of your risk comes from stocks. If stocks crash, the bonds are too weak to save you. You are not diversified; you are just “equity long.”
- True Parity: To make the “Safe Bucket” (Bonds) fight as hard as the “Risky Bucket” (Stocks), you must apply Leverage to the bonds. By leveraging low-volatility assets, you equalize their risk contribution. Now, stocks and bonds both drive returns equally.
- The All-Weather Hedge: Stocks win in Growth. Bonds win in Deflation. Commodities win in Inflation. Risk Parity holds all three in balanced risk weightings, ensuring one engine is always firing.
The Leverage Kill Switch
Leverage is a double-edged sword. While it smooths out the equity curve in the long run, it can be disastrous if stocks and bonds fall simultaneously (Correlation = 1), as seen in 2022. This strategy requires active volatility targeting, not “Set and Forget.”
Mechanic: Equalizing the Risk Contribution
Stocks
High Vol (1x)
Bonds
Low Vol (3x Lev)
Commodities
Inflation Hedge
Result
Smooth Curve
Simulation: 60/40 vs. Risk Parity (Through 2008 Crisis)
Drawdown Comparison
| Feature | Traditional (60/40) | Risk Parity (Bridgewater Style) |
|---|---|---|
| Risk Driver | 90% Equities | 33% Stocks / 33% Rates / 33% Inflation |
| Bond Allocation | Unleveraged (Low Return) | Leveraged (Equity-like Return) |
| Inflation Protection | Weak (Usually none) | Strong (Gold, TIPS, Commodities) |
“You don’t know what the future holds. Inflation? Deflation? Boom? Bust? Risk Parity is the admission of ignorance. It is designed to survive them all, rather than predicting just one.”
Essential Resources
INTERNAL
BMT Playbooks
asset-allocation
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