Let us understand the **risk parity strategy **better with the help of a couple of examples. These examples will help us understand the concept in-depth.

**Example #1**

We can take a simple two asset portfolio and do a few calculations to show how the risk parity approach can give a better Sharpe ratio than the traditional portfolio:

**Solution:**

**For Traditional Portfolio**

**Portfolio Return**

- Portfolio Return Formula = weighted average of returns = 0.60 x 18% + 0.40 x 8% =
**14%**

**Portfolio Standard Deviation**

- The rho symbol is the coefficient of correlation between the two assets.

Portfolio Standard deviation =

=** 14.107%**

**Risk Contribution = Weight of Asset * Standard Deviation of Asset**

- Stock Risk contribution = 0.60 x 22 = 13.2%
- Bond Risk contribution = 0.40x 6= 2.4%

**For Risk Parity Portfolio**

**Portfolio Return**

- Portfolio Return = 0.2143 x 18% +0.7857 x 8% =
**10 %**

**Portfolio Standard Deviation**

= **67%**

**Risk Contribution = Weight of Asset * Standard Deviation of Asset**

- Stock Risk Contribution = 0.2143 x 22 =
**4.71%** - Bond Risk Contribution = 0.7857 x 6 =
**4.71%**

So we can see that the risk parity approach has a higher Sharpe ratio, even with a lower portfolio return.

**Example #2**

The Teachers Retirement System (TRS) of Texas worth $11.2 billion that provides pension and retirement plans for teachers in public schools and other related organizations has come under serious pressure after struggling to provide enough returns during the turbulent times in the market in 2022-23.

However, since the economy globally seemed to be getting better towards mid-2023, the risk managers who work both internally and externally have said that the fund worth over $170 billion shall improve their risk balancing strategies to provide stable returns irrespective of market conditions.

Moreover, since September 2022, the portfolio has been adjusted to make returns despite the rising rates of inflation in the economy.