In AQR's case, these risks are broken down into four major "buckets": equity, fixed income, inflation, and credit and currency. The fund maintains equal weighting in each, and also uses a global macro overlay to adjust exposures when conditions merit it.

Criticisms

The approach is not without critics. For starters, risk-parity funds typically use both leverage and futures contracts. Leverage can increase the risk of a fund, although risk parity managers say they take this additional volatility risk into account when constructing their portfolios.

And there are other beefs. "The problem with this strategy is that it relies on historical data and assumes that risk is static," says Lee Munson, chief investment officer at Portfolio LLC in Albuquerque, N.M.

"My main issue with risk-parity models are that they don't use market information, especially valuation data," he adds. Munson points to the treasury market, which he says is currently overvalued but has had low--albeit increasing--volatility.

"Our firm uses a more dynamic approach that still considers risk, but also pricing and valuation data of each asset class," Munson says.

Risk parity managers counter that valuations across asset classes are generally correlated. "Stocks and bonds have seen declining risk premiums for 30 years, so both could be overvalued, which suggests again the value of diversification that is inherent in risk parity portfolios," says Hurst from AQR.

And AQR believes that the data supports its approach. "The empirical data suggests that risk and return are strongly related," says Yao Hua Ooi, a principal and portfolio manager at AQR. "Different asset classes pay you about the same per unit of risk."

Limited Track Record
Although Morningstar doesn't have a formal risk-parity fund category, it says there are more than 25 funds which follow a risk-parity strategy and which have nearly $9 billion in assets under management. The oldest funds in the group are the different share class versions of the Invesco Balanced-Risk Allocation fund, which were rolled out in June 2009. Columbia and Putnam also have multiple share class versions of the same risk-parity strategy.

"Invesco has been the biggest retail strategy in terms of gathering assets, while AQR has has the best pedigree because it's been doing risk parity work in the institutional space and are a major player there," says Morningstar analyst Josh Charlson.

"I think it's definitely growing and starting to gain more credibility," he adds, citingĀ  both Invesco's success in gaining assets and recent academic research supporting the theory behind the risk-parity strategy.

The Salient Risk Parity Fund (SRPFX), which began trading in July and is the newest kid on the block, doesn't have much to go on yet. The Columbia Risk Allocation Fund (CRACX), which debuted in June and so far has collected only $160,000 in assets, but has gained more than 10% over the past three months.