One of the buzz words used to explain the violent, sharp and unexpected market moves over the past two weeks, is "risk parity" popularized by Bridgewater's Pure Alpha fund (which also happens to be the largest in the world, excluding AAPL, the ECB and the Fed) and rather the dramatic shifts in asset allocation among these investment strategies, which have wreaked havoc with all those "risk managers" (who are happy to manage the proceeds of their "2 and 20", if not so much the actual risk) YTD P&L. Why just today Omega' Leon Cooperman blamed"risk-parity for the "the magnitude and velocity of the decline in equity markets last month", or in other words, it was someone else's fault all his YTD gains were wiped out in one week. But what happened? We provided an extended explanation of the recent volatility as seen through the prism of risk parity funds last Thursday when we wrote "JPM Head Quant Warns Second Market Crash May Be Imminent." It was. However, for a much simpler, and quicker explanation, here is BofA with the one-chart summary of what happened in theoretical, if not quite practical (for those we will need Bridgewater's latest P&L) terms: Over the past week, an increased amount of attention has been focused on the recent performance of risk parity funds and the potential impact of their deleveraging amidst the spike in global equity volatility. Risk parity is a cross-asset portfolio allocation model that assigns weights inversely proportional to volatility and typically prescribes being overweight fixed income assets and underweight equities. Risk parity has a very successful longer-term track record and in recent years has gained popularity amongst asset managers. The volatile sell-off in global equities from Thursday August 20th through Tuesday August 24th, alongside a relatively muted diversification benefit from fixed income, led many risk parity funds to suffer a sudden and sharp drawdown over the four-day period (Chart 1). The performance drawdown and subsequent spike in the volatility of risk parity funds likely triggered a significant deleveraging in their assets. And here is the "Black Monday" outlier event as seen by risk parity models, and the associated surge in volatility: it is this surge that led to forced-deleveraging across the entire industry. There is much more here, but long story short: as a result of the explosion in equity vol, coupled with the unexpected intervention by the PBOC to sell TSYs - keeping long-yields unexpectedly high - just as risk parity models were predicting a drop in yields, it played havoc with endogenous vol models, leading to nothing short of the 7th biggest deleveraging event among risk partity funds in history! The recent theoretical deleveraging due to target vol was a stand-out historically Using a target volatility overlay (10% target vol, max leverage 2x) on the hypothetical risk parity investment, we tallied 3-day changes in leverage and ranked the 10 largest deleveraging events since the early 1970s to get perspective on the recent sharp spike in risk parity portfolio volatility. In this hypothetical example the current deleveraging would be the 7th largest (Table 3) but could be the most impactful on markets given the growth in assets tracking risk parity in recent years. A recently published report estimated the size of assets tracking risk parity at $400bn. Based on typical characteristics in many popular risk parity funds, we can assume vol control overlays with target vols between 6% and 10% vol along with leverage caps from 1.5x to 3.0x. Under these assumptions, anywhere between 40% and 120% of unlevered assets under management could have been deleveraged last week. If we assume $200bn of the purported $400bn risk parity AUM uses vol control, then the above 40% to 120% range suggests that between $80bn and $240bn in levered risk parity notional could have been unwound over the prior week. With a 35/65 split between equities and fixed income, this would have translated to $28bn to $84bn of potential selling pressure in equities and $52bn to $156bn in fixed income. The good news is that - at least in theory - for the time being, central bankers appear to have stabilized the relative vol discrepancies, and if they haven't - they likely will, if market stability is indeed the core mandate: they have no choice. Why else did Ray Dalio strongly hint that the Fed's rate hike will be followed by QE4? Of course, if the Fed is actually intent on helping the economy for once with the upcoming rate hike (while punishing the market), something we will find out in less than three weeks, then the recent massive "risk parity" deleveraging which sent the S&P500 to its first "limit down "tailspin in history is just an appetizing glimpse of what is yet to come...