It is often said about journeys that it is better to travel than to arrive. The quality of the ride is more important than the end point. In the case of managing money the very opposite is true because you never know how rough the journey will be before you start.
On top of that it is sometimes necessary to get off your financial route at an unscheduled stop brought about by an unexpected development. In that case you would prefer your enforced disembarkation to be a smooth exit, not a perilous parachute jump at low altitude.
All investment funds promise you great returns if you stay the course and accept the rough with the smooth. In the long run the equity premium over bonds is what you get paid for the uncertainty of the short term. But if the destination is the same for all funds then why accept the bumpy ride that a volatile fund will give you? Although many funds promise to beat other funds, and the index, in reality the majority of collective investments more or less deliver the returns of the asset class plus or minus a bit. However, the way they deliver those returns can be remarkably different. Some are like a roller coaster soaring from peak to trough and back again while others, like us, give a more sedate experience.
On top of that wild ride high volatility funds have another drawback. They have to work harder to generate the same net return because after a 20% fall in a security it needs to recover by 25% to get back to its initial value. One that only fell by 10% can get back to its starting point after an 11% recovery, which is easier to achieve, and more probable. After all, if the starting point of both funds had the same degree of uncertainty about the future then the same must apply at the trough.
That might sound as though there is no point in trying to discriminate between funds. On the contrary; there is every reason to do so. If a fund has low volatility because of the way it is designed and run it will always be less volatile than one that just takes what the market throws its way.
The way to lock in low volatility is to use a process that…
