Low volatility helps returns and lets you sleep at night.

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 manages risk and the best way to do that is ignore share prices in constructing a portfolio. Having portfolio weights determined in some way other than share price or market capitalisation means that the fund is able to exploit market volatility to smooth its returns. If, for example, it is calculated that Anglo American (LON:AAL) should have a portfolio weight of 0.95% any movement in that share price relative to the index provides an opportunity to buy more if it goes down or sell some out if it goes up.

In this way risk can be accurately contained and the volatility of the portfolio is reduced. Using a frame of reference that is based on a fundamental analysis of each stock and its place in the whole market enables a portfolio to benefit from volatility and extract a small amount of value each time Mr Market gets too exuberant over a share or, equally, too depressed.

A classic example occurred when HSBC (LON:HSBA) announced its results for 2010 and declared its final dividend. Having been as high as 730p the week before the announcement the shares plunged to 655p at the end of the week. The dividend was exactly as predicted but the tone of the directors comments, which many viewed as entirely sensible, depressed investors and bumped trading up to 120m shares a day, four times the normal volume. Anyone who invests on time horizon of decades, as we do, found the event rather puzzling but entirely beneficial as it enabled us to buy more shares in order to rebuild the portfolio weight back to 7%, the same as its model weight. On the day of the results the fall in the share price had reduced the portfolio weight from its desired 7.07% to only 6.85%. Consequently we bought some at 669.5p and, later in the week, bought more at 655.6p to restore the fund to its desired weight.

We like volatility because we exploit it to add value. Averaging down and top slicing demonstrably reduces volatility of The Munro Fund and will, in the long run, be accretive to returns. That is what makes us different.