One Way to Dig Out of a Hole - WSJ.com.
Ms. Damato makes a strong case for lower volatility strategies but does miss a few additional points worthy of consideration.
The math is clear - the 37% decline in the S&P 500 in 2008 requires a subsequent gain of more than 58% to return to "even". An investor focused on returning to even, is going to assume more risk in an effort to gain back what he/she lost. Sort of like doubling down when gambling. It's not a good bet.
I believe, for the individual investor, the key risks to manage are downside risk and inflation risk. The investor (or advisor to the investor) should be focusing on constructing portfolios that will generate an absolute positive return that exceeds inflation plus a reasonable "risk" premium AND attempt to hedge the possibility of real losses such as witnessed in 2008. One approach is to emphasis low volatility funds within a portfolio. That's a good start, but correlations must be considered as well. A portfolio of low volatility bond funds may look attractive but if they all have a correlation of 1, they'll all move in the same direction. That can still produce larger than desired losses.
I believe in constructing portfolios that incorporate both low volatility strategies and higher volatility strategies. For me, the key is consider poorly correlated strategies. This can be accomplished by using strategies that actively "hedge" their long exposures. These hedges can reduce correlations and can improve downside risk management. There is a premium paid for this "insurance" and that is in the form of potentially lower positive returns when market performance is good. I also add higher volatility strategies, typically un-hedged, tactically, to provide greater potential upside.
It is prudent to consider low volatility strategies as part of the risk management of investments. Capital preservation is often overlooked in good times and lamented in bad times, as in " I wish I had paid more attention to risk". As I've started before, I believe it is always valuable to view the markets skeptically.
Ms. Damato makes a strong case for lower volatility strategies but does miss a few additional points worthy of consideration.
The math is clear - the 37% decline in the S&P 500 in 2008 requires a subsequent gain of more than 58% to return to "even". An investor focused on returning to even, is going to assume more risk in an effort to gain back what he/she lost. Sort of like doubling down when gambling. It's not a good bet.
I believe, for the individual investor, the key risks to manage are downside risk and inflation risk. The investor (or advisor to the investor) should be focusing on constructing portfolios that will generate an absolute positive return that exceeds inflation plus a reasonable "risk" premium AND attempt to hedge the possibility of real losses such as witnessed in 2008. One approach is to emphasis low volatility funds within a portfolio. That's a good start, but correlations must be considered as well. A portfolio of low volatility bond funds may look attractive but if they all have a correlation of 1, they'll all move in the same direction. That can still produce larger than desired losses.
I believe in constructing portfolios that incorporate both low volatility strategies and higher volatility strategies. For me, the key is consider poorly correlated strategies. This can be accomplished by using strategies that actively "hedge" their long exposures. These hedges can reduce correlations and can improve downside risk management. There is a premium paid for this "insurance" and that is in the form of potentially lower positive returns when market performance is good. I also add higher volatility strategies, typically un-hedged, tactically, to provide greater potential upside.
It is prudent to consider low volatility strategies as part of the risk management of investments. Capital preservation is often overlooked in good times and lamented in bad times, as in " I wish I had paid more attention to risk". As I've started before, I believe it is always valuable to view the markets skeptically.
