Volatility is not the real market risk

Very prevalent in portfolios, volatility as a measure of risk could itself become a major risk factor, some specialists believe.

Yan Barcelo 1 August, 2018 | 5:00PM

Volatility, which has become the main measure of risk over the last two decades, is very likely overrated, according to some experts who believe the ongoing rise in market volatility is simply hiding -- and revealing -- deeper and more unsettling risks.

Harry Markowitz introduced in 1952 his mean-variance model in which asset classes were the key portfolio building blocks. Since then, theoreticians have tried to optimize portfolios by replacing Markowitz’ classic asset-class-based allocation approach with models that integrate factors such as valuation, momentum, credit spreads, etc., say Thomas Idzorek and Maciej Kowara in a 2013 Financial Analysts Journal article titled Factor-Based Asset Allocation vs. Asset-Class-Based Asset Allocation. Idzorek is president and chief investment officer at Morningstar Investment Management, and Kowara is a portfolio manager and research director at Transamerica Asset Management; both are in Chicago.

Their paper shows that neither approach is inherently superior to the other. "Authors who strongly suggest that risk-factor-based asset allocation is inherently superior," Idzorek and Kowara write, "are at best over¬stating their case and at worst confusing investors with a false value proposition." Volatility, they note, is one of the latest "factors du jour," along with relative liquidity. "The problem," adds Paul Kaplan, director of research at Morningstar Canada, "is that people tend to become overly enthusiastic with one measure."

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About Author

Yan Barcelo  is a veteran financial and economic journalist with more than 30 years of experience, writing for many publications in Toronto and in Montreal, including CPA MagazineLes Affaires and Commerce.

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