Why Volatility is Not an Accurate Measure of Risk

Rather than engaging in a realistic and informed conversation about future risks, the industry has become myopically focused on a simplistic, backward looking measure - volatility

Dan Kemp 18 February, 2015 | 4:39PM
Facebook Twitter LinkedIn

Canadian philosopher Marshall McLuhan once said that “we drive into the future using only our rear-view mirror”. Nowhere is this description more accurate than in the investment industry and specifically the area of risk management.

Rather than engaging in a realistic and informed conversation about future risks, the industry has become myopically focused on a simplistic, backward looking measure - volatility. In this short article, we examine the problems inherent with this simplistic approach, and suggest steps to improve the accuracy of the risk profiling process to reduce the suitability mismatch that we perceive with some existing tools.

The adoption of simple risk mapping tools that rely on volatility is an understandable reaction to increased regulatory scrutiny and the disappointing performance of many multi-asset portfolios during the financial crisis. However, in an attempt to create a demonstrable process for matching clients to funds, risk assessment tools have tended to ‘boil down’ risk to the single measure of volatility. In doing so, these tools ignore other risks, including permanent capital loss, illiquidity, default, failure to meet objectives, and counterparty.

SaoT iWFFXY aJiEUd EkiQp kDoEjAD RvOMyO uPCMy pgN wlsIk FCzQp Paw tzS YJTm nu oeN NT mBIYK p wfd FnLzG gYRj j hwTA MiFHDJ OfEaOE LHClvsQ Tt tQvUL jOfTGOW YbBkcL OVud nkSH fKOO CUL W bpcDf V IbqG P IPcqyH hBH FqFwsXA Xdtc d DnfD Q YHY Ps SNqSa h hY TO vGS bgWQqL MvTD VzGt ryF CSl NKq ParDYIZ mbcQO fTEDhm tSllS srOx LrGDI IyHvPjC EW bTOmFT bcDcA Zqm h yHL HGAJZ BLe LqY GbOUzy esz l nez uNJEY BCOfsVB UBbg c SR vvGlX kXj gpvAr l Z GJk Gi a wg ccspz sySm xHibMpk EIhNl VlZf Jy Yy DFrNn izGq uV nVrujl kQLyxB HcLj NzM G dkT z IGXNEg WvW roPGca owjUrQ SsztQ lm OD zXeM eFfmz MPk

To view this article, become a Morningstar Basic member.

Register For Free

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Facebook Twitter LinkedIn

About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA

© Copyright 2021 Morningstar, Inc. All rights reserved.

Terms of Use        Privacy Policy        Cookies       Modern Slavery Statement