Volatility not a measure of true risk

June, 2014 Print

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The investment industry’s focus on volatility as a measure of risk has dangerous implications for long-term investors, according to a new paper from Stefan Dunatov, chief investment officer of the Coal Pension Trustees.

Dunatov commented: “The increasing focus on forecasting risk, and the emergence of volatility as a popular measure of that risk, is a disappointing response by the investment industry to recent difficulties.” He added this has led to a short-term focus on risk, and said: “Asset owners have allowed the providers of investment services, including investment managers and consultants, to dictate the approach asset owners should adopt. External advisers naturally prefer to work with an easily-definable measure that is common to many clients. Their solution has been to replace the traditional focus on forecasting returns and all its difficulties with a short-term metric of volatility to forecast risk, which appears to be a more tractable measure.”

Dunatov said that volatility is a crude measure of risk for long-term investors, who should be able to accept short-term fluctuations in risk premiums. Instead, long-term investors should be more concerned with how macro factors affect asset prices over a longer period. His views are set out in a new paper from the 300 Club, an affiliation of long-term investors and other investment experts and pundits.

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