Making a Fetish of Low Volatility

In 1936 the great economist (and great investor for himself and as bursar of King's College, Cambridge) John Maynard Keynes wrote that:

Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investors to concentrate their resources upon the holding of "liquid" securities. It forgets that there is no such thing as liquidity of investment for the community as a whole.

Today's fetish is the fetish of low volatility, which, more than anything else, undid those who "invested" with Bernard Madoff, as Buttonwood points out. Ironically, those who lost everything in the ill-fated pursuit of low-volatility returns were often those who needed low volatility the least--wealthy individuals and charities with long time horizons.

The other irony is that ultimately what counts is not volatility itself, but the ability to tolerate it. How many of Madoff's investors, having congratulated themselves on securing such a low-volatility source of returns that allowed them to "sleep well at night", turned around and ruined it by eliminating their ability to tolerate even a little volatility elsewhere in life, either by borrowing money against their Madoff investment, or taking on too much debt elsewhere, or taking on too much overhead, or doing something else to reduce their overall margin of safety?

A similar point holds for "regular" hedge fund investors in 2008, who were not swindled but who were nonetheless forced to do things they otherwise would not want to do because they could not tolerate anything but "absolute returns."

Comments

[Paul V. Azz...:]

Nice point Nadav !

From another angle: how about the global banks whom we thought were relatively low volatility, high dividend, regulated, solid, pension fund type bedrock investments, only to find that their managements took shareholders' and depositors' money, churned it, reported huge profits, got paid high bonuses, went home, and left negative net worth institutions on our hands? Where's all the money gone and who is responsible?

Forget stocks for the long-term !

Jan 20 10:17 PM