“That valuation approach and our through-cycle assessment of underlying fundamental stability has shown excellent returns in the past market drawdowns,” said Cole. “Like any equity investment, some patience is necessary, but DSTL’s design inherently takes advantage of periods of market volatility and drawdowns when conventional measures of risk lead investors away from taking smart risks, and we are drawn toward them.”
Low Volatility Doesn’t Translate to Low Risk
Another common misnomer in the capital markets is that low volatility translates to lower risk. According to Investopedia, volatility is defined as “a statistical measure of the dispersion of returns for a given security or market index.”
Therein lies the issue as the definition makes no mention of risk. To Cole, this is exactly where investors can fall into the trap of assuming that low volatility will equate to automatic downside protection.
“Stock price volatility is an often-used proxy to assess risk, but as Warren Buffet wrote in his 2014 letter to Berkshire shareholders, while the metric is universally used and taught, ‘… it is dead wrong. Volatility is far from synonymous with risk,'” said Cole. ” Many investors are buying low volatility presuming it translates to low risk or downside protection or in an attempt to take advantage of the ‘low beta anomaly’. They are likely to be disappointed.”
According to Cole, there are a number of moving parts to explain why price volatility doesn’t necessarily translate to risk. However, the important takeaway is that investors may be paying too much by purchasing products that purportedly have a low-volatility component built in to the strategy.
“The price paid for any asset is critical to the ultimate return,” said Cole. “The flows into low volatility ETF’s have driven the prices of stocks exhibiting low share price volatility higher, ignoring the risk that a high price in itself is a considerable risk. In the past, whether on a large or smaller scale, when the market becomes driven by factors that ignore price-paid, the results are typically quite poor and sometimes disastrous.”
Blunting the Swings of Volatility
Investors looking to DSTL as an option to mute or blunt the impact of volatility can examine its core strategy–one that looks at value through a different lens and screens for high value investments that will not only provide the best returns over time, but also minimize the impact of volatility should the heavy price oscillations of the market make more appearances in 2019.
“DSTL utilizes an assessment of company-level fundamental stability and balance sheet quality to better assess the risk of potential holdings,” said Cole. “We then systematically rebalance the portfolio into the stocks that rank the best on our measure of the valuation opportunities available in the market. The result is a very high quality portfolio of stocks that exhibit strong through-cycle stability, but also utilize valuation as a measure of downside protection.”
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