Saturday, March 03, 2012

high risk, low reward

In an absolute sense, it's of course true that the more money investors put at risk, the more they'll gain if their investments increase in value. However, with the kind of risk that's become synonymous with volatility in investment argot, the opposite has been true. On average, high-beta investments--those whose prices have swung wider than an index over a given period of time--have historically generated worse returns than less-volatile alternatives.

The pattern has been persistent. This study, which appeared last year in the CFA Institute's Financial Analysts Journal, found that between 1968 and 2008, a portfolio comprising the least-volatile quintile of the market's 1000 largest stocks swamped the most-volatile quintile over the course of 40 years. And in this explanation of why boring can be beautiful, Morningstar ETF analyst Samuel Lee cites the work of Lasse Pedersen and Andrea Frazzini. In this 2011 paper, the duo find better risk-adjusted returns resulting from "betting against beta" across a broad range of asset types and geographic boundaries over a 50-year time frame.

History doesn't always repeat. Over a lengthy stretch of time, though, investors have fared better by taking on less risk, not more.

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