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By Greg Flash

Volatility is one of the most discussed issues in the investment industry at this time. Volatility of world markets, volatility of our market, volatility of the rand. The world of finance is not unique to extreme changes, just look at the political world. In four days – if the latest polls are to be believed – we could see a gigantic shift in US political history with the first African American president being elected. Here at home, SA political issues have been raised to new highs, as we may be about to witness a split in the 90 year old African National Congress, and even stranger and definitely more entertaining, the launch of the first political party headed by a female impersonator in the form of Evita’s Peoples Party http://www.epp.org.za/! Let’s not even talk about the threat to our beloved Springbok Rugby emblem and the problem with some of our “Springboks” not being able to keep their breakfast down. Definitely not a dull time to be alive!

Let us return to the financial world. With the All Share Index (ALSI) having collapsed in the last two months, I thought it important to see how the Domestic Equity Unit Trust industry has oscillated in comparison. Using data from Morningstar, volatilities for all unit trusts in the Domestic General, Growth and Value Equity sectors were compared to that of the ALSI. The first unit trusts in these sectors date back to May 1987. I decided to compare the volatilities of these and subsequent unit trusts to the ALSI. In addition, the first multi-managed equity unit trusts date back to July 1998 and hence I have calculated the volatilities of these and subsequent multi-managed funds from this date. In the graph below, average 1 year rolling volatilities for the abovementioned funds are plotted.


As can be clearly seen, the ALSI is far more volatile than the average equity unit trust and the average multi-managed funds within these sectors. Looking at the last 10¼ years since multi-managed equity funds have been in existence, the ALSI has had a volatility of 21.8%, while the average equity fund has had a volatility of 18.4% and multi-managed equity funds for the same period have had the lowest volatility of just 16.2%.

These numbers are to be expected, particularly that of the multi-managed funds having the lowest volatility which can be attributed to their diversification characteristics. This multi-managed fund volatility is also lower than the volatility of the equity unit trusts over the longer period of 17.1% and the ALSI for this same 21½ year period of 20.7%. These numbers are summarised in the table below:


The other interesting thing to note from the graph is the level of volatility presently experienced and how this compares to absolute highs and lows over the period. Even though this graph only includes data to the end of September 2008 – the volatility of October 2008 will definitely be much higher – we can see that we are not at the highest level of volatility. The highest 1year rolling volatility for the average equity fund was 38.5% for the months of Nov ’98 to Jan ’99. Conversely, the lowest was 5.1% in August ’93.

Capital preservation should always be the starting point when constructing a portfolio. This could be achieved through the correct combination of funds in a portfolio, as this is likely to yield lower volatility over time, while still generating adequate returns. Managing and understanding the volatility of a portfolio is a key risk management tool. This is well referenced by well known author and investor Peter Bernstein who points out that maximizing return makes sense only in very specific circumstances.

Survival, according to Peter Bernstein is the only road to riches and you should try to maximize return only if losses would not threaten your survival and if you have a compelling future requirement for the extra return that you might achieve by taking on additional risk.

Source: Greg Flash, Alphen Asset Management, October 31, 2008.

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