Vantage Point: Volatility  

How volatility differs from risk

How volatility differs from risk
Credit: Mary Taylor/Pexels

Volatility and risk in investment terms are often lumped together like coffee and milk. But while they go together they are quite different and can frequently stand alone. 

Indeed, as Warren Buffett notably said: "Volatility is far from synonymous with risk." 

Risk comes in many forms and is open to interpretation at a personal and professional level. 

In simple terms, it is defined as permanent loss of capital. At a company level, it generally comes about when something has gone badly wrong at a fundamental level, for example operational issues, management changes, poor merger and acquisition choices, or indeed fraud. 

Volatility is temporary in both absolute terms and when compared to an index. It is driven by sentiment and can be emotionally and behaviourally difficult to stomach. It becomes risky when investors crystallise losses by selling stocks as a reaction to market gyration. Risk can be mitigated generally through diversifying stocks by sector and geography and sometimes by investment style, but the last concept can simply neutralise returns.  

Volatility cannot be helped except by taking a long-term view and rolling with the punches. Over time, things tend to sort themselves out so long as corporate fundamentals and prospects are sound. It can also provide opportunity and attractive points of entry for investors during periods of drawdown.

A word of warning: the investment industry likes to measure things as it offers a veneer of control and assumes certainty. Such metrics are applied to risk (Sharpe ratio) and volatility (standard deviation/tracking error) and often conflated, which can be unhelpful given that risk and volatility are not the same thing. 

Active investing

As long-term active growth investors, Baillie Gifford funds and trusts will experience periods of volatility against the market. We aim to find exceptional companies and invest in them with conviction. As a result, we will quite often find ourselves at odds with a short-term market sentiment. However, over five and 10-year periods we expect the fundamentals of the companies we select to be positively reflected in their share prices. 

As a result, we target significant outperformance versus relevant indices over such periods. This does not make us innately any more risky than other asset managers, just more volatile than those whose portfolios look more like the index. Indeed, we, like many other asset managers, are blessed with considerable resource and rigour when it comes to assessing risk to our portfolios. 

 

 

 

 

 

 

It could be argued the biggest risk for us and our investors is simply picking poor stocks, which we do from time to time. However, we strive to find winners rather than avoid losers. After all, in glib terms, you can only lose 100 per cent of any investment whereas the upside can potentially be unlimited.