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Volatility
Standard deviation is a statistical measurement which, when applied to an investment fund, expresses its volatility, or risk. It shows how widely a range of returns varied from the fund's average return over a particular period. Low volatility reduces the risk of buying into an investment in the upper range of its deviation cycle, then seeing its value head towards the lower extreme. For example, if a fund had an average return of 5%, and its volatility was 15, this would mean that the range of its returns over the period had swung between +20% and -10%. Another fund with the same average return and 5% volatility would return between 10% and nothing, but there would at least be no loss.
While volatility is specific to a fund's particular mix of investments, and comparison to other portfolios is difficult, clearly, for those that offer similar returns, the lower-volatility funds are preferable. There is no point in taking on higher risk than necessary in order to achieve the same reward.
Worked Example: Volatility
The average return of a fund conceals periodic fluctuations above and below the mean. The greater these fluctuations, the greater the risk that an investor could buy into a fund at a high point and subsequently dispose of the holding at a time when the fund hits a low. Volatility measure the extent to which the fund varies either side of the average, and hence this risk of loss.
In the following table a selection of performance measures is listed for two funds and their benchmark.
Table 24. Ratios table over 36 months from Unit Trust/OEIC universe against benchmark "UK Smaller Companies (risk-free rate at 3.5%)
| Name |
Ann Volatility |
Ann Alpha |
Ann Return |
| Discretionary UT TR |
10.07 |
10.75 |
24.82 |
| Liontrust Intellectual Capital TR |
17.03 |
0.44 |
24.68 |
| Sector: UT UK Smaller Cos TR |
14.4 |
0 |
22.2 |
Both funds show similar levels of annual return, and have outperformed the sector average. But the Liontrust fund is the more volatile, with returns fluctuating by 17% above and below the mean. This can be represented more graphically in the scatter chart below.
The example (click here to view the chart) shows how the the Discretionary fund is producing comparable returns to those of Liontrust's offering, while exhibiting noticeably less volatile behaviour than its competitor and, indeed, the sector average. The decision for the investor is clear.
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Data provided by FE fundinfo. Care has been taken to ensure that the information is correct, but FE fundinfo neither warrants, represents nor guarantees the contents of information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein. Past performance does not predict future performance, it should not be the main or sole reason for making an investment decision. The value of investments and any income from them can fall as well as rise.
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