Here's a statement of the obvious: The opinions expressed here are those of the participants, not those of the Mutual Fund Observer. We cannot vouch for the accuracy or appropriateness of any of it, though we do encourage civility and good humor.
Risk is not a scalar factor. It is multi-dimensional. There are many risk factors. One should instead consider a risk vector incorporating different types of risk.
Unfortunately, we cannot measure and quantify the risk numerically for all of risk factors. While volatility is not the risk, it can be be used as a "approximate" proxy as long as we keep that in the back of our mind. It is less than ideal but it allows for quantitative evaluation of the risk and we can get a feel. For this purpose, it has served well. The trouble is that people built whole complex models only focusing in one factor and ignoring the rest. That is what gets people (professionals included).
Beta is not really a measure of volatility but an indication of how sensitive the security is to movements of market. It is born out of CAPM model but proved insufficient. Fama-French model has expanded that to 3 factors: Fama-French beta (different from CAPM beta), and factors for Value and Small. This is better but still not incomplete. For example, how can you represent the manager risk, tail risk, behavioral risks etc.
Having said, that I would not be so quick to dismiss the volatility. Extreme volatility funds have proved more often than to be a famine or feast type investments. A lot of people have actually lost money in these because of bad timing even if the fund has can make claims of very high long term returns.
With respect, I don't see the point in buying an active fund manager, who in my case eats his own cooking and then handicap/dismiss him by the volatility (sic) of his fund. If I own funds that are not volatile it is more because the fund manager worries about permanent loss of capital, equating THAT with risk. There is a difference between cause and effect.
Anyone worried about beta should be buying index funds. After all beta is a relative and not absolute measure. A lot of people - myself included - lost money because they didn't know what the F they were doing. They were letting those peddling financial pron influence their decisions. And they continue to do so. Beta, Theta, Omega. This used to be a joke - there are three kinds of lies : lies, damned lies and Statistics. I don't consider that a joke anymore. Here's another one - Statistics is like a Bikini; what it reveals is interesting, but what it conceals is vital. I don't laugh when I hear that anymore either.
Buying an active fund means assuming manager risk first and foremost. Market risk is secondary. Buying a sector fund is obviously more risky than buying a more diversified fund since one is putting more of ones eggs in a more narrowly scoped basket obviously more susceptible to changes in like securities. I can buy that THIS is risky. If sector funds are ALSO more volatile than ANY benchmark one wants to compare against, that's incidental.
Again, Beta is Elementary. Homework is Fundamental.
Reply to @VintageFreak: Vintage, I am not going to argue much so you can have the last work after this.
Obviously, you have your own ideas. You do not see risk as long as there is no permanent loss of capital. You are fine if the recovery from temporary losses takes 5, 10, 100 years (OK, I am exaggerating). And you will never need this money before such undefined timeline. Unfortunately, to me your definition for me is a pie in the sky. You are ignoring many risks that are true to real life.
You really do not know if the fund decline or the funds investments in the securities that has declined has had permanent loss of capital. Only time will tell and you you might not think you had a permanent loss now, time might prove otherwise.
Also, there is also opportunity risk. While hanging on to loss positions, you might be giving up on better alternatives. You have opportunity cost and risk. Permanent loss and opportunity cost risk are only accountable after the fact. So, you really do not have any measure of risk but an abstract concept or something that is observable after the fact.
I agree volatility is not very good in capturing risk. It still gives me an idea on the riskiness of the security. Yours does not even rise to that level for me.
It might be OK for you. I've rather have something better to work with even if it is imperfect. Thanks for your comments though.
Comments
Unfortunately, we cannot measure and quantify the risk numerically for all of risk factors. While volatility is not the risk, it can be be used as a "approximate" proxy as long as we keep that in the back of our mind. It is less than ideal but it allows for quantitative evaluation of the risk and we can get a feel. For this purpose, it has served well. The trouble is that people built whole complex models only focusing in one factor and ignoring the rest. That is what gets people (professionals included).
Beta is not really a measure of volatility but an indication of how sensitive the security is to movements of market. It is born out of CAPM model but proved insufficient. Fama-French model has expanded that to 3 factors: Fama-French beta (different from CAPM beta), and factors for Value and Small. This is better but still not incomplete. For example, how can you represent the manager risk, tail risk, behavioral risks etc.
Having said, that I would not be so quick to dismiss the volatility. Extreme volatility funds have proved more often than to be a famine or feast type investments. A lot of people have actually lost money in these because of bad timing even if the fund has can make claims of very high long term returns.
Anyone worried about beta should be buying index funds. After all beta is a relative and not absolute measure. A lot of people - myself included - lost money because they didn't know what the F they were doing. They were letting those peddling financial pron influence their decisions. And they continue to do so. Beta, Theta, Omega. This used to be a joke - there are three kinds of lies : lies, damned lies and Statistics. I don't consider that a joke anymore. Here's another one - Statistics is like a Bikini; what it reveals is interesting, but what it conceals is vital. I don't laugh when I hear that anymore either.
Buying an active fund means assuming manager risk first and foremost. Market risk is secondary. Buying a sector fund is obviously more risky than buying a more diversified fund since one is putting more of ones eggs in a more narrowly scoped basket obviously more susceptible to changes in like securities. I can buy that THIS is risky. If sector funds are ALSO more volatile than ANY benchmark one wants to compare against, that's incidental.
Again, Beta is Elementary. Homework is Fundamental.
Obviously, you have your own ideas. You do not see risk as long as there is no permanent loss of capital. You are fine if the recovery from temporary losses takes 5, 10, 100 years (OK, I am exaggerating). And you will never need this money before such undefined timeline. Unfortunately, to me your definition for me is a pie in the sky. You are ignoring many risks that are true to real life.
You really do not know if the fund decline or the funds investments in the securities that has declined has had permanent loss of capital. Only time will tell and you you might not think you had a permanent loss now, time might prove otherwise.
Also, there is also opportunity risk. While hanging on to loss positions, you might be giving up on better alternatives. You have opportunity cost and risk. Permanent loss and opportunity cost risk are only accountable after the fact. So, you really do not have any measure of risk but an abstract concept or something that is observable after the fact.
I agree volatility is not very good in capturing risk. It still gives me an idea on the riskiness of the security. Yours does not even rise to that level for me.
It might be OK for you. I've rather have something better to work with even if it is imperfect. Thanks for your comments though.