Practical analysis for investment professionals
27 May 2013

Investment Risk in the Real World

Posted In: Risk Management

Is volatility a true measure of risk? That was the age-old question that Wong Kok Hoi, CFA, founder and chief investment officer of APS Asset Management, put to delegates at the 66th CFA Institute Annual Conference. His answer? “I don’t think so. There is insufficient evidence to back it up.” Wong noted that there are plenty of risk measurement concepts available to financial professionals — volatility, beta, value at risk (VaR), to name just a few — yet there is a disconnect between theory and our ability to detect risk. “With these concepts around, why have we fund managers done so consistently poorly in our attempts to identify potential risks?”

Wong noted that, according to modern portfolio theory (MPT), the higher the volatility, the riskier the security. “Over the last 30 years or so, there has been a debate about whether or not MPT resonates with market behavior. While the verdict is still out, we fund managers have been using it.” (For more on this topic, read “Modern Portfolio Theory: Bruised, Broken, Misunderstood, Misapplied?”)

Wong pointed out that in the United States, in the run-up to the downturn that swept through the markets in 2008, there was low volatility, “but the U.S. stock market experienced one of the most savage bear markets [and thus] the low volatility from 2005 to 2008 gave investors a false sense of safety.”

Wong said MPT “failed miserably” in the United States. But its failure was not just in North America. He also cited the example of Japan. “Interestingly, the Japanese stock market was also characterized by low volatility in the five years preceding the peak in December 1989. Not only did it drop 40% in 1990, it went into a 22-year bear market, the longest bear market in post-war history,” Wong said. “Needless to say, adherents of MPT have had their faith shaken beyond repair.”

Read more on the 66th CFA Institute Annual Conference blog


About the Author(s)
Lauren Foster

Lauren Foster was a content director on the professional learning team at CFA Institute and host of the Take 15 Podcast. She is the former managing editor of Enterprising Investor and co-lead of CFA Institute’s Women in Investment Management initiative. Lauren spent nearly a decade on staff at the Financial Times as a reporter and editor based in the New York bureau, followed by freelance writing for Barron’s and the FT. Lauren holds a BA in political science from the University of Cape Town, and an MS in journalism from Columbia University.

2 thoughts on “Investment Risk in the Real World”

  1. Narayanan Sivasailam says:

    It’s very easy to criticise the portfolio theory, pointing out the many times when it has failed to predict market crashes, and major movements. However, measures other than volatility tend to be even poorer predictors. Major crashes are the result of factors hitherto unconsidered, not a failure of portfolio theory – which is actually a framework for thought, rather than the alpha and omega of portfolio analysis.

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