We have now written about the importance of observing historical volatility when making rebalancing decisions (see here, here and here) and the importance of keeping portfolio volatility low (see here). This post will discuss the benefits inherent in volatility itself through the concept of “harvesting” the volatility of individual positions within a portfolio.
|Source: Butler|Philbrick|Gordillo and Associates*|
Source: Dempster, Evstigneev and Schenk-Hoppe
|Source: Butler|Philbrick|Gordillo and Associates*, data from Bloomberg|
This chart shows how the use of an uncorrelated asset class along with simple rebalancing can make a big impact on anyone’s investment success. The portfolio went from losing -48% and having a peak-to-trough maximum loss of -79% in the Nikkei, to making a profit of +138% and keeping the worst peak-to-though loss at a manageable -13.97%. Though the result of this two asset class portfolio is impressive, we would in no way espouse this model as an optimal framework not least of which because the stock / bond diversification ignores the myriad of opportunities available from other markets and asset classes (Click here for more detail on how we deal with this).