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Why Volatility Is Good
14 November 2017 | World Views | Wim Prinsloo
 


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(Excerpt from Verdi’s Rigoletto)

The first 10 months of 2017 have been relatively stable for the JSE, however, market volatility is set to increase due to the uncertainty surrounding the outcome of the approaching ANC National Conference in December. This is a good thing.

Markets, like the lady in Verdi’s Rigoletto, are fickle - volatile. But this volatility, just like the lady, presents exciting opportunity - not necessarily risk. For ’volatility’ and ’risk’ are not the same.

Over the past several years, South African investors have lamented how risky markets have become due to their, at times, extreme volatility. The belief that volatility is synonymous with risk is also customarily taught in business school text books. Though this pedagogic assumption makes for easy teaching, it is wide of the mark.

It is true, of course, that owning shares for a day, or a week, or even a year, is far riskier (both in nominal, and in purchasing-power terms) than leaving funds in cash-equivalents. However, the majority of equity investors are invested for multi-year horizons, and quotational declines are unimportant over these longer-term horizons.

In fact, the savvy investors are the ones who take advantage of the short-term aberrations in markets - they use volatility to increase their risk-adjusted returns.

What is risk, really?

Risk is not volatility but rather a permanent loss of capital, in real terms. There are generally two reasons that result in a permanent loss of real capital:

1. A portfolio which is unable to keep up with inflation.

2. Investing in an asset which is overvalued and which will decline in value as it reverts to its fair value.

3. A permanent deterioration of the key fundamentals on which the investment thesis is build.

Why volatility is good

If you are a savvy investor, volatility presents an OPPORTUNITY to buy a great share at a discount when other market participants are panicking. Purchasing an excellent company at a price far below its fair value will enhance your prospective returns. Likewise, your risk (defined as a permanent loss of real capital) is minimised due to the lower probability that the price of an excellent company will decline indefinitely. The volatility that caused the decline in price actually helped you to increase your risk-adjusted return on the investment.

Conclusion

The take-home message of this article is this: just because markets are more volatile doesn’t mean that they are riskier. Market volatility is not risk and it is not something to be feared - it should be seen as a good thing and an opportunity to increase your returns. In the end, it will be the patient accumulator of shares during volatile times who is rewarded with above average risk-adjusted returns.

Buckle up and sit tight: December may well afford you the opportunity to buy your favourite share at a very attractive price.

cta


Wim

Wim Prinsloo, CFA
Portfolio Manager at True North Capital Management

Wim Prinsloo serves as portfolio manager at True North Capital Management. He holds an honours degree in investment management from the University of Pretoria and is a CFA charter holder.

Wim’s work at True North includes the management of the firm’s equity and property unit trusts, development of its investment processes and ensuring best-in-class service to clients. He benefits from 7 years of experience in the investment industry and is a member of the Investment Analyst Society of South Africa.


Disclaimer:
The information contained in this article is for informational purposes only and must not be regarded as a prospectus for any security, financial product or transaction. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial issue. Investors should consider this research/article as only a single factor in making their investment decision. We recommend you consult a financial planner/advisor to take into account your particular investment objectives, financial situation and individual needs.

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