A new Parametric report titled A Wide-Angle Lens View of Volatility: Managing the Journey and the Destination compared two hypothetical equity portfolios of $10 million: one with volatility included, and one without.
Parametric found that the fund with volatility included in the modelling experienced ‘return drag’ of 61 basis points in contrast with the volatility–free portfolio.
“This return drag from volatility is akin to other hidden leakages in implementation such as fees, taxes and transaction costs that furtively and assiduously eat away at member returns over time,” the firm said.
Parametric also found that downside or tail-risk solutions that cost more than 8 or 9 basis points per year, or targeted volatility dampening programs that cost more than 11 per year, would end up costing fund members as much if not more than “simply maintaining a portfolio with full, unmitigated volatility”.
“The problem with these approaches concerns the member’s retirement balance, the report said. Either the portfolio continues to live with significant volatility (and the volatility drag to returns) or it costs so much to reduce the volatility that the member’s returns will be even lower than if the portfolio experienced the full volatility drag.”
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