Charles M. Lahr
And over 25 years, with the market returning an average of 7.65% annualized, a striking relationship exists between risk and return. This should be enough for investors to reexamine their perception of risk and return:
I hope I’ve convinced even the most ardent cynic that there’s some merit to investing in “boring,” historically low volatility stocks and that low risk and higher returns is a durable relationship, at least over the long term. But there’s one last area to address: emerging markets.
It’s straightforward that higher growth tends to lead to higher volatility. It doesn’t appear to matter whether it’s in developed markets or emerging markets. So the data here actually refute the notion that emerging market stock returns are all about growth. Certainly, structural growth is a good thing but overpaying for it is not. Once again, we see that lower volatility can lead to higher long-term return potential.
Why is this relationship so hard to escape? Hint: stock market participants in every country have this one thing in common – they’re all human.
Why Does This Anomaly Exist?This collection of data presents a compelling argument that higher risk generally does not result in higher returns over the long term. Not only does this fly in the face of a number of empirical finance theories, it also seems to contradict common sense. What are some other reasons for this anomaly? First, many people are naturally attracted to scenarios with the potential for high volatility and big payoffs even if they have low odds. Second, people tend to be overconfident in their ability to forecast the future and to be correct in their assessments. Forecasting and speculation may often take a major role in selecting high volatility equities. Third, there are structural factors within the investment community that can steer professional investors toward more volatile instruments and away from lower volatility stocks. Each of these three factors is described below.
Past performance is not a guarantee or a reliable indicator of future results. Equities may decline in value due to both real and perceived general market, economic, and industry conditions. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. Since June 2007 the MSCI World Index consisted of the following 23 developed market country indices: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United States. The index represents the unhedged performance of the constituent stocks, in US dollars. It is not possible to invest directly in an unmanaged index.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
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