Volatility: funny how the mere mention of the word sends investment professionals and the folks they advise to hide the women and children and batten down the hatches.

In the investment arena, battening down hatches can mean getting rid of high vol products (raise cash), reducing leverage (if used), engaging in shorts, hedging options/derivatives and the age old, stick your head in the sand. All have been known to work at some point or another, no argument there. Truth be known, we likely have done all of them too in earlier lives.

Let's share some key experiences that centers on how volatility should work for investors and reduce or eliminate the dreaded volatility drag. Does not matter what you put money in, stocks, bonds, currencies, real estate, etc, they all have volatility related to their rates of return. And, there are generally no long-run free rides: meaning, making more money at lower volatility with any rules-based, systematic approach. The Efficient Market Hypothesis and Liquidity guarantee that what works in academia/research papers (like minimum and low volatility products) won't work in reality at scale.

Let's compare SPLV to the SPY for a clear picture of this relationship . Its look like almost 20% give up over the past five years alone to the SPY (SP500 index tracker) and SPLV (Powershares Low Vol ETF) carried volatility that was almost the same! Of course, the much vaunted Sharpe ratio clearly favors SPY. The point here is that unless an investment strategy has a clear path to ferreting through volatility, you have little to no chance of besting a simple market cap indexing scheme. SPLV is just one of many largely failed ideas to trump (can we still use this word?) the Efficient Market Hypothesis.

You want to make money in the long-run, volatility is important to doing so. Get it, embrace it and look for smart opportunities to add it to your portfolio. Here are some possibly smarter ways to think about volatility and avoid surprises:

1) Mixing and matching a portfolio based on standardized volatility and correlation analysis (ala "Modern" Portfolio Theory) is generally a panacea in liquid, well developed markets

2) Strategies relying on systematic, rules definitions for calculation standard deviation and correlation won't deliver on such premises

3) Volatility drag works in both directions! But, only in the wrong direction, IF you pick strategies that have less upside volatility than downside volatility (see #2 above for such strategies)

4) Leverage is an artificial mechanism to increase an investment strategy's core unlevered return stream; get comfortable with a core strategy's return stream before deciding whether leverage is appropriate

5) Using leverage: adjusting leverage relative to an investment strategy's gain or loss is a recipe for losing as portfolio profits and losses are random occurrences and so changing the leverage on a random occurrence, why bother? Flip a coin.

6) Risk Parity, here is a fun one. Using systematic calculation of stock vs bond volatility, a portfolio is aligned to mix between the two asset classes and since the resultant mix will always favor a heavy dose of bonds (like 95%), then leverage it up a bit to get a reasonable return. Sounds slick enough on paper and in practice (see AQR's results relative to the SP500), until you see that you leave a ton off money on the table in search of what?

Does not matter what asset class you pick, they are all relative in their context. ProForza has several arrays of equity-based products, some are high beta and others lower risk by virtue of using some of the risk reducing ideas noted above. High beta products are not offered in leveraged format, but the lower risk, higher alpha ones are and that leverage ranges from 1.5x to about 4x in our long history of offering high alpha products with leverage enhancement. But, the kicker is this, we know that when a high leverage product draws down 10-30%, there is no change to our exposure, meaning we are making it back on the same basis as when we lost it, thereby eliminating the impact of volatility drag - this element is hugely important to understand for your investing future in any asset class!

Furthermore, we won't start investing with high leverage unless we know that we have sufficient capital to weather that 30-40% hit to the capital base. We also know that the underlying investment strategy is capable of delivering more up vs downside when it is right. We know that the portfolio composition is stable in terms of the holdings - meaning we make it back on the sames positions that take it away. We also know, very importantly, that at the end of the day, that a 30% drawdown is simply 4.6% unlevered so, if one does not fool around with the leverage settings for the reasons noted above (that others' do), then we need to simply wait for the investment strategy to make about 5% before we set a new equity high!

So, if you can get your head around these key ideas around volatility (not all inclusive, there are finer points but contact us for that), you are on your way to making much greater sums of money over long periods of time then wasting it on low volatility ideas.

You can eat a lot more by really managing volatility in your portfolio.