Beyond the Numbers: Why You Should Keep an Eye on Volatility of Fund Returns

Beyond the Numbers: Why You Should Keep an Eye on Volatility of Fund Returns

So, you had checked the performance of your fund, and it was the best performing fund for that month and over the last 6 months, you are very happy. A couple of months later, in keeping an eye on things you then noticed that whilst the fund is still a performer it had first dropped a spot, then 2 spots and you are wondering what’s going on. Well, that’s the nature of the markets. They go up and down, and a term used to describe the up and down is volatility. And you need to monitor that too.

A fund may generate the highest return in comparison to others, whilst another may generate mid-tier returns. How would you view the performance of each fund? In the ever-evolving landscape of investments, one term frequently bandied about is "volatility." It's a word that carries weight, often leaving investors feeling both intrigued and intimidated. But what exactly does it mean, and why should you pay attention to the volatility of fund returns?

Volatility, in its simplest form, is a measure of how much an investment's value fluctuates (goes up and down) over time. Imagine a roller coaster ride: high volatility resembles the thrilling twists and turns, while low volatility resembles a leisurely stroll.

At first glance, one might be tempted to solely focus on the performance of a fund – after all, isn't that what ultimately matters? While performance is undoubtedly important, volatility adds another layer to the investment equation. Here's why you should keep a keen eye on the volatility of fund returns:

1.   Risk Assessment:

Volatility serves as a barometer for risk. Investments with high volatility often entail greater uncertainty and potential for losses. Conversely, those with low volatility typically offer more stable returns but may yield lower overall growth. By monitoring volatility, you gain insight into the level of risk associated with a particular fund. This awareness empowers you to make informed decisions aligned with your risk tolerance and investment goals.

2.   Market Sentiment:

Volatility reflects market sentiment and investor behaviour. Sudden spikes in volatility may signal periods of uncertainty or market turbulence, while prolonged stability can indicate a sense of confidence and calm. Understanding these fluctuations can help you gauge the prevailing sentiment.

3.   Diversification:

Diversification is a cornerstone of sound investment strategy. By spreading investments across different asset classes, sectors, and geographic regions, your fund manager can reduce portfolio risk and enhance long-term returns. Volatility plays a crucial role in this process, as it helps assess the correlation between assets. If for example you are investing in other investments to be able to augment your pension in the future, you may wish to consider investments with low or negative correlations to the performance of your pension fund to serve as a hedge.

4.   Investment Horizon:

The investment horizon – the length of time that influences your tolerance for volatility. If you have a shorter time horizon, such as you are nearing retirement, minimizing volatility becomes paramount to preserve capital. Conversely, if you have a longer time horizon, you can afford to ride out short-term fluctuations and may even benefit from market volatility through naira-cost averaging and compound interest.

5.   Performance Evaluation:

While performance metrics like returns and Sharpe ratios provide valuable insights into fund performance, they only tell part of the story. Volatility adds depth to the analysis by contextualizing returns within the framework of risk. A fund may boast impressive returns, but if those gains come at the expense of high volatility and increased risk, you may decide to reconsider investment choices. By evaluating performance in conjunction with volatility, you can make more holistic assessments of fund performance.

Conclusion:

In the dynamic world of investing, volatility is a constant companion, shaping market dynamics and investor behaviour. While it may evoke apprehension in some, embracing volatility as an essential component of investment analysis can yield significant benefits. By understanding the relationship between volatility and risk, you can make more informed decisions, navigate market fluctuations, and ultimately, achieve your financial objectives.

As Warren Buffett famously said, "Risk comes from not knowing what you're doing." By keeping a watchful eye on the volatility of fund returns, you can better understand the risks they're undertaking and navigate the ever-changing landscape of the financial markets with confidence and clarity.

To review the current volatility tables of your pension fund, go here.

Volatility charts as of 31 March 2024