Buy high volatility for capital efficiency

 

Cliff Asness in his work "In Praise of High-Volatility Alternatives" argues that holding a higher volatility may be better for a portfolio. The normal view is that higher volatility will be a drag on compounded returns. Hence, many managers attempt to keep volatility low in their strategies. However, there can be better capital efficiency if you can lower the dollar exposure and take on the higher risk. This is subtle argument based on a number of assumptions, but it can make sense. If there is a volatility associated with a dollar investment, you can lower your dollar exposure through cutting the dollars committed to the strategy. 

This really work well with a strategy like managed futures. If you think the volatility is too high at a 5% exposure, then cut the exposure. As usual, you must look at the correlation and diversification benefit from a strategy. A low correlated alternative can have a higher volatility and provide strong benefit at a lower allocation. This is not an especially innovative paper, but it goes back to basics and provides some insights on portfolio structure. Volatility is not always bad.