## Insights

**Alpha**

A measure of risk-adjusted performance. Alpha is generated by regressing the portfolio's excess return on the benchmark (for example MSCI World) excess return. The beta adjusts for the risk (the slope coefficient). The alpha is the intercept.

Example: Suppose the portfolio has a return of 10%, and the short-term interest rate is 1% (excess return is 9%). During the same time the market excess return is 4%. Suppose the beta of the portfolio is 2.0 (twice as risky as the MSCI World). The expected excess return given the risk is 2 x 4% = 8%. The actual excess return is 9%. Hence, the alpha is 1% or 100 basis points.

**The cost of volatility **

"Volatility drag" is the shrinking effect that volatility has on returns. Although this is an easy mathematical concept, we think it receives far too little attention. However, most investors have felt its weight in the aftermath of the financial crisis.

The above figure illustrates the volatility drag or the impact of volatility with monthly compounding, comparing two generic investment alternatives both averaging a 6% yearly return, one with 5% volatility, the other with 15% volatility. With higher risk, cumulative returns diminish over time which reveals the cost of volatility.

In addition, a number of studies confirm that low-risk stocks historically outperformed high-risk stocks and that investors generally are overpaying for risk.

The conclusion is that higher risk does not necessarily equate with higher returns in the long term. In fact, lower risk does.

Related articles:

"Stock volatility - Not what you might think" - *Pimco*

**Size matters for hedge funds, and "small is good"**

Related article:

"Keeping assets at a manageable size was the only way you can be sure to conserve the alpha" - *IMQubator*