Magellan had a standard deviation of 21.1% and the S&P 500 came in at 16.0%. Compare this performance to the S&P 500 which had two slightly negative years. From May of 1977 through May of 1990 every full year return was positive. Consider the returns of Fidelity’s Magellan Fund under Peter Lynch. While the “fat-tails” phenomenon has been discussed many times before there are still more issues that arise when using standard deviation to quantify risk. History has taught us that crashes occur much more frequently than every several billion lifetimes. If the world of finance were Gaussian, an episode such as the crash (more than twenty standard deviations) would take place every several billion lifetimes of the universe Additionally, Nassim Taleb, in his now famous work The Black Swan discussed the disconnect between traditional statistical measures (such as standard deviation) and the occurrence of extreme events Influential managers Howard Marks and James Montier both share the perspective that true risk isn’t a statistical measure, but simply the permanent loss of capital. ![]() Over the past several years there has been a shift in thinking with regards to investment risk. However, there are some concerns with using these risk metrics that should be considered. Markowitz mean-variance optimization and the Sharpe ratio are two such examples under the umbrella of modern portfolio theory that reference variance or standard deviation as a proxy for risk in their formulation. ![]() Traditional financial theory has relied heavily on standard deviation or variance (the square of standard deviation) to quantify historic risk.
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