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How to deal with increased volatility

Markets are becoming more volatile, but what do you do about it? Fidelity Investments vice-chairman Robert Pozen gives his answer.

Wednesday, August 8th 2001, 6:48AM

The nature of volatility is changing and investors need to be aware of this fact and position their portfolios appropriately, Fidelity Investments vice-chairman Robert Pozen says.

Investors often think they are doing well because their funds produce massive double digit, or even triple digit, returns. Often though these funds then record significant losses.

Others who are invested in funds that just creep along get return envy when they see the numbers being achieved by others.

Pozen says there is more to this situation than meets the eye.

Say an investor puts $10,000 each into a growth fund and a more conservative balanced fund on January 1, 1999.

Assume that the growth fund surges up 103% in 1999 then falls 47.6% in 2000. The balanced fund, by contrast, inches up just two-tenths of a percent in 1999 and 4.5% in the year 2000.

Pozen asks: "Which fund is ahead on New Year’s Day 2001?"

The answer is neither. They are both worth about $10,600.

He says the growth fund has an additional impact on its investors - sleepless nights resulting from watching its wild volatility.

Pozen says the nature of volatility is changing and it is more important than ever to understand it.

One recent study concludes that over a 35-year period from mid-1962 to 1997 the volatility of individual stocks has more than doubled – while the volatility of composite market indices – the NYSE, the AMEX and NASDAQ -- remained fairly stable.

Among the reasons that the study cites for increased individual stock volatility are the replacement of conglomerates with more narrowly specialised companies and the earlier listing of many firms on the public markets.

Pozen says from an investor’s viewpoint, the study’s most important conclusion is this: in order to compensate for the increased volatility, an investor needs more than twice as many stocks in a portfolio to achieve the same level of diversification of risk as he or she did in years past.

"This is occurring at a time when many 'experts' suggest that portfolios should hold fewer stocks – supposedly to indicate a greater level of conviction from the portfolio manager."

The baseline message is, however, that higher volatility -- greater dispersion of returns among individual stocks -- increases the need for portfolio diversification.

There’s no getting away from that, he says.

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