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And so, regardless of its detractors, most folks do consider it a measure of risk.
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And, the GIPS standards now require it (although they've shied away from calling it a "risk measure"). However, Spaulding Group research has shown that it's the most common measure of risk. Since many consider risk to be either (a) the failure to meet the client's objective or (b) losing money, it wouldn't qualify, because it does neither. The former is for a single time period (standard deviation of annual portfolio returns for 2011, for example) and the other across time a longitudinal measure, if you will (e.g., the 36-month standard deviation of the composite for the period ending 31 December 2011). The GIPS® standards (Global Investment Performance Standards) now require both (a) a measure of dispersion (and standard deviation is just one way to accomplish this) and (b) the 36- month, annualized standard deviation for both the composite and benchmark. Both of these are used in the context of standard deviation being a measure of risk what some call "external dispersion."Īs for "dispersion," I usually mean this in the same context as some do for "internal dispersion," meaning how the composite's returns compare / vary. However, in an email to me not long ago, he said using either the term "variability" or "volatility" is fine. Is it a measure of variability, volatility or dispersion?īill Sharpe, in his 1966 paper used the term "variability" to describe standard deviation (he referred to what we know as the "Sharpe Ratio" as the "reward to variability" (recall it has standard deviation in the denominator) and Jack Treynor's risk-adjusted measure as the "reward to volatility" (it has beta in the denominator)). Most firms seem to use "n," so I say "why not join them?" We can debate which is appropriate, but why bother? Dividing by "n" makes standard deviation a bit smaller. We're supposed to use "n" when we're measuring against the population, and "n-1" when against a sample. I recall that the AIMR-PPS® flip flopped on this one (the first edition (1993) had one form, the second (1997) a different one ). But if you insist on doing asset-weighted, be my guest.īy "n" we mean the number of accounts. If you've been reading my stuff for any length of time, chances are you know the answer: EQUAL! Okay, so you're allowed to do asset-weighted, but why would you? What does the number mean or represent? This was an idea that some folks thought made sense almost 20 years ago ("since returns are asset-weighted, shouldn't standard deviation?"), but didn't and doesn't. I'll be brief, but promise to expound further upon this subject in this month's newsletter.