The second quarter 2010 letter from Pzena Investment Management tested an interesting idea and came to an surprising conclusion:

?Given the enormous market dislocations of the 2007/08 period, many market participants have contemplated ways to reduce volatility in their portfolios.

Volatility, however, has always been useful to the value investor, and is one of the reasons the cheapest quintile of stocks has produced excess returns over the long term – the “value advantage.”

So we have undertaken a study to explore the impact of volatility in a deep value portfolio and have observed that moderate volatility is good for the value investor, but extreme volatility can actually detract from performance.

In fact, our study showed that performance can be improved, and volatility reduced, when the most volatile stocks are removed from the portfolio.?

Their tested results include a lot of data, over 31 years of market data and 14 years of their own portfolios.

In both cases the portfolios without the most volatile stocks outperformed the portfolio with them.

So higher risk does not equal higher returns.

Read the whole report here:

Pzena Invest Management Second Quarter Newsletter Commentary