Volatility Harvesting: Why Does Diversifying
and Rebalancing Create Portfolio Growth?

Abstract

Investors have traditionally equated volatility with risk and viewed it as unavoidable. However, volatility also affects how returns compound over time, which raises the question: Is it possible to profit from volatility? The answer is a definitive yes. This article explores the concept of volatility harvesting, or the extra growth generated from systematically diversifying and rebalancing a portfolio. The authors use the term harvesting because the activity is akin to farming, where seeds are spread widely and results are patiently harvested over time. This is in contrast to hunting for securities with high return potential. The excess return from volatility harvesting is not an expected arithmetic excess return derived from forecasting skill, security selection, or an informational advantage. Rather, it is the excess compounded return generated from rebalancing volatile assets over multiple time periods. This excess growth is available in liquid markets with assets that have volatilities greater than zero and correlations less than one. However, only investors with the discipline to trade systematically will harvest this extra growth.

TOPICS: Analysis of individual factors/risk premia, portfolio construction, performance measurement