In Praise of High-Volatility Alternatives

Cliff Marks contends that high-volatility alternative investments, though harder to hold through drawdowns, deliver better risk-adjusted returns at the portfolio level than their lower-volatility cousins when investors can maintain discipline through rebalancing. The core insight is that volatility drag matters only for whole-portfolio compound returns, not for individual line items; a modest-sized, uncorrelated asset can improve overall outcomes even at high volatility because it allows capital to be deployed more efficiently. Marks illustrates this through optimization examples. When alternatives are available at 10% volatility with zero correlation to stocks and bonds, they replace bonds entirely in an optimal 10%-vol portfolio, adding 40 basis points annually. When those same alternatives are offered at 25% volatility (with proportionally higher expected returns), the portfolio compounds at 90 basis points better than without alternatives—and 50 basis points better than the low-vol version—because the optimizer can hold fewer dollars in the volatile asset while achieving the same portfolio volatility, leaving room for bonds and improving overall diversification. The practical challenge is behavioral: investors often redeem from high-volatility positions at the worst time, spoiling otherwise sound investments. Marks acknowledges this lived experience from AQR's 1998 launch, when the firm's 20%-vol market-neutral strategy fell 30–40% in its first 19 months before recovering. He argues the solution is not to avoid high-vol alternatives but to offer both low- and high-vol versions transparently, so investors can choose consciously and rebalance with discipline. Paradoxically, in true disaster scenarios (manager fraud, -100% loss), holding less capital at higher volatility is actually safer due to limited liability.