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Update - November/December 2017
December 21, 2017
Happy holidays! It sure looks like this will be another great year for the market. But not all portfolios perform as expected. Most of the suitability cases in our office this year have focused on risk-adjusted performance; i.e., did the portfolio perform in line with the stated risk tolerance indicated by the client? Recently, a member inquired about the definition of concentration. At what level does a specific security become concentrated, and thus too risky? Some say 5%, some say 10% - in my view, there is no single number that is reliable because each security adds or subtracts risk to a portfolio in different ways.
The best way to analyze the problem is to track the performance of the portfolio compared to the performance of an appropriate benchmark, and then track the risk of the portfolio at issue compared to the risk of the same benchmark. The monthly performance of a portfolio is calculated as follows:
(End of Month Market Value - .5 x Net Contributions or Withdrawals divided by Beginning of Month Market Value + .5 x Net Contributions or Withdrawals) - 1
Perform this calculation for each month covered by the analysis, then chain link each result to get the total return for the period at issue. You can calculate the risk by using the MS Excel Standard Deviation formula as applied to the complete set of monthly returns. That will provide you with the monthly standard deviation, which you can then annualize using the following formula:
Monthly Standard Deviation x SQRT (12)
You can use this analysis to safely offer an opinion as to whether the portfolio was risk-appropriate for the claimant. Alternatively, you can perform the analysis to reflect that the claimant’s expert opinion is simplistic and invalid because the expert failed to empirically measure risk. Let the hard numbers tell the story as opposed to some general narrative that is unlikely to survive serious scrutiny.
Another question I think about a lot is whether experts should use past results in cases to market their services. One of the founders of SER reminded me many years ago that the cases do not belong to the expert. We are not advocates. Therefore, we cannot win or lose cases. The wins and losses belong to the attorneys and their clients. Using past results can be treacherous anyway. With experience, eventually all of us become involved in case “outliers;” i.e. expected wins that wind up as devastating losses. If you decide to use a favorable case outcome to present yourself as a great expert, you should expect to be asked about one (or all) of the “clunkers” during a future cross-examination. In my view, it’s better to cede that ground to the lawyers.
Your Board of Directors will be meeting in Dallas at the end of January. If there are any topics you would like us to consider, please lets us know!
Respectfully, Ross Tulman, President
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