Understanding Risk Adjusted Portfolio Performance

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A Vital Feedback Loop for any Medical Professional’s Investment Program

By Dr. David Edward Marcinko MBA, CMP™

[Publisher-in-Chief]

While recently visiting the beautiful Johns Hopkins University and Medical School in Baltimore Maryland, I realized that investment portfolio performance measurement — much like an annual physical exam in the Spring — is an important feedback loop to monitor progress towards the goals of the medical professional’s investment program.

Performance comparisons to market indices and/or peer groups are a useful part of this feedback loop, as long as they are considered in the context of the market environment and with the limitations of market index and manager database construction.  Inherent to performance comparisons is the reality that portfolios taking greater risk will tend to out-perform less risky investments during bullish phases of a market cycle, but are also more likely to under-perform during the bearish phase.  The reason for focusing on performance comparisons over a full market cycle is that the phases biasing results in favor of higher risk approaches can be balanced with less favorable environments for aggressive approaches to lessen/eliminate those biases.

THINK: The “flash crash” of March 2009, and the DJIA now hovering near 12,000 of  late.

The Biases

Can we eliminate the biases of the market environment by adjusting performance for the risk assumed by the portfolio?  While several interesting calculations have been developed to measure risk-adjusted performance, the unfortunate answer is that the biases of the market environment still tend to have an impact even after adjusting returns for various measures of risk.

http://www.amazon.com/Financial-Planning-Handbook-Physicians-Advisors/dp/0763745790/ref=sr_1_1?ie=UTF8&s=books&qid=1276795609&sr=1-1

Assessment

However, medical professionals and their advisors will have many different risk-adjusted return statistics presented to them, so understanding the Sharpe ratio, Treynor ratio, Jensen’s measure or alpha, Morningstar star ratings, etc. and their limitations should help to improve the decisions made from the performance measurement feedback loop.

And, these are discussed elsewhere on this ME-P.

Conclusion

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Speaker: If you need a moderator or speaker for an upcoming event, Dr. David E. Marcinko; MBA – Publisher-in-Chief of the Medical Executive-Post – is available for seminar or speaking engagements. Contact: MarcinkoAdvisors@msn.com

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4 Responses

  1. Buy Equities Now!

    PIMCO’s Neel Kashkari says now is the time to stock up on equities. He cites attractive valuations, income growth and dividends

    Furthermore, Pacific Investment Management Co.’s Kashkari said investors should buy equities because valuations, income growth and dividends show the asset class is attractive.

    http://www.investmentnews.com/article/20110912/FREE/110919993

    What do you think, Dr. Marcinko?

    Craig

    Like

  2. Risks

    When an advisor recommends a particular investment, how do you know it’s right for you? Financial writers, myself included, say you need to ask questions. The trouble is, according to a recent survey, most investors ask the wrong questions.

    The survey, funded by Dimensional Fund Advisors and conducted in March 2014 by Advisor Impact, polled 1,229 investors. The respondents were almost evenly split among female and male. Most had an investment net worth of over $500,000 and almost half had an annual household income of over $100,000.

    Investors were asked, “When your advisor makes an investment recommendation for your portfolio, which, if any, of the following are important for you to know?”

    For 70% of the respondents, the most important information was the risk associated with the investment. At face value, this seems to be quite logical. What investor is unconcerned with risk? Behavioral economists tell us that most of us are far more averse to a loss than an equal chance of a gain.

    The issue is in understanding the definition of “risk.” To simply ask an advisor, “What risk is associated with this investment?” is like asking the butcher at Safeway to tell you about the risk associated with eating meat.

    The butcher, thinking about the chance of choking on a bite and dying, might say there is almost no risk. Yet this answer wouldn’t necessarily apply if the customer were thinking about the risks associated with saturated fat, mad cow disease, hormones, contamination, or allergic reactions.

    To answer the question fully, the butcher would need to ask a lot of questions and address the many potential risks associated with eating meat. The chances of that happening at a busy meat counter are highly unlikely. The consumer will probably be left with a skewed understanding, perhaps overly positive or negative, of the associated “risks”.

    The same is true with investments. A few of the risks associated with most securities include economic, political, default, legal, interest rates, business cycle, managerial, and diversification. Rarely does an investor understand the nuances of all the various components of risk. Many advisors don’t fully understand them or explain them, either.

    The second most important factor, which 58% of investors wanted to know, was what return they could expect from the investment going forward. Again, the answer to this question won’t be very helpful; there is no way the advisor can know this, unless the investment’s return is guaranteed (like a certificate of deposit or a fixed annuity). Even then, no return is completely guaranteed, even those that are guaranteed. There is always a risk factor that can terminate any guarantee, the biggest being the bankruptcy of the guarantor or political interference.

    The third most important thing investors wanted to know was the amount of the fees associated with the investment. I was surprised, though, that even though this question ranked third, less than half—47%—of the respondents thought it was important. Fees paid to advisors and middlemen are an essential consideration. They are one of the few things investors can actually control, and the fees you pay can single-handedly turn a great investment into a poor one.

    Even if you’re among the minority who inquire about fees, there is no guarantee you will get a straight answer. I’ve had many life insurance and annuity salespeople swear to me there are “no costs whatsoever” charged by their companies to the customer.

    To become an informed investor, then, your first step may be to learn what questions to ask. It’s also important to keep asking those questions until you get clear and satisfactory answers.

    Rick Kahler MS CFP
    http://www.KahlerFinancial.com
    http://www.amazon.com/Comprehensive-Financial-Planning-Strategies-Advisors/dp/1482240289/ref=sr_1_1?ie=UTF8&qid=1415028345&sr=8-1&keywords=david+marcinko

    Like

  3. Managing Sequence Of Return Risk With Bucket Strategies Vs A Total Return Rebalancing Approach

    If there’s one fundamental takeaway that’s been drawn from the research on safe withdrawal rates, it’s the fact that market volatility really matters during the retiree withdrawal years. Even when long-term returns average out in the end, if the sequence of volatile returns is unfavorable, there is a danger that ongoing distributions during the “bad” years early on could deplete the portfolio before the “good” years ever show up.

    http://www.kitces.com/blog/managing-sequence-of-return-risk-with-bucket-strategies-vs-a-total-return-rebalancing-approach/

    An essay by Michael E. Kitces MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL

    Ann Miller RN MHA

    Like

  4. Value at Risk (VAR)

    VAR is another risk measure that has been gaining in popularity for several reasons.

    First, FAs and doctors should intuitively evaluate risk in monetary terms rather than standard deviation.

    Second, in marketable portfolios, deviations of a given amount below the mean are less common than deviations above the mean for that same amount. Unfortunately, measures such as standard deviation assume symmetrical risk. VAR measures the risk of loss at some probability level over a given period of time.

    For example, a physician-investor or FA may desire to know the portfolio’s risk over a one-day time period. The VAR can be reported as being within a desired quantile of a single day’s loss. In other words, assume a portfolio possesses a one-day 90% VAR of $5 million. This means that in any one of 10 days the portfolio’s value could be expected to decline by more than $5 million. Note that VAR is only useful for the liquid portions of an endowment’s portfolio and cannot be used to assess risks in classes such as private equity or real assets.

    Thus, it would seem self-evident that a risk that is not fully understood cannot be consciously managed or mitigated.

    Dr. David Edward Marcinko MBA CMP™
    http://www.CertifiedMedicalPlanner.org
    http://www.amazon.com/Financial-Planning-Handbook-Physicians-Advisors/dp/0763745790/ref=sr_1_1?ie=UTF8&s=books&qid=1275315635&sr=1-1

    Like

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