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http://briefcase.yahoo.com/bc/tmryan11/vwp?.dir=/&.dnm=mptfail.gif&.src=bc&.view=l&.done=http%3a//briefcase.yahoo.com/bc/tmryan11/lst%3f%26.dir=/%26.src=bc%26.view=l

the above plot is an output from a well known (and highly regarded) analysis program marketed by a very successful company that portfolio managers use to evaluate the "risk" of their portfolios, risk here being a measure of volatility relative to the volatility of the S&P500. i am not criticizing the software - or the business that markets it - it's a terrific piece of portfolio management software. in this chart, a value of "risk" equal to 100 corresponds to the same expected volatilty of the S&P500. a value less than 100 means that the portfolio is less "risky" than the S&P500 and a value higher than 100 corresponds to a portfolio with higher risk than the S&P500. standard MPT stuff.

so, how in the world could a partly hedged portfolio with 18% cash and a projected risk 31% lower than that of the S&P500 spike in three days (no portfolio changes in those three days) to 6% higher than the S&P500? obviously the correlation coefficients of the portfolio's individual assets changed dramatically in those three days.

i post this, as a lesson to all who enter - MPT risk management is a rear view mirror approach that is highly sensitive to the correlations of the assets.

despite what those highly respected individuals tought you in college with Brealy and Myers.....be wary of your idols!

tr

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