Paradoxes of Portfolio Performance Calculation for Wealth Management: Avoiding Reporting Pitfalls

Abstract

Clients of wealth management banks are usually informed about their portfolio through regular reporting. To maintain client trust, it is important that this reporting be both comprehensive and comprehensible. This reporting is grounded on complex mathematics in order to calculate myriads of profit and loss, performance and risk indicators. As the amount of information provided to clients increases so does the chance that certain elements will be confusing to them, at the risk of undermining their confidence in their wealth management bank. This risk is compounded by the general increase in portfolios of complex financial products involving different time horizons. The reporting is typically a decision aid tool for the client to monitor and control and make investment decisions. One example of such risk is that the calculated risk and performance indicators are delivered to the client with no explanation and can, in some cases, lead to incorrect perception due to misunderstanding of these numbers, even if calculations are correct. A typical example could be that the client is informed that the performance of the portfolio is 7% and in reality, the portfolio is losing money. In this paper, we want to address this kind of problem. As such we have identified a set of typical pitfalls that we are faced within the profession. Then, based on a rigorous reference to the scientific literature we have popularized these pitfalls and employed a series of simple and didactic illustrations to provide an appropriate toolbox in order to reduce the risk of financial reporting misunderstanding. In order to maintain client confidence, we highlight the importance of identifying areas of potential misunderstanding prior to providing reports to clients and of offering clear explanations for unusual numbers. We address the following themes: Profit and Loss Analysis, Performance Calculation, Performance Contribution, Realized and Unrealized Profits and Losses, and Bond Yields.