Posted by

The Portfolio Effect And The Free Lunch

Risk Track

Downloadable Files:




The portfolio effect is the reduction of risk achieved by funding multiple projects that are not perfectly correlated with one another. It is relied upon in setting confidence level policy for programs that consist of multiple projects. The idea of a portfolio effect has its roots in modern finance as pioneered by Nobel Memorial Prize winner Harry Markowitz. However, in two prior ISPA-SCEA conference presentations, “The Portfolio Reconsidered” in 2007 and “The Fractal Geometry of Cost Risk” in 2008, the author has demonstrated that the portfolio effect is more myth than fact. Additional cost growth data have been collected for an updated study. The number of data points for cost growth considered has increased from 40 in the previous study to 112. Data for schedule growth is also presented, and the distribution of schedule growth is discussed. Tail behavior for cost growth is discussed and the cost growth data are shown to closely follow a lognormal distribution with a high coefficient of variation. The portfolio effect for cost is still found to be minimal, at best. The concept of cost overrun insurance is introduced as one method for effectively implementing a true portfolio effect. The theoretical cost of this insurance, based on the equivalence principle, is found to be significant. Thus in order to achieve a portfolio effect, one must pay for it, in accordance with the famous principle that “there ain’t no such thing as a free lunch!”


Christian Smart
Dr. Christian Smart is currently employed as a senior parametric cost analyst and program manager with Science Applications International Corporation. An experienced estimator and analyst, he is responsible for risk analysis and cost integration for NASA’s Ares launch vehicles. Dr. Smart is in charge of overseeing the development of the NASA/Air Force Cost Model and has developed numerous cost models and techniques that are used by Goddard Space Flight Center, Marshall Space Flight Center, and NASA HQ. Dr. Smart is a past president of the Greater Alabama Chapter of SCEA, and has served as a reviewer for The Journal of Cost Analysis and Parametrics. He has given numerous presentations on cost modeling and risk analysis both in the U.S. and abroad. Dr. Smart was cited as 2006 Professional of the Year for the Greater Alabama Chapter of SCEA and was awarded best of conference paper at the 2008 Annual Joint ISPA-SCEA conference in Noordwijk for “The Fractal Geometry of Cost Risk”. He is a SCEA certified cost estimator/analyst (CCEA), a member of the Society for Cost Estimating and Analysis (SCEA) and the International Society of Parametric Analysts (ISPA). Dr. Smart earned bachelors degrees in Economics and Mathematics from Jacksonville State University, and a Ph.D. in Applied Mathematics from the University of Alabama in Huntsville.