Building on Brilliance: Honoring Harry Markowitz and the Enduring Power of Portfolio Theory
In a quarter filled with talk of potential Treasury default and the second largest bank failure in U.S. history, markets chose to look forward. This was a quarter of AI captivating markets. The S&P entered bull market territory, catching up to international markets which had recovered earlier from the lows of last October. But for those of us who knew him, the events of the quarter were overshadowed by the loss of Harry Markowitz.
Harry Markowitz, Father of Portfolio Theory
The greatest loss of the quarter occurred on June 22, marking the passing of Harry Markowitz. Harry’s substantial contributions to finance established the modern concept of a portfolio. The concept was simple—portfolios must be diversified since no one should take more risk than they need to. But the answer to intelligently diversify a portfolio required math and technology for Mean-Variance Optimization (MVO) that had not been invented.
Without MVO, investing was done one stock at a time. Investors would typically only invest in a small number of stocks they determined to be most desirable on an individual basis and weight them by hand. This thinking is still pervasive – many investors focus on one stock, or even fund at a time and ignore correlation between assets as well as the tradeoff between risk and return.
Unfortunately, the problems of Modern Portfolio Theory (MPT) as implemented by many investors are unfairly attributed to his work. For example, MPT is often criticized for relying on historical data and being backward looking, but Harry understood that the reason to diversify is precisely because the future may not perform like the past.