How Lucky Am I?
July 16, 2013
I have been afforded the rare opportunity to work with and spend time with the Nobel Prize-winning economics pioneer, Dr. Harry Markowitz, also known as the “father of Modern Portfolio Theory”. Dr. Markowitz is most widely known for having developed Mean-Variance Optimization, the method for building diversified portfolios that maximizes return for a given level of risk. Even at the age of 85, Dr. Markowitz continues to conduct significant research in the field and regularly produces academic journal articles. Dr. Markowitz’s work is at the core of Miller/Russell’s investment process and implementation.
Dr. Markowitz serves on the board of one of Miller/Russell’s institutional clients, where my colleagues and I have had the great privilege of interacting with him regularly. While at times an intimidating experience, Dr. Markowitz is a very humble and generous man, always willing to share his time and wisdom with us. Fortunately for our firm and our clients, we have dynamic conversations with Dr. Markowitz regarding not only his research but the investment environment today. We consider it a unique privilege, and we are grateful to him for his generosity.
Another example of his generosity occurred on Wednesday May 8th, when Dr. Markowitz agreed to conduct a live webinar with me on behalf of the CFA Societies of Arizona. The topic of our discussion was “The Great Confusion: Reflections on Mean-Variance Optimization”.
During the webinar, we discussed his research regarding alternative methods to calculate risk, which some have suggested is necessary to improve Mean-Variance Optimization. His conclusion, which will be published in a forthcoming book, was that adjustments to account for changes in risk or distribution are not necessary, and that the original components of Mean-Variance Optimization are sufficient to build optimal portfolios that perform as expected during any market environment. He also reiterated that Mean-Variance Optimization did work in 2008, in that a diversified portfolio performed better than an all US equity portfolio would have. However, in times of market crises when assets move uniformly, the real assessment should be done on the investor’s risk tolerance relative to his or her asset allocation.
While Dr. Markowitz goes into great detail on a number of academic points, near the end of the webcast we discuss more of the art of portfolio management and its application in today’s world. This includes comments on behavioral finance, the implications of quantitative easing and regulatory changes on portfolio construction, the impact of high frequency trading, whether investors should have a “home bias”, and determining appropriate asset classes and constraints.