Harry Markowitz, Modern Portfolio Theory Pioneer, Dies at 95

Observant1

Harry Markowitz, the Nobel-winning economist renowned for developing Modern Portfolio Theory,
died on Thursday in San Diego. Mr. Markowitz was 95. May he rest in peace.

"Until Dr. Markowitz came along, the investment world assumed that the best stock-market strategy was simply to choose the shares of a group of companies that were thought to have the best prospects."

"But in 1952, he published his dissertation, 'Portfolio Selection,' which overturned this common sense approach with what became known as modern portfolio theory, widely referred to as M.P.T."

"The heart of his research was grounded in the basic relationship between risk and reward. He showed that the risk in any portfolio is less dependent on the riskiness of its component stocks and other assets than how they relate to one another. It was the first time that the benefits of diversification had been codified and quantified, using advanced mathematics to calculate correlations and variations from the mean."
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An interesting side note pertaining to behavioral economics.
Jason Zweig interviewed Prof. Markowitz in 1997 regarding his portfolio asset allocation in the mid-1950s.

Mr. Markowitz responded:
"I should have computed the historical co-variances of the asset classes and drawn an efficient frontier.
Instead, I visualized my grief if the stock market went way up and I wasn’t in it – or if it went way down
and I was completely in it. My intention was to minimize my future regret.
So I split my contributions 50/50 between bonds and equities."
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hank

”It was the first time that the benefits of diversification had been codified and quantified, using advanced mathematics to calculate correlations and variations from the mean.”

Amen

David_Snowball

Harry was in interesting soul. His work lays, as you point out, the foundation for much of the modern finance industry. And yet he, himself, was not a finance guy and not particularly interested in the subject. He started out writing algorithms and running simulations. Financial markets were merely a rich source of interesting data with which to test the models.

Early on he ran a quant merger arbitrage hedge fund, the first of its kind. But he wasn't wedded to it and I get the sense he didn't stick around all that terribly long.

A surprisingly large number of fund managers have their credentials in mathematics, computer science, physics or engineering. I wonder if for them, as for Harry, all this money stuff is just an interesting puzzle to work out?

yogibearbull

Wiki: "Markowitz.....optimization.....optimal mean-variance portfolios..... In 1954, he received a PhD in Economics from the University of Chicago with a thesis on the portfolio theory. The topic was so novel that, while Markowitz was defending his dissertation, Milton Friedman argued his contribution was not economics"

And Milton Friedman was his PhD co-advisor!

https://en.wikipedia.org/wiki/Harry_Markowitz

BenWP

Friedman therein gave his advisee a concrete introduction into the nastiness of faculty politics.

David_Snowball

The purported comment was "it's interesting ... but it's not economics."

FD1000

"The heart of his research was grounded in the basic relationship between risk and reward....."

It's interesting...but how does it help my portfolio risk-adjusted portfolio by telling me what to do at what time? We saw in 2022 that both stocks and bonds lost. A better option was to sell to MM or short if you are brave.

David_Snowball

Harry started his critique of traditional finance practice by thinking about the behavior of bettors in a casino. "I'll put it all on red 27" is a recipe for misery, so bettors spread their bets, trying to tilt the odds in their favor. Sometimes that pays off, sometimes it doesn't. You pays your money and you takes your chances.

He seems to see markets similarly.

hank

It’s well known that Bill Gross cut-his-teeth as a professional blackjack dealer before becoming an investor. Perhaps lesser known is that the legendary Louis Rukeyser of PBS’s Wall Street Week fame was also a devoted casino gambler.

”One cost of celebrity for Mr. Rukeyser was the jibes he would have to bear while indulging his fondness for casino gambling. No sooner had he settled into a blackjack game, he once recalled, than someone would ask him if the odds at the table were really better than those on Wall Street.”

Interesting 2006 NYT article putting Rukeyser and the show into perspective:
https://www.nytimes.com/2006/05/03/business/media/03rukeyser.html?smid=nytcore-ios-share&referringSource=articleShare

BenWP

According to the Times obituary published Monday, Friedman’s comment was part of a practical joke played on the doctoral candidate.

Observant1

I stumbled across an informative article today discussing Markowitz's contributions to investment theory.

"Markowitz agreed with Williams’s approach to valuing individual investments. It was far better than the old prudent man approach. But Markowitz still saw it as incomplete. The shortcoming: While it’s important to evaluate individual investments, it’s equally important—if not more so—to consider how a collection of investments will work together in a portfolio. Markowitz was the first, in other words, to show investors how to effectively diversify a portfolio."

"In his 1959 book, Portfolio Selection, adapted from his thesis, Markowitz provided this example: 'A portfolio with sixty different railway securities, for example, would not be as well diversified as the same size portfolio with some railroad, some public utility, mining, various sorts of manufacturing, etc. The reason is that it is generally more likely for firms within the same industry to do poorly at the same time than for firms in dissimilar industries.'”

"As noted above, today this might seem obvious. But before Markowitz, it had never occurred to anyone. And it wasn’t just a casual observation. Portfolio Selection runs more than 300 pages and is dense with formulas. In it, Markowitz provided a framework for building optimal portfolios—those that offered either the maximum possible return for a given level of risk, or the least possible risk for a given level of return. Markowitz called these portfolios 'efficient,' and presented them visually in a diagram he called the efficient frontier."

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