The Fordham Schools of Business celebrated the 60th anniversary of Modern Portfolio Theory with a conference and keynote speech delivered via videoconference by Nobel laureate Harry Markowitz, Ph.D.
Markowitz, an adjunct professor at the University of California at San Diego, developed the theory in a 1952 paper written at the University of Chicago, where renowned economist Milton Friedman was one of his advisors. In 1990, Markowitz won the Nobel Prize in economics for the theory.
Many in the audience had written extensively on the subject, including Graduate School of Business Administration (GBA) Associate Professor Yusif E. Simaan, Ph.D., who wrote his dissertation expanding on the theory with Markowitz as an advisor.
Simaan said that though Markowitz’s portfolio theory was developed in the early 1950s, it was pretty much ignored throughout that decade.
“He proposed a way to manage and assess risk that was quite new, before that risk was not managed in any quantitative way,” said Simaan. “He came to results that were sensible, but nobody believed that they could be consistent with economic theory.”
That perception began to change after Markowitz published his 1959 book, Portfolio Selection: Efficient Diversification of Investments (Blackwell, 1959).
Sris Chatterjee, Ph.D., professor and associate dean of GBA, said Markowitz’s theory showed that it was important to look at how the stocks interact. Whereas two stocks can be risky on their own, they might not go up or down in the same direction at the same time.
“Think about two seasonal products: One that you buy in summer and one that you buy in winter–they both can be risky–but if you hold them together in your portfolio, the risk is mitigated,” Chatterjee said.
Chatterjee added that as Markowitz moved that basic idea of diversification forward, he showed how investors could minimize overall risk by selecting stocks in a way that counteract each others’ movements.
“Of course much of this was turned on its head during the [2008] crisis,” said Chatterjee. “People who held diversified portfolios certainly found that everything was going down together, but it was not so much that the theory was called into question as its application was.”
Markowitz used natural selection as a metaphor to explain his theory.
“Suppose a young male rabbit woke up one day and didn’t aspire to a carrot and stayed in his little hole the rest of his short life. Well, his genes would fall out of the pool very rapidly,” Markowitz said. “Now suppose he did aspire to a carrot, but he ran out of his hole willy-nilly, not mindful of hawks, owls, and foxes. Again, his genes would not pass into the pool.”
Markowitz said one could take any gene pool and think of it as a portfolio and think of natural selection as the manager.
“The gene pool seeks growth, but it has to be mindful of downside risk,” he said. “If it becomes too undiversified, the pool disappears. So, in my mind, the first application of mean variance analysis was four billion years ago with the gene pools.”
