Login Here
Efficiently Harnessing Market Returns for Investors.

Asset Allocation from Nobel Laureate Harry Markowitz

Without Harry Markowitz, much of what we know about Modern Portfolio Theory (MPT) would not be as it is today. Born in 1927 in Chicago, Markowitz developed an interest in physics and philosophy, in particular, the ideas of David Hume. He followed this interest during his undergraduate years at the University of Chicago, ultimately deciding to specialize in economics.

Markowitz built upon the work of:

He formulated the idea that:

These thoughts led Markowitz to publish Portfolio Selection (also known as Mean Variance Optimization, MVO, or Mean Variance Analysis MVA) in the March 1952 issue of the Journal of Finance. In portfolio theory this work is considered to be seminal by which many other great works wouldn’t have been developed without.

In a simple sense, Markowitz built better portfolios than Present Value portfolios by incorporating multiple assets in a beneficial way based on:

By taking these three variables and plugging them into:

Markowitz Equation

... an Efficient Frontier was created:

Efficient Frontier

Maximizing the portfolio’s risk adjusted return consistent with the investor’s objectives. This built superior portfolios.

Wait, what did we just say, in English please:

  1. Take a bunch of different assets.
  2. Try to predict how risky each asset is.
  3. Try to predict each asset's return.
  4. Try to predict how the assets will behave versus other assets.

Conclusion (in English):

Try to get the best returning least risky portfolio. That's it.

But what are the problems?

Is this model helpful? Although problematic, it sure is. Why? Because, although with certain types of assets other models might work better, this model can help investors better understand portfolio construction and it can be directly applicable for the combination of certain assets, particularly equity assets.

How much of the investment world uses this model? It’s difficult to say, but it might be reasonable that almost all professional investors directly use this model in some form, and most others use a descendant or variant of this model.

In other summary pages, like Sharpe, Black-Litterman, APT, Tobin, and Fama French, we will bring back variations and extensions of this work to help bring the ideas of MPT (Modern Portfolio Theory) together.

Interested in learning more, let's move to William Sharpe and the CAPM (Capital Asset Pricing Model).

Learn More