Harry Markowitz’s perfect portfolio

Posted By Darren Winters on Jul 27, 2018


Harry Markowitz’s perfect portfolio

Harry Markowitz’s perfect portfolio theory (also known as modern portfolio theory) is one of the most important economic theories dealing with finance and investment. Harry Markowitz’s perfect portfolio theory was published under the title “Portfolio Selection” in the Journal of Finance in 1952. Whatmore, six decades later Harry Markowitz’s perfect portfolio theory is still in vogue today among the investment community.

So what is the basic idea behind Harry Markowitz’s perfect portfolio?

Harry Markowitz's perfect portfolioHarry Markowitz’s perfect portfolio is about crafting a portfolio to maximize returns by taking on a quantifiable amount of risk. Essentially, investors can reduce risk through diversification using a quantitative method.

Harry Markowitz believes that it is not enough to look at the expected risk and return of one particular stock. Investors should instead have a diversified portfolio and thereby reap the benefits and reducing the risks of owning more than one stock. Harry Markowitz’s perfect portfolio theory quantifies the benefits of diversification, or not putting all of your eggs in one basket.

In a recently published interview, Harry Markowitz was asked whether he thought there existed a perfect portfolio for individuals and institutional investors?

Harry Markowitz’s perfect portfolio theory rejects the view that a market portfolio is perfect.

“I don’t believe that the market portfolio plus or minus leverage is even efficient, so it is certainly not perfect,” said Harry Markowitz.

“What I provided in Markowitz (1959) was a computer program that found mean variant efficient portfolios subject to any linear equality or inequality constraints. They are linear constraints.

The correct portfolio for the individual depends on, the risk preferences their willing to trade off risk from a return,” said Harry Markowitz.

Harry Markowitz’s perfect portfolio theory stresses the importance of investor’s time-frame

“You don’t want them dropping out of the program prematurely so if it looks like the right thing for the long run, ….. maybe it is 50% in the emerging market which s very volatile and if it has a bad bounce investor will leave the program thinking that is a stupid asset manager.”

What then is Harry Markowitz’s perfect portfolio?

“So there is no perfect portfolio there is a right portfolio for them and part of the process is to involve the user, what is their trade-off between risk and return.”

Harry Markowitz’s perfect portfolio theory rejects the view that the market portfolio is not efficient for everyone. However, Harry Markowitz also acknowledges that the market portfolio could work in an unreal situation.

“If you could borrow all you want at the risk-free rate then the only mean variant efficient portfolio would be the market plus or minus leverage,”

So reading between the lines a decade of the central bank’s quantitative easing has provided a few with the means to create Harry Markowitz’s perfect portfolio.

But Harry Markowitz’s perfect portfolio theory could be inputted into a robot asset manager

“Where do you think the industry is going?” asked the interviewer.

“The way I see the industry going in the next 60 years is for human, machine division of labor to cover more fully various aspects of financial planning. Decision support systems that help investors plan.”

For the full interview click here.

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