Professors of Finance Andrew Lo (MIT) and Stephen Foerster (University of Western Ontario) recently published In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest. It provides historical perspective on the development of modern investment theory and practice. If this is an area of interest for you, I strongly recommend it!
The book’s structure is simple. The authors explore the lives and contributions of ten prominent pioneers of modern investment theory and practice – both academics and practitioners. They then ask each pioneer to opine on “The Perfect Portfolio.” A concluding chapter develops guidance for sixteen “ideal type” investors.
I’m going to attempt to extract insights in a slightly different way, by summarizing the “perfect portfolios,” looking for agreement among the pioneers.
The pioneers are a Who’s Who of academic finance research and investment innovation:
Harry Markowitz
- Contributions: Originator of diversification theory, mean-variance optimization, efficient frontier, modern portfolio theory
- Honors: John von Neumann Theory Prize 1989, Nobel laureate 1990
- Commercial Activities: Loring Ward (IM), Research Affiliates (IM),
- Index Fund Advisors (IM)
William Sharpe
- Developer of the Capital Asset Pricing Model, Index fund as efficient portfolio
- Nobel laureate 1990
- Founder of Financial Engines (IA)
Eugene Fama
- Developer of the Efficient Market Hypothesis, identifier of return factors (value, company size, etc)
- Nobel laureate 2000
- Board member of Dimensional Fund Advisors (IM)
John Bogle
- Creator of the first retail index fund
- Founder of Vanguard group (IM)
Myron Scholes
- Cocreator of the Black-Scholes/Merton Option Pricing Model
- Nobel laureate 1997
- Salomon Brothers (IB), Long-Term Capital Management (HF), Janus Henderson (IM)
Robert Merton
- Cocreator of the Black-Scholes/Merton Option Pricing Model, developer of continuous time finance
- Resident Scientist at Dimensional Fund Advisors (IM), Long-Term Capital Management (HF)
Martin Leibowitz
- Pioneering bond analyst and theorist, developer of asset-liability management
- Salomon Brothers (IB), TIAA-CREF (IM)
Robert Schiller
- Prominent efficient market hypothesis critic, developer of CAPE (cyclically adjusted price earnings ratio), codeveloper of Case-Schiller housing price indices
- Nobel laureate 2000
- Case Schiller Weiss (index provider)
Charles Ellis
- Author of Winning the Loser’s Game, early advocate of index funds
- Founder of Greenwich Associates (evaluator of investment research)
Jeremy Siegel
- The “Wizard of Wharton”, author of Stocks for the Long Run, suggests ‘mean reversion’ of stock returns
- Wisdom Tree Investments (IM)
I find it fascinating that the academic pioneers all had significant commercial careers, and the practitioner pioneers all made significant theoretical contributions. In investing, theory and practice interact directly and immediately.
Investing is inherently practical – investors seek a return on their investment, and their returns are easy to measure. Investors are eager to hear ideas that may increase returns or reduce risk. They frequently urge the contributors of the ideas to help implement those ideas.
Investing is also inherently quantifiable. Practitioners with ideas to contribute must write them down mathematically. Publishing these ideas is the natural next step. In addition, the successful theoretical contributions of the pioneers have led many investors to believe that secure theoretical underpinnings for investment strategy are essential to consistent success.
Next time, we’ll discuss the perfect portfolio attributes the pioneers identified.
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This article originally appeared in Forbes.com.
Photo by Michael Dziedzic on Unsplash