Harry Markowitz – Nobel laureate who changed investing

Harry Markowitz

Renowned economist Harry Markowitz passed away in the USA on 22 June at the age of 95. Nobel laureate, whose ideas, published more than 70 years ago, became revolutionary for the financial market and cornerstone ideas for mutual funds and risk management strategies in investment.

In essence, he applied the adage “don’t put all your eggs in one basket” to the world of equities and developed a new approach to selecting securities for a portfolio.

The beginning of his journey, influences and thesis

Harry Markowitz was born in Chicago in 1927. His parents owned a grocery shop and managed to survive the economic downturn relatively unscathed after the US stock market crash of 1929. In his Nobel biography, Markowitz wrote that he did not know the Great Depression, and as a child lived quite well. At school he began reading the works of Charles Darwin and classical philosophers such as René Descartes and David Hume. It was Hume and his deconstruction of predictive outcomes that influenced the development of the future Nobel laureate’s ideas.

“Although we release the ball a thousand times, and each time it falls to the floor,” Markowitz wrote in his biography, citing Hume’s ideas, “we do not have the necessary evidence that it will also fall the thousandth first time. Markowitz applied this approach to economics. According to him, there is no certainty other than the fact that investment and the economy will rise and fall.

Markowitz graduated from the University of Chicago in 1947 with a bachelor’s degree in philosophy and chose economics to pursue graduate studies, receiving his degree in 1950.

There he studied under, among others, Milton Friedman, who went on to win the 1976 Nobel Prize. Markowitz received his doctorate from the University of Chicago in 1954, two years after publishing his dissertation.

There was a hitch in Markowitz’s defence of his thesis. The topic was so new that it did not relate to economics at that time. According to Friedman, Markowitz’s work was a mathematical exercise, not an economic one. However, he was still given his doctorate. In his 1990 Nobel speech, Markowitz admitted that his portfolio theory was not yet part of economics at the time of his thesis, but things have changed in the intervening years.

Portfolio theory and the Nobel Prize

Markowitz’s ideas in his thesis “Portfolio Selection” were published in 1952 in the Journal of Finance. They became the basis for modern portfolio theory. At that time, investors considered each security separately and focused on dividend yield and growth prospects of a particular stock, without correlating assets with each other.

The revolutionary nature of Markowitz’s ideas was that financial choices involve a systematic search for a trade-off between risk and return, and that risks should be evaluated in the context of the entire portfolio rather than individual securities. These ideas were radical at the time, but are now fundamental to portfolio construction.

Markowitz saw investing essentially as a numbers game that could be used to one’s advantage. He believed that risk could be calculated using data and, having realised how much a company’s performance might deviate from expected numbers, mitigate it by balancing it with other investments in the portfolio. In 1990, Markowitz won the Nobel Prize for his theory. By then, most financial managers in the US were already following his investment principles.

“Man of the Century.” Markowitz’s other works

In 1999, Pensions & Investments named Markowitz “the man of the century”.

In addition to creating portfolio theory, Markowitz became famous in two other areas. He developed “sparse matrix” methods for solving very large mathematical optimisation problems. These are now standard in manufacturing software for optimisation programs. The economist also designed and directed the development of the Simscript language, which is used to program computer simulations of systems such as factories, transport and communication networks.

In 1989, Markowitz received the John von Neumann Prize in Theory from the American Society for Operations Research for his work with portfolio theory, sparse matrix methods, and Simscript.

His focus has always been on the application of mathematics and computers to practical problems, especially those related to business under uncertainty.

“I am not a one-time Nobel laureate doing only one thing,” he said in an interview in 2014.

It’s worth noting that Markowitz himself was never a public stock picking guru. He avoided giving advice on where to invest. In 2005, the economist told the Los Angeles Times that his own investments were fairly simple. He divided his money between a mutual fund and “low-interest” assets. “In retrospect, at a younger age I should have had more stocks,” Markowitz claimed.

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