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Dr. Harry Markowitz: 2008 Was Not So Different

November 2013

Dr. Harry Markowitz

Nobel Prize-Winning Economist


Graeme Porrett

Senior Product Manager, Global Risk Solutions, Asset Servicing

"Booms and busts keep happening," Dr. Harry Markowitz says. "Everyone says, 'This time was different.' And indeed, every time is different, in terms of the fundamental causes. But as you go back over history, you will see a historical probability distribution of returns, negative and positive, on large caps, small caps, and so on. And 2008 didn't change the distribution."

Markowitz is responding to a question from Graeme Porrett, Senior Product Manager for Global Risk Solutions at BNY Mellon, regarding whether the 2008 financial crisis altered the risk perceptions and practices of institutional investors. Markowitz, who won the Nobel Prize in Economics in 1990, is collaborating with BNY Mellon on a survey of investors' post-crisis views of risk.

Modern Portfolio Theory And Alternative Investments

Dr. Markowitz is certain 2008 was not an outlier event. "...It's a one-in-40 event. It wasn't the worst year of return."

Markowitz created a buzz in 1952 with the appearance of his article "Portfolio Selection" in The Journal of Finance. It put a process around the portfolio building task for investment managers. Graeme asks if the theory, now called Modern Portfolio Theory (MPT), still helps investors understand risk in alternative asset classes.

Markowitz acknowledges there are historical challenges with instruments or strategies too opaque for anyone to easily understand. He therefore advises investors to "make forward-looking estimates, but attach a very large variance to it. And discount any expected return estimates the sell side gives you."

How Investors Should Approach Risk Management

Graeme asks Markowitz if he's seen a prevalence among investors towards risk budgeting. Markowitz isn't sure, but suggests the current survey will reveal more. Meanwhile, he advises investors to establish forward-looking estimates and constraints to get a risk frontier, and avoid any process that leads to inefficient portfolios. "If you say, 'I'm going to risk budget,' and that leads to inefficient portfolios, that's like burning money," Markowitz says. If you're coming to the wrong place on the frontier, because you're not looking at the consequences of that particular choice "that's bad."

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