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Despite the hype by some commentators that today’s market constitutes a ‘Black Swan’, the fall in equities markets experienced in the past year is well within normal expectations, according to Harry Markowitz. Asked by Investment & Technology recently to discuss the latest market disruption, the father of modern portfolio theory was quick to make a distinction between his work and the financial engineering for which he blames the crisis. “Portfolio theory is top down asset allocation with money allocated to professional funds managers; while financial engineering is structured products, which has led to a lot of highly leveraged products,” he said.
“The S&P500 went down 28 per cent in 2008, which is between a 2 and 2.5 standard deviation event and completely within the normal distribution, it is not a Black Swan, which is about eight standard deviations.” The current government intervention in markets and companies is a sore point, and he calls the bailout by the US government “silly”, believing instead that markets should be left to their own devices. According to Markowitz this financial crisis is the result of two major forces.
“Back in 1999 Congress passed laws and put pressure on Fannie Mae to accommodate low-cost housing, they basically mandated the sub prime mortgages. This combined with financial engineering – CMOs, CDOs etc – contributed to the financial crisis. Modern Portfolio Theory completely holds up,” he said, warning institutions to stick by their long-term asset allocation. Markowitz supports the asset allocation of the larger endowments, and more pertinently their refusal to tinker with them to pander to short-run criticism. Indeed he even named David Swensen, chief investment officer of Yale endowment, as his idol.
Markowitz met Swensen for the first time in March, and his fandom was no doubt a comfort for the endowment pioneer, given the recent flak directed at his style of investing, which for instance has no exposure to US Treasury bonds. Markowitz admits the endowmentstyle investment model is not for everyone. “Swensen says you have to have 25 to 30 professionals looking into private placements, if you don’t have the time and skill to do that then stay away from it,” he said. Being a mathematician, Markowitz is an advocate of ETFs. However, he added :“I ran an arbitrage fund for about three years in the 1970s before everyone was doing it, and there are times that certain arbitrages work,” he said.
