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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

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.


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