I went to a talk a few weeks ago given by Harry Markowitz. Markowitz is the Nobel Prize winning economist who originated what is called Modern Portfolio Theory (MPT) during the 1950s. In simple terms, MPT says that the mix of types of assets you own determine the risk/return ratio for your whole portfolio. According to the theory, it’s the type of assets that you own that count, not which specific ones. Whether you own Apple and IBM or instead Intel and Cisco doesn’t matter as much as that they are all high tech companies.
MPT is highly favored by many people in the financial community. Financial planners, academics, some investment advisors and many financial journalists really like the idea of picking investment types and sectors rather than individual securities. But here is where we come to the curious thing. During his talk Dr. Markowitz explained that he was working with an investment advisor to do some arbitrage with closed end funds. He essentially is trying to exploit some mispricing of closed end funds to make an above average profit. I was stunned. His whole idea is to metaphorically pick the baskets of fruit, yet here he is selecting individual apples for his own portfolio.
I think there is an important lesson here. I don’t believe Markowitz has completely abandoned his theory. But I do think he realizes that a theory of something as complex as investing does not cover all situations. There are some special opportunities available, theory or no. It reminds us not to slavishly follow a particular methodology for our investing. We need to keep our eyes open and be flexible about potential opportunities and pitfalls that will happen along the way.