Why I Do NOT like Modern Portfolio Theory

I don't believe that modern portfolio theory should be used all the time and that some circumstances require different views.

As you know I love investing…

It’s what I do for a living!

But I simply think that there are better ways to invest than others,

And I don’t like Modern Portfolio Theory.

Now don’t get me wrong, there are pieces of it that I do like and I’m thankful that we have it.

Since the 50s and 60s it has built the foundation of our financial models!

But ultimately I think it puts people in boxes and I believe there are some things you need to leave out when starting a fund.

The Gist of It.

Modern Portfolio Theory was originally presented in a paper by Harry Markowitz.

He actually won the Nobel Prize for it,

Which is no small accomplishment by any means…

It essentially states that your portfolio should contain assets and that those assets will hedge another.

Meaning that it will only go up over time,

Theoretically.

There is also something that he calls the Efficient Frontier that determines what the optimal risk/reward is for your portfolio.

Now I get all of this…

And those are the parts that I like.

The part that I don’t like is that they base the risk on VOLATILLITY.

In a book called The Black Swan by Nassim Taleb, he said,

“The market changes much more than MPT says that it will.”

What he means is that market volatillity isn’t that predictable and could be much worse…

People get stuck in their model and it becomes frozen in time,

They don’t update it to current market conditions.

I believe that modern portfolio theory is good for personal, longterm investments,

But for Fund Managers who are trying to manage risks everyday, this isn’t so easy.

You need to go above and beyond that!

Investors are coming to you to get higher than expected returns… not regular ones.

That’s why I’m not the biggest fan of MPT for funds.

When starting a fund you cannot settle on being average. You will have a hard time pitching investors and even if you do get commitments you will probably have a hard time keeping them. Swing for the fences!

When starting a fund you cannot settle on being average. You will have a hard time pitching investors and even if you do get commitments you will probably have a hard time keeping them. Swing for the fences!

Modern Portfolio theory will give you good returns, but we are looking for better and best!

I have a friend who helped me see it this way…

People who say, ‘higher risk, higher reward, lower risk, lower reward” don’t want you investing in markets.

He also mentioned that you have couple different things in your fund that is different to MPT:

  1. Alpha – This is your unique value proposition to the world. This is what sets you apart from others.
  2. Beta – This is your risk profile. You have risk, return, and control. MPT looks at return and risk, but not what you can control.

When we can go out and specialize and find asymmetric risks, that’s when you know you can start a great fund that will outperform Modern Portfolio Theory.

Conclusion

Just to make it clear,

I’m not saying you should never use MPT.

I believe it has its place in investing.

I just know form personal experience in my own funds that in order to get better and best returns you need to stray a little from this 70 year old formula.

What are your thoughts on Modern Portfolio theory?

Let me know below or check out my YouTube channel.

Take Care,

Bridger Pennington

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DISCLAIMER: This content is for educational and informational purposes only. It is not to be taken as tax, financial, or legal advice. You should always consult a legal professional before taking action. Furthermore, this is not a recommendation to buy or sell any security. The content is solely just the opinion of the authors.


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