Nobel Prize winner Harry Markowitz, who conceived Modern Portfolio Theory, is 91 years old, boasts a list of corporate clients as long as your arm and has no intention of keeping his controversial views to himself, as evidenced in an interview with ThinkAdvisor.
For starters, here’s what Professor Markowitz thinks of artificial intelligence, the darling of multiple industries: “Artificial intelligence — quote-unquote — is artificial idiocy,” he argues. “There’s no magic elixir that somehow the Sorcerer’s Apprentice is conjuring up mysterious intelligence. It’s a [computer] program!”
In 1990, Markowitz, then a professor at the City University of New York, received the Nobel Memorial Prize in Economic Sciences for developing MPT. The award was shared with professors Merton Miller and William Sharpe for their work in financial economics. The previous year, Markowitz won the Von Neumann Award from the Operations Research Society of America. Operations research applies mathematical and computer techniques to solving problems of business and government.
Throughout the years, the Chicago native has focused on using such techniques to find answers to practical problems, especially those relating to “business decisions under uncertainty,” as he writes.
In the interview, he discusses MPT, the vagaries of securities investing and why he shifted to virtually all equities when hurricanes hit the U.S. in 2017. He also talks about the virtues of robo-advisors and what human FAs should bear in mind when it comes to MPT’s risk-reward curve.
A research associate at The Rand Corp. in 1952, Markowitz wrote a paper he called “Portfolio Selection,” whose contents would become known as Modern Portfolio Theory. Quant analyst Barr Rosenberg, an early advocate, gave it the MPT name, Markowitz recalls.
His article, published in the Journal of Finance in March 1952, showed diversification — that is, the use of uncorrelated asset classes and other considerations — as a way to invest optimally while reducing risk. In 1959, he expanded the theory into a book, “Portfolio Selection: Efficient Diversification of Investments.”
MPT, anchored in buy-and-hold, would become synonymous with investing efficiency and was widely adopted by the financial services industry.
In 1984, a year after leaving the research staff of IBM, Markowitz founded Harry Markowitz Co., now based in San Diego. His current clients include Hudson Bay Capital, Invesco Group Services, Loring Ward Financial, Personal Capital and Research Affiliates. And he is on the advisory boards of the financial wellness system Acorns, Skyview Investment Advisors and Index Fund Advisors, among others.
Markowitz has held teaching posts at The City University of New York’s Baruch College; Rutgers University; the University of California, Los Angeles; and the Wharton School, among other colleges and universities. Most recently — 2007 until early this year — he was an adjunct professor at the Rady School of Management at UC San Diego.
In the private sector, he was a consultant to General Electric between two stints as research associate at the Rand Corp.
On top of making shrewd stock market investments, Markowitz has built wealth through real estate. Last year, he purchased an Alpine, California, house and the land it’s on, which he uses solely for entertaining. Cost: $1.60 million. He now estimates that package to be worth a total of $4 million to $5 million.
His main residence, bought for under $500,000, has likely now appreciated to $1 million, he says. And a small condo that he accesses mainly for midday napping (“I go to bed at 2 a.m.”) is worth about $360,000. He paid less than $300,000 for it.
Dr. Markowitz is looking ahead to celebrating his 92nd birthday this August. It’s not unreasonable to expect that that will happen at a big party in his Alpine mountain home, which features a $60,000 Steinway concert grand. He calls the picturesque digs his “cabin in the sky.”
ThinkAdvisor recently interviewed the industry pioneer, on the phone from his main San Diego residence. Sipping a Starbucks venti latte, he explained elements of MPT, quoted Shakespeare and noted that it was someone else who named his seminal work Modern Portfolio Theory.
Here are highlights of our conversation:
THINKADVISOR: How would you describe yourself?
HARRY MARKOWITZ: I’m an economist. I’m also an operations research guy. I’m also a computer guy. With my article, “Portfolio Selection,” I created the portfolio theory industry. [The late economist] Merton Miller said my article was the Big Bang [theory] of modern finance.
What are your thoughts about artificial intelligence?
Artificial intelligence — quote-unquote — is artificial idiocy. Suppose you knew somebody who could drive from Point A to Point B without hitting anyone but couldn’t butter a slice of bread. Suppose you knew someone else who could play chess at a champion level but couldn’t drive from Point A to Point B. He would be an idiot savant.
So what are you getting at?
There’s no magic elixir that somehow the Sorcerer’s Apprentice is conjuring up mysterious intelligence. It’s a program! It follows somebody’s rules. Programs are based on theories. And they may have a bug: A very large airplane carrying lots of people encounters a bug in the artificial intelligence being used to help fly the plane — [people] die.
Many fear that AI and robots will take over the world.
If you get malicious programs, you get malicious results.
Do robo-advisors and the principles on which they operate use MPT?
Sure. They’re a way to bring advice to the masses. Robo-advisors can give good advice or bad advice. If the advice is good, great. As an institution, robo-advisors are extremely useful, like hedge funds as an institution are extremely useful.
Please discuss diversification as the heart of Modern Portfolio Theory.
We’re trying to minimize risk for a given return, so we want to diversify. It’s clear that not putting all your eggs in one basket is [what to do]. Even in [the 16th century], Shakespeare knew about diversification: In “The Merchant of Venice,” when [Salarino] asks Antonio if his business is making him glum, he says: “Believe me, no. I thank my fortune for it. My ventures are not in one bottom trusted [not invested in one entity only].”
Why is diversification fundamental?
To get a high return for given risk, you have to diversify. There’s a trade-off between risk and return. Man has faced risk since the days of the saber-toothed tiger. If you don’t face risk, you can’t go out and gather food or shoot tigers and bears. Man was born in a risky world and remains in a risky world. Ten years from now, it will be a risky world as long as you want to earn money and invest money.
Diversification is indeed a strategy with which financial advisors are familiar. What’s key for them to remember?
The biggest [issue] with advisors is to make sure that individual clients are at the right place on the [risk-return trade-off] curve that’s subject to the kinds of restrictions and needs they have.
Some people believe there’s no need to diversify. Your thoughts?
They come to sorrow.
Do you think a U.S. recession will hit soon?
Yes, of course. But the question is: When?
This bull market has been extremely long, though we did have a correction — and then it came back.
I predicted that. It was obvious it was going to happen. When the  hurricanes hit Houston and Florida, I sold my bonds except for some tax-exempt or tax-deferred ones. I [figured] all that damage had to be rebuilt. I went all-equity. It was the “Markowitz Bet.” I [deduced] that the building industry had to rebuild Texas, Florida and then Puerto Rico [after Hurricane Maria].
What stocks did you buy?
I went into three asset classes: big-cap, small-cap and emerging markets. In big-cap, I bought six individual stocks [including] Caterpillar; 3M; and elevator companies, like Otis. I [also] bought [building products maker] U.S. Gypsum.
Did you win your bet?
The equities had a big spike and then came down, but I remained long. I got out of almost all my bonds, even tax-deferred or nontaxable ones because they were paying little. And I’ve been waiting.
When long-term tax exempt bonds get to 4%, I’m going to rebalance. I’m just letting it ride and ignoring the bond market until interest rates come up to a level that interests me.
How much longer can this bull carry on?
The bull market has lasted an awfully long time. It’s got to come down — someday. Markets go up; markets come down. There’s a natural cycle: People are enthusiastic, and the market goes up, up, up. The dumb money buys on the assumption that it’s going to go up further. Suddenly, people realize it’s overvalued, and it comes down faster than it went up. Then they decide it’s gone too low, and now it’s time to go up again.
What do investors do at that point?
Sell on the assumption that it’s going to go down further — whereas the smart money rebalances. All you have to do is rebalance. You can’t lose.
What do you think of technical analysis?
I don’t pay attention to it.
What are your thoughts about behavioral finance? That discipline, per se, didn’t exist in 1952, when you wrote your paper on Portfolio Selection.
What makes you think it didn’t exist in 1952? I wrote three papers in 1952. One was called “The Utility of Wealth,” which behavioral finance [experts] say was the first behavioral finance article.
When Daniel Kahneman [psychologist and economist author of “Thinking, Fast and Slow”] and Amos Tversky [late psychologist and Kahneman’s collaborator] were experimenting, there were things they couldn’t explain. Then Tversky remembered the then-25-year-old paper I wrote, “The Utility of Wealth.”
What was the crux of it?
I said that if you’re trying to explain actual behavior — not theoretical behavior — the utility [value] is not attached to the level of wealth but to the change in wealth. And there’s an inflection point at a certain place. Kahneman says this was truly a behavioral piece — and it was. So I play both sides.
You’re now completing Volume 3 of a four-volume series, “Risk-Return Analysis” (McGraw-Hill Education- Vol. I, 2013; Vol. II, 2016). What’s your writing routine?
I mostly write my books at Bruegger’s Bagels. I arrive at about 11 a.m., get a large cup of coffee and sit there writing by hand. Then I give it to my secretary, who types it up.
Are you still teaching at UC San Diego?
No, I just retired. When I was lecturing last quarter and signaled to change the slide, I started to fall asleep before [they put it up]. So I thought: That’s it — I’m retiring. I’m a night owl: I go to bed at 2 a.m. and get up at 8. I’ll be 92 on August 24. I like to take naps.
You grew up in Chicago the only child of grocery store owners. Do you think being a singleton had a big impact on your becoming a high achiever?
I was just a nerd.
— Related on ThinkAdvisor: