Taking a deep dive to examine the philosophies of 10 prominent investing pioneers, professors Andrew W. Lo, of MIT, and Stephen R. Foerster, of Western University, have created a new book, “In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest” (Princeton University Press, Aug. 17, 2021).
In an interview with ThinkAdvisor, Foerster, a chartered financial analyst, explores what five of the experts say go into making the perfect portfolio.
But he stresses: “We want to encourage our readers to develop an investment philosophy and to have a conviction and a reason for that particular philosophy that should guide their actions.”
As for what constitutes the perfect portfolio, the co-authors argue: “Our perfect portfolio today is really just a snapshot of what’s best for you at the moment and in the current environment.”
Lo is a professor at the MIT Sloan School of Management, director of the MIT Laboratory for Financial Engineering and a principal investigator at the MIT Computer Science and Artificial Intelligence Laboratory.
Foerster is a finance professor at Ivey Business School at Western University in London, Ontario. He writes regularly for The Perfect Portfolio Investing Blog.
In the interview, Foerster discusses the philosophies of investing superstars John Bogle, Charley Ellis, Harry Markowitz, Robert Shiller and Jeremy Siegel, shedding light on both their investing similarities and differences.
At least one says stocks and bonds alone form the perfect portfolio; others take a more broad-based approach.
Active or passive investing? Foerster talks about how the pioneers strongly disagree on this, along with varying opinions concerning portfolio rebalancing.
But here’s a theme consistent among all the pioneers, six of whom were Nobel Laureates: Pursuit of the perfect portfolio requires an astute financial advisor referred by a reliable source.
This is “to save us from ourselves in terms of the biases we have,” as Foerster puts it.
ThinkAdvisor recently had a phone interview with Foerster, who was speaking from London, Ontario.
In conducting the extensive research for the book, he got a real surprise: One of the experts uncharacteristically bought gold for a particular investment.
Read on to find out who.
THINKADVISOR: How diverse are the investing philosophies of the experts you’ve profiled?
STEPHEN FOERSTER: Not even these 10 luminaries agree on one philosophy.
As one of them, Martin Leibowitz [who co-wrote “Inside the Yield Book: The Classic that Created the Science of Bond Analysis”], said, at certain periods, being passive might work a lot of the time — but it might not necessarily work all the time.
Let’s look at the “perfect portfolio” as described by five of the experts you’ve written about.
First: Harry Markowitz. He conceived Modern Portfolio Theory and won a 1990 Nobel Prize for developing it. What does he think goes into creating the “perfect portfolio”?
Markowitz’s big breakthrough was showing mathematically why diversification matters. It’s all about correlations — how stocks move relative to one another, which is really important.
So by having a diversified portfolio of risky assets, we can get the proverbial free lunch, where we can either reduce the amount of risk for a given level of expected return or have a higher expected return for a given level of risk through diversification.
Markowitz’s perfect portfolio would be to invest in low-cost ETFs and a number of individual bonds. He said that the perfect portfolio is about “rational decision-making for financial planning.”
In contrast to Markowitz, Robert Shiller, a Nobel Prize-winning economist and author of the bestselling “Irrational Exuberance,” is a proponent of active investing. Please discuss.
Shiller’s point is that we should always be looking for new innovations that can help us optimize the portfolio in terms of risk and return.
Aspects of his “trill” idea [a new security he proposed called trillionth] — buying shares in a country’s GDP — have been adopted by some countries. But I think it has a long way to go to get traction.
The idea is that if the government creates a product that would be related to the performance of the overall economy, it’s almost like you’re sharing in the equity of the country and its overall productivity.
It’s sort of a win-win because it would have inflation protection and be built on growth opportunities — and the governments wouldn’t be as leveraged.
His point is that we should be open from a public policy perspective and that governments should look into these types of ideas.
Behaviorist Shiller argues that individuals should “get a good financial advisor — one that good people recommend” since do-it-yourself investing isn’t the best approach for many. Did others in your book advocate that too?
It was a consistent theme among many of our luminaries.
Shiller is best known for uncovering irrational behaviors that many investors have. So left to our own devices, we might trade excessively and end up underperforming.
Having a financial advisor should give us a good reality check to keep our emotions in [control] and try to save us from ourselves in terms of the biases we have.
John Bogle famously created the first stock index mutual fund and founded The Vanguard Group. Your book quotes him as saying, “Stop trying to find the needle; invest in the haystack.” Please explain.
The haystacks would be all the equities that might be available in the U.S. market, and the needle would be the ones that seem to consistently outperform.
His notion is that since you could potentially end up underperforming, you’re better off buying the haystack — all the securities that are available in that market. Thus, his notion of index funds.
No other asset classes, such as real estate or other alternatives, are required in the portfolio, Bogle argued.
This is a point where our luminaries have some differences of opinion. Others would take a more broad-based approach and certainly have real estate as part of the overall portfolio