Book review: Portfolio selection. Efficient Diversification of Investments, by Harry M. Markowitz

Author

Harry M. Markowitz won the 1990 Nobel prize in economics for establishing the foundation of modern portfolio theory.  His diagram of the “efficient frontier” was published in 19521 and is often quoted in books and papers on portfolio management.  The efficient frontier is the greatest of possible returns for a given level of risk among feasible portfolios of diversified stocks.

Review

The topic of this book2 is portfolio analysis.  Harry Markowitz made it clear from the beginning that his book was written for institutional investors interested in managing investment portfolios that contain large numbers of securities.  Ordinary investors are invited to seek an efficient portfolio through the services of an institutional investor.

The formulation of an efficient portfolio requires a team of securities analysts who review large portfolios of securities in terms of historical returns, risk, and correlations.  The team leader is a portfolio analyst who assumes that past performance is predictive of future performance.  The information required for portfolio analysis includes the investment goal, estimated returns of securities, uncertainty of returns of securities, and the correlation between pairs of securities.  The portfolio analyst is personified as a rational person who evaluates correlations between securities in order to define the efficient portfolio most suitable for the needs of the investor.  The entire process is detailed, extensive, and based on statistics.

Impression

This book is of historic interest as the foundation for building portfolios.  Ordinary investors –including me– lack the time, interest, and skill to formulate an investment portfolio based on Markowitz’s methods.  Today’s investors can choose a small number of investment funds rather than a large number of securities to create a diversified portfolio based on desired risk and return.  Online calculators provide guidelines for creating a portfolio based on selected risk and return.

References

1         Markowitz, H. (1952), ‘Portfolio Selection’, Journal of Finance, 7(1), 77-91.

2         Portfolio selection.  Efficient Diversification of Investments.  Harry M. Markowitz.  John Wiley & Sons, New York, 1959.

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