Nobody's Perfect
Even the world's best investors are not immune from making mistakes. Come find out why.
Capital Thinking • Issue #689 • View online
Harry Markowitz. The man who popularized diversification with the creation of modern portfolio theory.
In 1990, he shared the Nobel Prize in Economics with William Sharpe (the creator of the Sharpe ratio) and Merton Miller (of the Modigliani–Miller theorem) for “pioneering work in the theory of financial economics.”
Markowitz’s pioneering work was illustrating that, by combining different asset classes, one could create a portfolio that had the highest return per unit risk (based on historical data).
You would think that the man who popularized such a precise theory would use it to invest his own money, but you would be wrong.
As Nassim Taleb is known for saying, “Don’t tell me what you think, show me your portfolio.”
We All Make Mistakes
Nick Maggiulli | Of Dollars and Data:
When Jason Zweig asked Markowitz what was in his portfolio and whether he used modern portfolio theory, Markowitz replied (emphasis mine):
I visualized my grief if the stock market went way up and I wasn’t in it — or if it went way down and I was completely in it. My intention was to minimize my future regret…So I split my contributions 50/50 between bonds and equities.
As Zweig correctly points out, many investing experts urge “do as I say, not as I do.”
The funny part about this is that Markowitz didn’t run a mean-variance analysis to find his optimal portfolio. Instead, he made a portfolio based on his expected reaction to various market events.
Behavior trumps math.
But, that’s not even the punchline. In a 2017 interview, Markowitz stated, “Well, that was in 1952. But, that’s not what I would do today.”
So how does Markowitz invest today?
According to a Barron’s article in February 2018, Markowitz had 100% of his liquid assets in equities with 1/3 in a small cap index fund, 1/3 in an emerging markets index fund, and 1/3 in just 6 stocks. Yes, 6 stocks.
Which ones? Weyerhaeuser, USG, Corning, Caterpillar, 3M, and United Technologies. Notice a pattern? They are all construction related.
So what caused the global champion of diversification to make a bet on construction stocks? In his own words (from Barron’s):
It’s for the long run, but not the indefinite long run. My thought process is this: They are someday going to rebuild Houston. It will take a while, but they’ll rebuild Houston. They’re going to rebuild Florida….And they’re going to rebuild Puerto Rico.
Yes, Harry Markowitz wagered 1/3 of his portfolio on infrastructure rebuilding after a series of hurricanes struck the Gulf states and Puerto Rico in 2017.
How has that bet turned out?
You guessed it. Markowitz has underperformed the S&P 500 by about 6% since the article’s publication:
My point with this isn’t to dunk on Harry Markowitz. Markowitz has done more for the investment world than just about anyone and likely belongs on the Mt. Rushmore of Finance.
My point is to illustrate that we all make mistakes.
Yes, Markowitz’s “mistake” is trivial and will likely have no impact on his long run financial goals. However, it does illustrate a deep truth about the difficulty with investing.
If one of the most brilliant minds in finance can error, why should you be any different?
This question was masterfully addressed by my colleague Michael Batnick last year in his book Big Mistakes.
Batnick demonstrates how some of the greatest investors in history (i.e. Buffett, Bogle, Druckenmiller, etc.) all made huge blunders during their investment careers.
But, it wasn’t Warren Buffett’s stock acquisition of Dexter Shoe or Bill Ackman’s failed short against Herbalife that were the most memorable, it was the chapter Batnick wrote about his own struggles in investing.
This chapter was so good because self-reflection and admitting failure are exceedingly rare.
Few people will acknowledge their mistakes. Few people will confess when they acted foolishly.
Nick Maggiulli
*Featured post photo by tabitha turner on Unsplash
*Originally posted on October 02,2020