Harry Markowitz, Economist, 1927–2023

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The study of finance can be easily divided into two eras: before and after Harry Markowitz.

The economist, who died on June 22, was one of the first academics to introduce abstract mathematical concepts – and rigor – into investment decision-making. In doing so, he revolutionized the way financial markets were understood.

“Everyone knew about diversification — not putting all your eggs in one basket,” said co-author Andrew Lo, a professor at the Massachusetts Institute of Technology. In search of the perfect portfolio, “But Markowitz told us much more than that. He told us how many eggs we should put in different baskets and how to diversify systematically.”

Markowitz had key insights As he read stock prices are the present value of future dividends. He felt that that definition failed to account for uncertainty; In fact, the valuation of stocks can be done only by their expected That idea developed into his PhD thesis, where he modeled the optimization of investments across portfolios.

This development caught on widely. Almost all modern professional investing is built on this type of quantitative analysis, with a focus on optimization and risk management concepts that might not exist in their current form without Markowitz.

His innovation also helped create trillion-dollar passive-investment Giants like Vanguard took off, and in the process displaced a cadre of fund managers and stockpickers who relied primarily on corporate fundamentals and acquired knowledge to manage money.

Markowitz’s work was built upon by William Sharp, who invented the standard for modeling and measuring risk-adjusted returns. Sharpe, Markowitz and Merton Miller won the Nobel Prize in Economics in 1990. Sharp said, “Without Harry’s work, there was no way I would have gone down that path.”

Markowitz, born in Chicago in 1927, was the only child of Morris and Mildred, who owned a grocery store. He said that he always had enough food to eat despite the recession. He first studied liberal arts at the University of Chicago and then turned to economics for his MA and PhD. He learned from Milton Friedman, Leonard Savage and Tjalling Koopmans. He noted that Koopmans’ course on activity analysis was “an important part” of his education, as it defined efficiency and provided a framework for analyzing efficient sets.

After Chicago, he did a mix of academic and corporate work. Sharpe and Markowitz first met in the late 1950s at the RAND Corporation, where Sharpe worked while completing his Ph.D. Sharp said, “I was completely formed by the RAND Corporation.” Markowitz also studied operations at RAND, another field that has benefited from real-world application of mathematical principles.

Rob Arnott, founder of Research Affiliates, felt Markowitz’s influence early in his career. In his first job at the Boston Company in 1977, he said, he used the Economist’s algorithm in a quadratic programming optimizer. He has since built a systematic investment empire that manages approximately $130 billion worldwide.

Arnott said, “He knew he had changed the world of finance beyond recognition.” “Before Harry, investing was a set of general rules. , , When someone of his phenomenal stature dies, it is easy to paint him as the intellectual giant that he was. But he was also a kind, gentle and fun-loving person.

Many friends and colleagues spoke of Markowitz’s irrepressible sense of humor and open-mindedness. He says that his distaste for acquired knowledge and intellectual rigor may have helped him to fundamentally change the status quo in the financial markets. It is rare for a mathematician to see his work have such a widespread impact during his lifetime. But the transition towards systematic and passive investing did not go unchallenged.

“The industry was slow to adopt these ideas. , , (Markowitz and Sharp) were certainly idolatrous, but more importantly, they threatened the livelihoods of stockbrokers and gunsmiths, who were charging as much as 5 to 10 percent in some cases for their services. Were,” Lo said.

However, Markowitz was not a propagandist of passive management or systematic investing. Arnott said, he felt that quantitative strategies were only as good as the thinkers who created them.

Arnott said, “He was a patient, gentle man, but he was not patient in the matter of willful stupidity.” “Optimization becomes garbage-in, garbage-out if your inputs are haphazardly prepared. He was always amazed when people put numbers into a formula without thinking carefully.