# Is there anyone still using Markowitz modern portfolio theory?

I was reading about the MPT (Use standard deviation as risk measure) on "Mathematics for Finance by Marek Capinski". I was just wondering is there anyone actually applying this theory to their portfolio?

And if there's someone who using this theory. Why would they? Why don't they use another coherent risk measure?

PS. I'm math/stat major who is interested in finance.

Lots of wealth management firms still use MPT; in my experience regulators like it because they understand it.

If asset returns are normally distributed, the standard deviation of the portfolio is a coherent risk measure (this can be seen by noting that the normal distribution's CVaR, which is a coherent risk measure, can be written as $$\mu+c \sigma$$ for a constant c). In the long run, asset returns become more and more normally distributed due to the CLT. For a 30 year time horizon MPT is still useful, assuming a reasonable estimate for the vector of expected returns and the covariance matrix.

MPT should be called Medieval Portfolio Theory, it is a theory from 50 years ago with huge theoretical flaws (mean-variance utility, use of Pearson's correlation that is not coherent, based on historical data). Come on, it is an error maximizer. The least one could do is Michoud resampling, but it is patented. Or a bayesian Black-Litterman would be more appropriate.

So to answer the question: no, anyone reasonable in the world of asset management won't use MPT. Of course one should care about higher moment, asymmetries, using conditional measures and robust/coherent risk measures. It complicates hugely the formulas though, where a closed form formula or "beautiful solution" may not exist, and we should rely on quantitative modelisation that works.

• I also had a lecture at university by a practicioner, and he said MPT is of no use and can be easily shown by backtesting. Today's methods are much more sophisticated than MPT. – emcor Oct 13 '14 at 12:17

Sure a lot of traditional (mutual) buy side funds use MPT. They also mostly subscribe to the efficient market hypotheses. And they also do not hide the fact that they have no interest to lobby many retirement investment and savings schemes to allow for long/short investments but hold on to long-only. And finally, most of them underperform simple benchmark indexes (probably around 70-80% of money invested underperforms indexes). See any correlation between above facts and the generated returns? Changes have to be driven by investors, changes will not originate from the fund side because the status quo earns them fat fees and they would otherwise have to hire a lot smarter analysts and PMs if they were suddenly benchmarked alongside long-short funds and against more suitable benchmarks in order to stem otherwise massive AUM outflows.

• +1: I see it the same way... – vonjd Oct 13 '14 at 12:41
• So they don't really care how the fund perform as long as they earn the fees? – devon Oct 14 '14 at 0:21
• Of course do fund managers care about their performance. But it is shocking to see fund managers padding themselves on their shoulder just because they outperformed most of their peers by an average 2% while they may in absolute terms have lost 20% in a given year. Where did I hint at the possibility that fund managers might not care about their performance? – Matthias Wolf Oct 14 '14 at 5:17
• The fact that they use MPT rather than another coherent risk measure or better risk measure. It's kinda bizarre. – devon Oct 14 '14 at 19:03

I am engineer studying Finance, therefore Im not an expert in Math/Stat, but not noob.

I disagree with the previous answer. In fact, I know portfolio managers and hedge fund assesors that usses MPT. It must be said that you need to know what that represents, and also not only focus your investment in MPT, but consider other methods. Like in every other thing in finance.

I will advice you to use it as a tool to decide your investment but not use it as the only tool.

Hope it helps.