The Nobel Prize, Daiwa Securities, and Applied Investment Research at McKinley Capital Management
During his academic career, Harry taught MBA and Ph.D. level courses in investments and portfolio management. He was a professor at UCLA (1968–1969), University of Pennsylvania’s Wharton School (1972–1974), and Rutgers University (1980–1982). From 1974 to 1983, he was a staff member at IBM’s T. J. Watson Research Center, Yorktown Heights, New York. In 1982, Harry was President of the American Finance Association, one of two presidents of the association from industry in the past 40 years and was appointed the Marvin Speiser Distinguished Professor of Finance and Economics at Baruch College, City University of New York. In 1993, he retired from Baruch College as Distinguished Professor Emeritus. He was a visiting Professor at Hebrew University, Jerusalem; University of Tokyo; and the London Business School. Harry moved to San Diego in 1993, where he lived with his wife Barbara. He was an adjunct professor at the Rady School of Management, University of California, San Diego. Harry and Barbara support the nonprofit Rational Decision-Making Research Institute, where he developed a new nonproprietary version of EAS-E (Yost 2002, 33–34; EAS-E.ORG 2009).
Harry continued to consult during his academic tenure, serving, from 1984, as President of the Harry Markowitz Company, and, from 1990 to 2000, as Director of Research, Global Portfolio Research Department (GPRD), for the Daiwa Securities Trust Company, the U.S. affiliate of Japan’s Daiwa Securities. The GRPD published several journal articles in addition to managing institutional assets. Harry created the GPRD as a start-up research department and allowed researchers considerable flexibility in terms of suggesting models to be tested; Harry, however, insisted on using academically rigorous standards in a Wall Street atmosphere.
In 1990, Harry Markowitz developed an equity research group, the Daiwa Portfolio Optimization System (DPOS), at Daiwa Securities Trust Company in Jersey City, NJ. Financial modeling used traditional fundamental variables, such as earnings-to-price, book value-to-price, cash flow-to-price, sales-to-price, cash flow-to-price, small size, institutional holdings, earnings forecasts, revisions, recommendations, and breadth, earnings surprises, and dividend yield variables, identified in Dimson (1988), Jacobs and Levy (1988), and on-going conversations with William (Bill) Ziemba as anomalies. The DPOS research resulted in Bloch, Guerard, Markowitz, Todd, and Xu (1993), which reported the testing of 368 models of Japanese and US stocks. The geometric mean-maximizing model was funded as Fund Academy, after Harry was awarded the Nobel Prize in January 1991. Professor Joshua Livnat of New York University hosted a joint NYU /Daiwa research conference in 1991 to celebrate Harry, and Paul Samuelson was the luncheon speaker. The conference papers were peer-reviewed and published in Japan and the World Economy, an NYU economics journal. Fund Academy substantially outperformed in its first year, as noted in the Bloch et al (1993) paper, and came to national attention. See Jason Zweig in Forbes (1993) on Harry and DPOS. DPOS used robust regression to address outlier issues in the fundamental data, and latent root regression to address multicollinearity problems. Furthermore, Guerard and Takano (1992), Guerard, Takano, and Yamane (1993) reported weighted latent root regression results in the US and Japan. The Fund Academy was ranked as the second highest-returning Japanese Equity Fund of 65 managers, after 3.5 years, as reported in Guerard, Takano, and Yamane (1993). The weighted regression analysis was used and reported in Guerard, Xu, and Gultekin (2012) and Guerard, Rachev, and Shao (2013).
In June 2008, The International Symposium on Forecasting (ISF) met in Nice, France. Nice, is of course, often ranked in the top three among beautiful beaches in the world. Harry Markowitz was invited by the Program Committee to give a keynote address but was unable to attend the meeting. Harry gave, via a professional recording studio, the address to a packed conference audience in Nice. His topic was “Three Decades of Portfolio Management”. No single human being, in the opinion of the author, is more qualified to give such an address, and very few have heard it delivered more than the author. McKinley Capital Management (MCM) sponsored the Markowitz video. Martin Gruber, the Nomura Professor of Finance at New York University, gave the portfolio seminar to the ISF audience in Nice. Marty Gruber is certainly one of the greatest experts on portfolio construction and management, and his Wiley MBA text, Modern Portfolio Theory and Investment Analysis is outstanding, although it is lacking several Markowitz references of the past 30 years, including several of the papers on which he was a referee. The Markowitz presentation at the Nice ISF meeting was outstanding. Harry joined a list of Nobel laurates, including Lawrence Klein, Robert Engle, and the greatest forecaster of the 20th century, Clive Granger, in being part of the ISF. Harry later published in the International Journal of Forecasting (IJF), in 2015, see Guerard, Markowitz, and Xu (2015), updating the Nobel Prize celebration paper of NYU, in 1993, to include an effective variable of analyst’s revisions and breadth that have produced alpha for over 30 years.
Harry Markowitz joined McKinley Capital’s Scientific Advisory Board in 2014 where the author was serving as the Director of Quantitative Research. Harry Markowitz and McKinley Capital co-hosted a research conference on January 21, 2014, in San Diego. The theme of the conference was “Portfolio Selection in 2076: Data, Techniques, and Measurement”. The invited conference participants were selected by Professor Markowitz and John Guerard. The attendees included Ganlin Xu (Guided Choice), Bruce Jacobs (Jacobs Levy Equity Management), Anureet Saxena, Jose Menchero (MSCI Barra), Robert Stubbs (Axioma), Jack Treynor (retired, a fellow of the Q-group), Rob Gillam (CIO, McKinley Capital), and Lisa Goldberg (of the University of California, Berkeley). Harry Markowitz chose the year 2076 because it has been 62 years since his “Portfolio Selection” appeared in the Journal of Finance and 2076 will be 62 years in the future. The year 2076 will be the three hundredth anniversary of Adam Smith’s The Wealth of Nations, as well as the 300th birthday of the United States of America. A picture of the conference participants is attached, as Photograph 1. Several of the conference participants had published in the authored tribute to Harry, Handbook of Portfolio Construction: Current Applications of Markowitz Techniques (New York: Springer, 2010), as a “thank you gift” for his 2008 ISF presentation. The author based his book on the model of a chapter (or three) of introductory Markowitz Efficient Frontier materials and a collection of academic papers from the leading experts on Markowitz. Marty Gruber and Ed Elton had produced an outstanding tribute to Harry in 1979, entitled Portfolio Theory: 25 Years After (Amsterdam: North-Holland). In his role as the Head of the MCM Scientific Advisor Board, Harry published with John and Ganlin Xu, as they had at Daiwa, some twenty years earlier, including Guerard, Markowitz, and Xu (2014), and Guerard, Markowitz, and Xu (2015), and Markowitz, Guerard, Xu, and Beheshti (2021) used to test the DPOS models, which were enhanced by the addition of the I/B/E/S proprietary forecasting variables. Robust regression is a highly (appropriate) statistically significant technique to use in recreating expected returns.[1]
Harry was brilliant, and yet human. In 2003, Richard (Dick) Michaud challenged Harry and his optimizer to a Horse Race, as one saw in a Pensions & Investments (P&I) article in 2003. Michaud won. However, Dick Michaud was not only gracious, but his firm, New Frontiers Advisors, LLC, established an annual award in conjunction with the Journal of Investment Management (JOIM), in 2010 to honor Harry. The Annual award serves to recognize the impact of Markowitz on modern finance and to encourage future research and innovation. The 2015 Special Distinction Awards were given to Clifford S. Asness, Antti Ilmanen, Ronen Israel, and Tobias J. Moskowitz for their paper “Investing with Style,” and Harry M. Markowitz for “Consumption, Investment and Insurance in the Game of Life.” You could disagree with Harry, but you had better bring your “A+” game to the table if you expected to be competitive. As Harry often said when he encountered persons not familiar with his Portfolio Selection Cowles Foundation 16 monograph, “I have forgotten more than you will ever know”. In 2010, McKinley Capital hosted a Horse Race using the DPOS Model of Markowitz and the USER Model of Guerard, Xu, and Gultekin (2012), and invited the big risk management firms to attend and present research. One of the best presentations, and the best paper, according to Harry was written by Anureet Saxena and Robert Stubbs of Axioma, see the Saxena and Stubbs Journal of Investing (2012).
On October 17, 2015, the University of California at San Diego, UCSD hosted a great party to celebrate the 25th anniversary of Dr. Harry Markowitz’s Nobel Prize in Economics for Modern Portfolio Theory, a construct he had actually discovered almost 40 years prior. The Rady School of Management at UC San Diego hosted a celebration the last night of conference to honor Markowitz, who was then 88. Guest speakers included Martin Gruber, Stephen Horan, Jack Rivkin, Bruce Jacobs, and Robert Arnott. Harry taught at Rady as an Adjunct for years and left UCSD his Nobel Prize Medal.
Harry loved to tell the story of seeing a person reading his monograph in an airport. He walked up to the gentleman and said, “I am Harry Markowitz, the author of your book”. According to Harry, the young man said “Yea, right old man” . Harry showed the man his Driver’s License and the young man said, “Yea, I can buy a fake Driver’s License too”.
Harry Worked Well with Others, Particularly Jacobs and Levy
In the early 2000s, Harry worked in joint research with Bruce Jacobs and Ken Levy of Jacobs Levy Equity Management, a provider of quantitative equity strategies for institutional clients, where he helped to construct the JLM Market Simulator (Jacobs et al., 2004, 2010). The JLM simulator is an asynchronous simulation that investors can use to create a model of the market using their own inputs. The investor’s portfolio selection choice comes from the risk–aversion coefficient parameter that helps the client choose from a desired portfolio on the efficient frontier. Together, they examined optimization of portfolios with short positions (Jacobs et al. 2005, 2006). Later, Jacobs and Levy incorporated a term for leverage aversion within the investor utility function. They extended the mean-variance optimization model to become a mean-variance-leverage optimization model. The leverage term captures the unique risk inherent in margin calls, see Jacobs and Levy (2013), Markowitz (2013).
Harry has made great intellectual contributions to the worlds of finance, investment management, LP, sparse matrices, and computer simulation, many of which are discussed in his collected papers (Markowitz 2008). He has been a successful endowed professor, consultant, research staff member, and entrepreneur. Modern portfolio theory is now a standard topic in college courses and texts on investments, and widely used by institutional investors and by many quantitative money managers for stock selection for equity portfolios.
Bruce Jacobs and Ken Levy have been great friends of Harry for decades. As Wharton alumni, they have been exceedingly generous in creating and endowing the Wharton-Jacobs Levy Prize for Quantitative Financial Innovation and the Jacobs Levy Equity Management Center for Quantitative Financial Research at The Wharton School. Harry won the Wharton-Jacobs Levy Prize in 2013 for his groundbreaking innovations in individual retirement planning. Photograph 2 is Bruce Jacobs, Harry, and Ken Levy. Bill Sharpe won the second Wharton- Jacobs Levy Prize in 2015.
GuidedChoice and for Harry, the Best Retirement is No Retirement
Harry Markowitz was co-founder and Chief Architect of GuidedChoice, a 401(k) managed accounts provider and investment advisor. Markowitz’s more recent work included designing the backbone software analytics for the GuidedChoice investment solution and heading the GuidedChoice Investment Committee. He was actively involved in designing the next step in the retirement process — assisting retirees with wealth distribution. Harry continued to work with Ganlin Xu, his DPOS dedicated mathematician.
At the time of Harry’s passing, Harry was retained by Hudson Bay Capital, McKinley Capital Management, Research Affiliates, SkyView Investment Advisors, and Matson Money. If one looks at Harry Markowitz on SSRN, one finds that his backtesting paper with Rob Arnott and Campbell Harvey is his most cited paper of the past 30 years. Of his SSRN papers, four papers were co-authored with Bruce Jacobs and Ken Levy, and four papers were co-authored with Ganlin Xu and the author. Photograph 3 is Harry, Ganlin, and the author, circa 2014.
What Readers Should Know
Harry Markowitz was a brilliant man who forever changed the world of investments in 1952 through 1959. However, much of Wall Street did not understand or implement much of Harry’s work until the early 1970s. As technology improved and computer power became far cheaper, quantitative management firms’ assets under management grew exponentially. Some firms in quantitative options modeling were associated with the Crash of October 19, 1987. Several financial institutions built financial instruments, including structured mortgage products, that helped cause and extend the 2007- 2008 Global Financial Crisis (GFS). There will always be firms that are run by people that are not honorable. The Quant models that Harry Markowitz’s Daiwa Team, DPOS, built in 1991 have continued to produce highly statistically significant stock selection and Active Returns. Has the world changed? Yes. Is everything that Harry taught us from 1952 -1959 to 2019 obsolete? No! Can they be enhanced? Yes, more predictive data sources may become available. (Legal) insider trading enhances returns. KLD data for Socially Responsible Investing (SRI) can help reduce portfolio risk and increase Sharpe, Treynor, and Information Ratios for institutional institutions. Text recognition and Natural Language Processing (NLP) can enhance returns.
Will these new data sources dominate earnings forecasting work and are Harry Markowitz and Bill Sharpe the “dinosaurs” some financial writers suggest? No! My best guess is that in 2053, some thirty years from now, some Duke or Georgia Tech (and / or Peking University or LSE) student will test the Markowitz DPOS and USER Models and find them to be statistically significant for the 2023 -2053 period. It is my hope that the students will raise a glass of single malt scotch to Harry and possibly a gin & tonic or Jack Daniels to Ganlin Xu and the author.
What should the reader do with our information? It does not take a Rhodes Scholar to realize that if you have not read Portfolio Selection, that you are intellectually deficient in Finance. Furthermore, if you have not read Haim Levy’s outstanding The Capital Asset Pricing Model in the 21st Century (Cambridge: Cambridge University Press, 2012), with its chapters on expected utility and the Mean-Variance Rule, then your mind needs additional enhancement. Haim Levy contributed a chapter to the author’s Springer volume to honor Harry. Professor Levy tested the equal holdings of all asset classes from the Torah (capitalized for a reason). When the author asked Harry about his own portfolio holdings, and whether he actively manages stocks or uses a 50/50 stocks / bonds rule, that he used as a long-term benchmark, Harry laughed and said “I abandoned that 50/50 stocks and bond philosophy several years ago, and I have minimized my equity holdings. I went even longer into California property holdings. The return to risk ratio was far better than stocks!”. Indeed, Harry’s home in San Diego, purchased in 1993, has outperformed the Case-Schiller Index by a factor of two over the past 30 years. I have to laugh when I think of Harry. Harry was brilliant, driven to be nothing but the best, one of the very few men who achieved national and international acclaim in several disciplines, and living to 95. He received paychecks for outstanding consulting research delivered up to the moment of his final Exodus (capitalized for a reason). There was only one Harry Markowitz. Harry did what he wanted to do; lived the life that he wanted to live; had several setbacks but far, far more successes, and he would tell that he lived his life, as Frank Sinatra sang “I did it my way!” Haim Levy, Martin Gruber, Ed Elton, Ganlin Xu, and Dick Michaud are among the greatest Markowitz researchers and are among those having the greatest love and respect for Harry. With friends like that, you must have done a great many things well in your life!
Acknowledgements
The author is grateful to Professors William F. Sharpe, Martin J. Gruber, and Haim Levy for their comments and helpful edits. Practitioners, Ph.D.’s in industry, Richard Michaud, Bruce Jacobs, and Ganlin Xu, provided comments and edits. Any errors remaining are the sole responsibility of the author.
This is an appreciation, not a journal article. Rather than present five pages of references, I refer the reader to J. B. Guerard, S. Deng, R. A. Gillam, H. Markowitz, and G. Xu, “Investing in global equity markets,” Wilmott, vol. 2020, issue 106, p. 56–75, 2020, and its references.
Chernoff, J. (2003). “Markowitz says that Michaud Built a Better Mousetrap”, Pensions & Investments, December 22, 2003.
Guerard, J.B. (2011). “Harry Markowitz”. In: Assad, A., Gass, S. (eds) Profiles in Operations Research. International Series in Operations Research & Management Science, vol 147. Springer, Boston, MA. https://doi.org/10.1007/978-1-4419-6281-2_35.
There are several texts and articles that I must point out in closing. These texts and articles are essential reading for the 25-year-old Financial Engineering researchers. The author chose nine texts that are more essential than the articles. That is a personal perfence.
Essential Textbooks
Markowitz, H. M. 1959. Portfolio Selection: Efficient Diversification of Investment. Cowles Foundation Monograph No.16. New York, John Wiley and Sons.
Sharpe. W. F. 1970. Portfolio Theory and Capital Markets. New York: McGraw-Hill.
Mossin, J. Theory of Financial Markets. Englewood Cliffs, NJ: Prentice-Hall, Inc.
Rudd, A. and H. K. Clasing. 1982. Modern Portfolio Theory: The Principles of Investment Management. Homewood, Illinois: Dow Jones-Irwin.
Michaud, R. O. 1998. Efficient Asset Management: A Practical Guide to Portfolio Optimization and Asset Allocation. Boston: Harvard Business School Press.
Elton, E.J., M.J. Gruber, S.J. Brown, and W.N. Goetzman. 2007. Modern Portfolio Theory and Investment Analysis. John Wiley and Sons, Inc., Seventh Edition.
Connor, G., Goldberg, L. and Korajczyk, R.A. 2010. Portfolio Risk Analysis. Princeton: Princeton University Press.
Levy, H. 2012. The Capital Asset Pricing Model in the 21st Century. Cambridge: Cambridge University Press.
Lo, A. 2017. Adaptive Markets. Princeton: Princeton University Press.
Essential Articles
Markowitz, H. M. 1952. Portfolio selection. Journal of Finance, 7, 77-91.
Markowitz, H. M. 1976. Investment in the long run: new evidence for an old rule. Journal of Finance, 31, 1273-1286.
Rosenberg, B., and Marathe, V. 1979. Tests of capital asset pricing hypotheses. In H. Levy ed., Research in Finance vol. 1.
Rudd, A, and B. Rosenberg. 1979. “Realistic Portfolio Optimization.” In Portfolio Theory, 25 Years After. E. Elton and M. Gruber, Editors. Amsterdam: North-Holland.
Jacobs, B. I. and Levy, K. 1988. Disentangling equity return regularities: New insights and investment opportunities. Financial Analysts Journal 44, 18-43.
Michaud, R. O. 1989. The Markowitz optimization enigma: Is ‘optimized’ optimal? Financial Analysts Journal 45, 31-42.
Rubinstein, M. 1991. Portfolio selection: A fifty-year retrospective. Journal of Finance 57, 1041-1045.
Bloch, M., Guerard Jr., J. B., Markowitz, H. M., Todd, P., and Xu, G.-L. 1993. A comparison of some aspects of the U.S. and Japanese equity markets. Japan and the World Economy, 5, 3-26.
Markowitz, H. M., and Xu, G. L. 1994. Data mining corrections. Journal of Portfolio Management 21, 60-69.
Elton, E. J., Gruber, M. J., and Gultekin, M. 1981. Expectations and share prices. Management Science, 27, 975-987.
Markowitz, H. M. 1999. The early history of portfolio theory: 1600–1960. Financial Analysts Journal 55, 5-16.
Markowitz, H. M. 2002. Efficient portfolios, sparse matrices, and entities: a retrospective. Operations Research 50, 154–160.
Lo, A. W. 2004. The Adaptive markets hypothesis: Market efficiency from an evolutionary perspective. The Journal of Portfolio Management 30: 15-29.
Jacobs, B.I., K. N. Levy, and Markowitz, H. M. 2005. Portfolio optimization with factor, scenarios, and realistic short positions, Operations Research 53, 586 -599.
Jacobs, B.I., K. N. Levy, and Markowitz., H. M. 2006. Trimability and fast optimization of long-short portfolios, Financial Analysts Journal, 62, 36-46.
Levy, H. and Duchin, R. 2010. Markowitz’s Mean-variance Rule and the Talmudic Diversification Recommendation. In The Handbook of Portfolio Construction: Contemporary Applications of Markowitz Techniques. J.B. Guerard, Jr., Editor, New York: Springer.
Menchero, J., Morozov, A., and Shepard, P. 2010. “Global Equity Modeling”. In The Handbook of Portfolio Construction: Contemporary Applications of Markowitz Techniques. J.B. Guerard, Jr., Editor. New York: Springer.
Brennan, T.J. and Lo, A. 2010. Impossible frontiers. Management Science 56, 905-923.
Saxena, A., and Stubbs, R. A. 2012. An empirical case study of factor alignment using the USER model. Journal of Investing 21, 25-44.
Jacobs, B., and Levy, K. 2013. Leverage aversion, efficient frontiers, and the efficient region. The Journal of Portfolio Management 39, 54-64.
Markowitz, H. M. 2013. How to represent mark-to-market possibilities with the general portfolio selection model. The Journal of Portfolio Management 39, 1-3.
Guerard, J.B., Jr., Markowitz, H.M., & Xu, G. 2015. Earnings forecasting in a global stock selection model and efficient portfolio construction and management. International Journal of Forecasting, 31, 550-560.
Domowitz, I. and A. Moghe. 2018. Donuts: A picture of optimization applied to fundamental portfolios. Journal of Portfolio Management 44: 103-113.
Guerard, J.B., Jr., & Markowitz, H.M., 2018. The Existence and Persistence of Financial Anomalies: What have you Done for me Lately? Financial Planning Review. https://doi.org/10.1002/cfp2.1022.
Guerard, J.B., Jr., Xu, G. and Markowitz, H.M. 2021. A further analysis of robust regression modeling and data mining corrections testing in global stocks. Annals of Operations Research (2021) 303:175–195.
Markowitz, H.M. J.B. Guerard, Jr., G. Xu, and B. Beheshti. 2021. Financial anomalies in portfolio construction and management.” The Journal of Portfolio Management 47, 51-64.
About the Author
John Guerard
Scientific Advisory Board, McKinley Capital Management, LLC
Anchorage, AK
[1] The quarterly and monthly regressions are plagued with approximately twice the number of observations outside the 95 percent confidence interval as one might expect given a normal distribution of residuals. These aberrant observations, or outliers, lead us to re-estimate the monthly regression lines using a Beaton-Tukey bi-weight or bisquare (or robust, ROB) regression technique, in which each observation is weighted as the inverse function of its ordinary least squares (OLS) residual. The application of the Beaton-Tukey ROB procedure addresses the issue of outliers, see Beaton and Tukey (1974), Andrews, Bickel, Hampel, Huber, Rogers, and Tukey (1972), Keaz and Ready (1997), Maronna, Martin, Yohai, and Salibian (2019). The weighted data is plagued with multicollinearity, the correlation among the independent variables, which may lead to statistically inefficient estimates of the regression coefficients. The data of several studies with differing time periods were plagued with outliers.
