Do Physician Investors and/or their Financial Advisors Use and Abuse Modern Portfolio Theory?

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The Cultural Clash of Passivity versus Activity

By Dr. David Edward Marcinko MBA CMP™


Ninety-three year old Professor Harry Markowitz PhD, coined the phrase “modern portfolio theory” [MPT] and concluded that investors are rewarded for taking certain risks but may not get rewarded for taking others. He developed the notion of an “efficient frontier” for different groups of asset classes and the idea that the higher the expected return, the higher the risk.

The Brinson, Hood, Beebower Study

In their 1986 study, Brinson, Hood, and Beebower attempted to measure three investment activities: (1) asset class selection, (2) market timing, and (3) security selection. They concluded that asset class selection had, by far, the greatest effect on the risk/return characteristics of a portfolio (some 93.6% of performance). But the most startling conclusion was that, if left alone, investment policy would have produced a higher average return than when market timing and security selection were taken into account. These latter factors actually reduced the average return over a 10-year period.

The Fama & French Study

In 1982, Fama and French found that three factors—market exposure, company size, and “value”—were systematic risks that explained the vast majority of equity market returns. “U.S. small-cap value stocks” is therefore a discreet asset class possessing all three of these systematic risks.

Most physicians and financial advisors are aware of modern portfolio theory but some fail to apply the principles to actual investor situations. Three examples: (1) using erroneous asset-class definitions, (2) using actively managed funds, and (3) relying on market timing. The abuse of modern portfolio theory can create portfolios loaded with latent risks that, on the surface, appear benign.

Not all Agree

Not everyone is in agreement with modern portfolio theory. Some detractors agree in principle, recognizing, for example, that “value” stocks have had higher returns than “growth” issues but they cite the cause as “mispricing” rather than risk.


Institutional investors have gradually increased their commitment to passive strategies from virtually zero 20 years ago to 30% or more in the last decade [Think: Vanguard].

Individual and physician investors, on the other hand, have less than a 5% commitment.

Note: “Modern Portfolio Theory: Fact or Fiction?,” Gerard F. Stellwagen and Robin P. LaCouture, NAPFA Advisor, July 1997, pp. 1–7, National Association of Personal Financial Advisors for Fee-Only Financial Advisors.


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9 Responses

  1. More on Asset Allocation

    Since the 1986 study of large pension funds suggested that investment policy, rather than market timing or security selection was the primary determinant of portfolio performance, investors have seized upon asset allocation as the Holy Grail of investing.

    Although there has been ongoing debate regarding the original study’s methodology and conclusions, David Swensen, the Chief Investment Officer of Yale University, made the following observation with respect to asset allocation.

    “Investors often treat asset allocation’s central role in determining portfolio returns as a truism. It is not. The Brinson, Singer, and Beebower study describes investor behavior, not finance theory.”

    IOW: It is its power in controlling investor behavior that makes asset allocation so valuable.

    Any thoughts?

    Dr. David Edward Marcinko MBA


  2. Is Modern Portfolio Theory Antiquated?

    Dr. Marcinko – At last month’s Financial Planning Association’s annual conference, many were surprised by the number of Certified Financial Planners™, asset managers and financially advisors who were beginning to believe that MPT is dated.

    Any thoughts?



  3. What happened to the market in August and September?

    Between July and the end of September, markets lost between 13.5% (Dow) and 27% (Emerging markets) depending on which market you are looking at.

    I pored through economic data and could not see any marked deterioration in the economy. In fact, on balance, I see continued slow improvements.

    Pundits attribute the market tumble to 1) political gridlock inWashingtonand the 2) European debt crisis. I don’t buy either of these explanations.

    More from Michael Zhuang:


  4. The Modern Portfolio Theory … A Continuing Controversy

    The MPT debates centers on the operative definition for boundaries of “risk”.

    The Classic MPT
    Here risk is defined as the standard deviation that is equally distributed above and below the expected rate of return line [parametric].

    The New-Wave MPT
    Here risk is defined as the standard deviation that is not equally distributed and lies only below the expected rate of return line [non-parametric]. Thus, it is more conservative than the classic theory.

    What do you think, Bradley and Michael?

    Dr. David Edward Marcinko MBA CMP™


  5. Are Wealth Managers Clinging to Old, Ineffective Investment Models?

    “[A] segment of wealth managers appear to live in denial, clinging to investment methodologies that have patently failed twice over the past decade and are likely to fall short again,” the authors of this white paper say.

    Dr. David Edward Marcinko MBA


  6. Modern Portfolio Theory (MPT)

    Wasn’t this hypothesis was confirmed by Brinson, Hood and Beebower, who demonstrated that 94% of portfolio returns are explained by diversification? This study supports the concept that it is better to be in the “right asset class”, than the “right investment”, and that asset allocation is the main determinant of portfolio performance, not security selection or market timing.

    Mutual collaboration is needed to develop a governing document, known to us as a Medical Investment Policy Statement©.

    Unfortunately, some analysts hired by Wall Street to disregard MPT and make buy, sell or hold recommendations, are suspect because of their pack mentality. There is usually a lead analyst for each stock, and when he moves, the others follow. They often worry about investment-banking clients.

    The conflict of interest is obvious.

    Dr. David Edward Marcinko MBA


  7. Does Modern Portfolio Theory Still Work?

    The booming stock market rally of recent years makes now a prudent time for advisors to revisit what we learned about modern portfolio theory and apply those lessons — before we find ourselves in the middle of another down cycle when mistakes snowball.

    Dr. David Edward Marcinko MBA CMP™


  8. Fama, French and Auld Lang Syne with video

    How many of your co-workers from decades ago are still on your annual holiday greeting card list? Of those, how many are respected colleagues with whom you continue to collaborate – so closely, in fact, that you have a forum named after you? Such is the relationship between University of Chicago Professor (and Nobel Laureate) Eugene F. Fama and Dartmouth Professor Kenneth R. French. This Auld Lang Syne pair is the namesake behind the Fama/French Forum, and dozens of groundbreaking studies on what makes the markets tick.

    When Professor French posted a recent homage to Professor Fama, “Things I’ve Learned from Gene,” we were reminded of the value of long-thriving acquaintances like theirs. Here are some inspirational take-aways from French’s post and our own reflections on the same.

    “If you are not willing to do something now, don’t agree to do it later.” – Prof. Eugene F. Fama

    So true. What do we really think will change? We will suddenly have more time? More energy? More willingness to step out of our comfort zone? Not likely. Acknowledging this from the beginning can prevent future regrets and accumulated excuses.

    “You make enough mistakes by mistake, don’t make one on purpose.” – Prof. Eugene F. Fama

    Professor French’s additional reflection: “I finally figured out why my life always seems more frenetic than Gene’s. … Whenever it looks like I’ll have some slack in my schedule, I commit to do more and, if things turn out better than expected, I add even more. … [My] approach ensures that if anything goes wrong I am screwed.” Our own take on it (and perhaps a 2015 New Year’s resolution): Stuff happens. Leave some wiggle room in your day.

    “When writing papers, [Fama] works hard to make his logical arguments and statistical tests as simple as possible.” – Prof. Kenneth R. French

    There is indeed something to be said for simplicity, but the “simple as possible” part is important too. There is a difference between stumbling along in blind ignorance versus advancing with elegant understanding.

    “Our job is not to write papers, our job is to get people to read papers.” – Prof. Eugene F. Fama

    Professor French elaborates: “Gene tries to be clear, succinct, and precise. He can usually have all three, but when there is a conflict he sacrifices clarity and brevity for precision.” These insights emphasize how important it is to avoid red-herring distractions and stay focused on one’s actual goals.

    “[Fama] is blunt occasionally, but that is efficient, not rude. … Gene rejects all ad hominem attacks. He consistently focuses on the idea he is arguing about, not the person he is arguing with.” – Prof. Kenneth R. French

    If only more people would appreciate this distinction. Let’s begin with some of the conversations that take place in Washington. And, admittedly, each of us may be guilty as charged more often than we’d care to admit.

    “It’s our fault if a smart, careful reader does not understand the paper.” – Prof. Eugene F. Fama

    No need to show off. People can tell if you are smart.

    Sheri Iannetta Cupo CFP®
    [NJ Fee-Only CFP® professional]
    SageBroadview Financial Planning, LLC

    via Ann miller RN MHA


  9. On MPT

    The problem is that MPT is no longer “modern” and the basic attempts of using poor theory resulted in the devastation of 2000 and 2008 and more to come.

    The poor and middle class cannot afford 50% equity losses once or twice a decade, particularly during retirement. The upper class of physicians should rail at what the planners are still (not) doing for their clients. Maybe they can mange holding on lower values and wait till the reversion happens.

    But, it could be 30 years before it happens.



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