Back to Markowitz?

5. September 2012 by Joachim Goldberg


Markowitz-ian portfolio diversification really does work, if one has a long time horizon and one is patient. That, at least is the opinion of David Swensen, the Yale Endowment Fund manager. Professor Swensen is a known fan of broad risk diversification in the spirit of the Nobel Prize winner, but had to take a lot of flak in the wake of the financial crisis when he discovered what can happen when many professional investors around the globe follow precisely the same schema. The popular appeal of a broad diversification in supposedly unrelated asset classes (in many cases purchased with borrowed money) meant that previously uncorrelated assets became highly correlated when the crunch came. When those loans were called in after the subprime crisis exploded and Lehman’s went broke, it didn’t matter what assets investors had bought with their borrowed money; they all had to be sold. What seemed to be such an appealing idea for risk diversification went the same way as so many other ‘Golden Rules of Investing’: it worked as long as everyone else was not doing the same thing.

Now, after the years have dulled the memory of huge price collapses of the crisis’s peak, it seems some are again looking favourably at the good, old Markowitz approach. But how can one genuinely diversify one’s portfolio? It is not surprising, given the still high level of uncertainty, that there is a popular preference for tangible assets, not least because the yields on the safest bonds are at record lows. For those who already own gold or silver – which is quite a few – this means a shift into even less movable assets. However, apart from real-estate, what is left? Classic cars? Art? Vintage Bordeaux? Yesterday’s Financial Times Deutschland shared the opinion of one private banker: if one has a penchant for fine wines or some other physical asset, and knows the niche well, this could nonetheless constitute a good investment. However, any purchase must really be a coup-de-coeur, he insisted. “Hmmm, something for me,” I thought to myself.

Whenever I read the expressions ‘long-term’ and ‘patience’ in the same sentence an uncomfortable feeling often comes over me. The combination sounds like an engagement that, at least in the present, cannot be liquidated without realising a loss. This is precisely the case in the Bordeaux wine market. Prices, as measured by the Live-Ex Fine Wine 100 Index[1], more than tripled in the five years to mid-2011. I can still remember, at that time, a single bottle of Chateau Lafitte-Rothschild 1869 changed hands at Sotheby’s in Hong Kong for $233,000. Since then, however, the prices have only fallen. The benchmark has shed some 27 percent since the peak and is now back at the level that prevailed in 2008. This is not to mention the impressive bid-ask spreads of 20-30 percent that non-professionals have to contend with. It is no wonder that so many give diversification into pricey, opaque, tangible assets a miss.

Fortunately, I am a genuine wine fan. I chase the ruby nectar not for the yield or the diversification, but for fun and for the passion. No, I will not fill my portfolio with wine, even if Markowitz is again in fashion.

[1] This is a leading wine industry benchmark. Bordeaux represent a good 90 percent of the weighting.

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vposted on 5. September 2012 at 9:31 am

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