The History of the Modern Portfolio

When talking about investment portfolios, it is common that a person would know its exact meaning and the reason behind it. Further it’s shocking that such a fundamental aspect didn’t exist in the early 60’s almost 50 years back. Wherein no one would know what it is at the slightest. The investment portfolio simply means accumulation of income producing assets in order to meet a financial goal set. It has complex mix according to the preference of the investor or the managers he assigned his work to. Since the appointed are professionals to do this job with precise knowledge and accuracy.

So in this article we would know the brief history of the investment portfolio of how it started. The evolution over the years of investment portfolio is to a point currently where it’s really common. Wherein if you ask a person that “you need to diversify your portfolio”, he would exactly know what you mean.

The Beginning:

In the late 30’s there was a term known as portfolio. Although the meaning of the term was different as the investors intention was to lay their bets on the stocks. That were sought to be at their best price which captured the thinking of the dividend discount model. Thereby there were professional managers who knew the exact meaning like Benjamin Graham who first got accurate information, analysed correctly. They later made his investment decisions but no one focused on risk factors at that time.

Risk factor evaluation in the portfolio:

Harry Markowitz, a graduate student in operations research. He was studying his thesis on linear programming. It employed a model to maximize output for a given level of cost, or vice versa. He was in a conversation with a stockbroker wherein he suggested applying his thesis in the stock market. Therefore he wrote an article on “portfolio selection” which introduced the investors to the risk factor as an important term. It includes investing in their portfolios.

Modern theory started to churn up:

Markowitz formalized the investor trade-off wherein people realized the importance that there are stocks of high risks with high returns. Also there are debt terms with the exact opposite and mathematically solving the risk tolerance. Further reward expectations to create an ideal portfolio.

He even denoted the Greek letter beta to represent the volatility of the market. Wherein the low beta would conclude that it is passive investing. Going forward high beta would conclude that the stock is more volatile than the market.

Therefore this gives investors choices to define their requirements based on the risk and returns. Rather than taking assistance of the broker. Also this gave rise to the various models such as Capital assets pricing model (CAPM). It helped in creating balanced portfolio that gave rise to Modern Portfolio Theory (MPT) with the CAPM and risk factor.

Conclusion:

This broke the wave in the Wall Street and managers who used to work on gut feeling. It became hostile towards the investors. For those who were using the risk factor knowledge to dilute rewards by minimizing their risk.