Finance's Wrong Turn: A Critique of 20th Century Active Management

The invention of Markowitz (1952) mean-variance (MV) optimization altered the course of 20th century finance from security valuation to portfolio risk management.  The Markowitz frontier is a model of long-only institutional investment behavior representing a universal framework for asset management theory and practice.  The Capital Asset Pricing Model (CAPM) is MV preference theory based on Von Neumann and Morgenstern game theory rationality axioms.  CAPM theory was instrumental in the development of a 20th century multi-trillion dollar institutional quantitative asset management industry. 

Today, finance theory and active management is in crisis.  Market meltdowns, internet bubbles and ineffective active strategies are leading investors to rule-based minimal cost no-information index or fixed-factor funds.  Is theory, investment technology, or understanding of capital markets to blame?  We argue that all three factors significantly contribute to contemporary asset management ineffectualness.

CAPM theory is inconsistent with human decisions, (Allais 1953), effective investment (Jobson and Korkie 1981), investor behavior (Kahneman and Tversky 1979), and Markowitz (2005) optimization.  However, Markowitz MV optimization is itself estimation error sensitive and ineffective in practice (Michaud 1989).  Proposals for remedying estimation error sensitivity are ineffective (Michaud et al 2013, 2017).  In addition portfolio monitoring methods are generally ad hoc and not portfolio based.

A resolution for limitations of Markowitz optimization in practice and ad hoc portfolio monitoring is proposed in Michaud (1998).  Given limitations of efficient market theory (EMH) and CAPM, a resetting of understanding of capital markets is in order.  A useful route may begin with Knight (1921) uncertainty, Keynes (1936) speculation, limitations of rationality axioms, and consilient social-psychological theory of positive feedback markets.  Capital markets emerge as rational though inefficient and unstable highlighting the serious need as well as opportunity for effective active management technology in practice.   

Beginning in March, New Frontier President and CEO, Dr. Richard Michaud, will partner with CFA Society Boston to teach a 5-week course that addresses the crisis in modern finance and quantitative asset management. 



Allais, M. 1953. "Le comportement de l’homme rationnel devant le risque: critique des postulats et axiomes de l’école Américaine." Econometrica 21: 503-546.

Jobson, D.  and B. Korkie, 1981.  “Putting Markowitz Theory to Work.”  Journal of Portfolio Management 7(4): 70-74. 

Kahneman, D. and Tversky, A. 1979. "Prospect Theory: An Analysis of Decision Under Risk." Econometrica 47: 263-291.

Keynes, J. 1936. The General Theory of Employment, Interest and Money. 1st ed. Macmillan, p.116.

Knight, F. 1921. Risk, Uncertainty and Profit. Boston: Houghton Mifflin Company.

Markowitz, H.  1952.  “Portfolio Selection.”  Journal of Finance 7(1): 77-91.

Markowitz, H. 2005.  “Market Efficiency: A Theoretical Distinction and So What?”  Financial Analysts Journal 61(5):17-30.

Michaud, R.  1989.  “The Markowitz Optimization Enigma: Is Optimization Optimal?”  Financial Analysts Journal 45(1): 31-42. 

Michaud, R. 1998.  Efficient Asset Management.  New York: Harvard Business School Press.  Now published by Oxford University Press.

Michaud, Richard O., David N. Esch and Robert O. Michaud. 2013. Deconstructing Black-Litterman: How to Get the Portfolio You Already Knew You Wanted,” Journal Of Investment Management, Vol 11. No. 13. https://

Michaud, Richard O., Robert O. Michaud and David N. Esch 2017. “Estimation Error and the ‘Fundamental Law of Active Management,’”  Working Paper.

About the author

Dr. Richard Michaud is President and CEO of New Frontier Advisors, LLC.  He earned a PhD in Mathematics from Boston University and has taught investment management at Columbia University.  He is the author of Efficient Asset Management (1998, 2nd ed. 2008 with Robert Michaud), a CFA Research Monograph (1999) on Global Asset Management, and numerous academic and research articles available on and  He is co-holder of four U.S. patents in portfolio optimization and asset management, a Graham and Dodd Scroll winner for his work on optimization, a former editorial board member of the Financial Analysts Journal, associate editor of the Journal Of Investment Management, and former director of the “Q” Group.

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