Diversification - Markowitz’s greatest gift

By Marek Krzeczkowski - Portfolio Manager and Ryan Falls - Senior Analyst

Hailed as the ‘Father of modern portfolio theory’, Markowitz won the Nobel Prize in 1990 in Economic Sciences for his invaluable contribution to the field. Arguably his greatest gift to the world was his commodification of an age-old adage into the world of investment – ‘don’t put all your eggs in one basket’ a.k.a. diversification.

First and foremost, one of the tenants which Mr Markowitz’s investment framework¹ relies on is that the expected return for any asset is directly proportional to the level of expected risk. In simple terms this means, higher risk means higher return and vice versa, as shown in Figure 1. So, to maximise the return that you expect to get, that naturally would mean you maximise the amount of risk you can take (up until the point you are comfortable with). However, as Mr Markowitz goes on to show - there are more efficient ways to achieve the same level of return for a lower level of risk.