Thomas/Jason:

Thanks for shedding light on this very important issue.

I have always had my doubts about MPT equating volatility to risk. This mathematically convenient "assumption" sits at the heart of every portfolio management decision. We know this is not correct, yet volatility is a widely-accepted measure of risk for portfolio managers. And therein lies the problem.

Essentially, active portfolio managers are the victims of MPT, which (through volatility-based constraints) corners them into making sub-par investment decisions to stay within their investment mandates. You are right, in this context they are nothing more than closet indexers and I take my hat off to those, who manage to generate alpha under these conditions. I also agree that active equity portfolio managers show their true potential when they are given the freedom to pursue their strategies without the overwhelming checklist of MPT-based limitations.

If we drop the erroneous assumption that volatility equals risk, we could free our collective minds to explore, measure and interpret real equity risks. Maybe in the process we would stumble upon a framework that would better encapsulate the true nature of equity analysis.

My conclusion, though, after spending more than a decade in finance industry, is that equity analysis does not lend itself to a static model or a scientific generalization. This is due to the embedded, unpredictable human nature in the decision-making processes of companies, consumers, suppliers, etc.

The most promising way to make sense of it all is to develop a non-static, AI-based framework and integrate it into the portfolio decision making process.