Hello Nathan,

Thanks for taking the time to comment and to append your thoughts to our article.

I do not think that someone who is critical of something is necessarily responsible for providing an alternative. There are several phases: one, identify the flaws of a broken paradigm; two, research new ways of viewing the world; three, test those new methods; and four, implement them widely. In the case of MPT, what is good about it is that it suggests that investors should be compensated for the risks that they take on. This is logical, and intelligent. However, it then goes on to propose a measure of risk that is merely mathematically convenient, rather than being mathematically useful. On this basis alone MPT and its calculations can be rejected. Another good thing about MPT that is logical and intelligent is its suggestion that not all diversification matters. Few people would reject these ideas, and none do, as far as I know.

Without MPT, how do you build a portfolio? I never used MPT in my investment management career and I bested my benchmark, the S&P 500 by 49.1%, with 2/3rds the volatility, and double the dividend yield. How did I do it? By applying my mind to the problem and developing something other than MPT. What that is remains proprietary to my former employer. But I will point out that physicists and mathematicians - the honest ones at least - believe that about 40% of natural phenomenon can be described with mathematics. Therein I have revealed a big clue about what you can do.

Another problem with MPT, in my mind, is that it does not get rid of the ex-ante/a priori problem. Namely, you still are left making predictions about the future. In the case of MPT you need to have return and risk estimates for every security in the portfolio. Most people stop short of making predictions about these things and use past data to inform their future view. If they do, in fact, make non-historical based predictions then, to my mind they have simply added another layer of predictions needed before investing. Why add another layer of abstraction and complexity to an already abstract and complex activity: investing?

I find your use of language to be a bit fast and loose; and here I am referring to what I believe is a conflation of 'things other than MPT' with irrationality, as evidenced in your series of sentences, "I’m not ignoring the flaws in MPT, just pointing out that there is no better alternative for process driven portfolio construction. Clearly rational decision making is preferable to irrational, and disciplined investing preferable to undisciplined." I do not think that comparison is appropriate and it awards MPT a distinction undeserved by its poor evidence in delivering alpha. While on the subject of 'rational;' is it rational to use a theory that you admit is flawed ("I'm not ignoring the flaws in MPT...")?

Last, as for what should we do? I would say roll up your sleeves, put on your thinking cap, and get busy.

In closing, the philosophy of MPT is better than the mathematics created for its implementation. And therein resides another clue.

Yours, in service,

Jason