Abstract
The big boon to modern diversification was not just structural in nature with the introduction of the open-end mutual fund; it was also theoretical. In 1952, a young Ph.D. student at the University of Chicago, Harry Markowitz, published a groundbreaking paper, “Portfolio Selection” (Markowitz, Harry, “Portfolio Selection”, Journal of Finance, Volume 7, Issue 1, March 1952, pp. 77–91). Markowitz had chosen to apply mathematics to the analysis of the stock market as the topic for his dissertation. So, Markowitz took a simple concept—“don’t put all your eggs in one basket”—and demonstrated how even the addition of a high beta asset (a more volatile, higher-risk stock) could bring down overall portfolio risk through lower correlation across the asset mix. In retrospect, this was no easy task: How could higher-risk assets reduce overall portfolio risk? In itself, the concept is counterintuitive. The trick was balance within the overall portfolio.
The practical application of theory, combined with goal setting, is an important function of the board. How much do we need and when? The simple approach discussed in this chapter for asset allocation allows the organization to set reasonable goals, ensure enough cash flow, and balance risk with return. It should be revisited regularly, however, as capital market assumptions will change, as will the internal needs of the organization.
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Notes
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Markowitz, Harry, “Portfolio Selection”, Journal of Finance, Volume 7, Issue 1, March 1952, pp. 77–91.
- 2.
Source: NACUBO (National Association of College and University Business Officers).
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Merker, C.K., Peck, S.W. (2019). Theory Time. In: The Trustee Governance Guide. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-21088-5_9
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DOI: https://doi.org/10.1007/978-3-030-21088-5_9
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