The cocoa worked its beneficent mind-clearing magic and in no time he was his old self. Naturally, once he found his footing, he wanted to talk about his investments. In particular, he asked me to bring him up to date on what had become of Modern Portfolio Theory. Was it still, for example, modern?
We fell easily into an extended conversation--so intense that I barely noticed that Investo was making notes in some sort of weathered steno pad. Hours passed without my being conscious of the time, but as the sun began to break through on the horizon, I could see Investo start to shake his head as if to help focus on the world, "I have to go," he said, "but this is for you"--whereupon he ripped out what was to all appearances a carbon copy of the notes he had taken. Before I could offer him breakfast, he slipped out through the door and into the early dawn.
I laid the carbon aside and forgot about it as I turned my attention back to my own life. But later in the day I noticed it and gave it a quick skim. Here is the first page:
MPT 20 years later:Did I say all this? Was it true, I wonder? Will he come back and explain to me what I could possibly have been thinking?
Markowitz diversification: Still largely true, made into a Godzilla by securitization but then completely undercut by tranching.
Sharpe Beta: Dead, and getting deader, except perhaps in old-fashioned textbooks and in the training manuals of second-tier salesmen.
Tobin separation: Actually, still alive and healthy insofar as it underlies index funds and such, but everyone has pretty much forgotten the name.
Fama ECMH.: Oh dear. Nobody believes Fama ECMH any more, not even Fama. It tells you nothing about bubbles and crashes, and it doesn't alert you to the notion that we may all be irrational in systematic or predictable ways. Yet it's still true that the market is not for amateurs, and that if you go into a strange poker game, you look around for the sucker and if you don't see him, you get out because you're it.
Black Scholes Option Pricing: This may be a two parter. Black Scholes taught everybody that options traffic in risk, and that you can slice and dice risk into a million pieces (and no, don't pretend you knew that all along). But Black Scholes was more or less vaguely based on the notion that outcome distributions are "normal" and we have learned to our dismay that they are nothing of the sort.
Modigliani Miller Leverage Irrelevance: Kinda sorta true, as we come to grasp that there is no clear line between debt and equity, between "owners" and "lenders;" all are just claimants against the asset pool.
Modigliani Miller dividend irrelevance: True if you believe that managers maximize shareholder value. And that pigs will fly.
Oh, and one more thing: down at the bottom of the page: note to self, must check on my investment in Lehman Brothers.