Moving Beyond Modern Portfolio Theory

Chapter 1: The MPT Revolution Devours Its Children
Modern Portfolio Theory (MPT) revolutionized investing and the world’s economy. But it is deeply flawed. The evolution of capital markets, the explosion in computing power, and the increasing recognition of systematic risk as driving more than three quarters of investment risk and return has exposed MPT’s weaknesses. The authors examine many of the associated theories surrounding MPT -- capital asset pricing model, economic rationality, random walks down Wall Street and the efficient market hypothesis – and find them based on flawed assumptions. They also note the “performativity” of the MPT tradition; that is how it tends to create its own validity simply because people believe and follow it and becomes a victim of its own success.  They note MPT’s real world impacts, such as index effects, super portfolios, and changes to companies’ corporate governance and spending on research and development. 
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Chapter 2: The MPT Paradox
Investing should generate a risk-adjusted return for investors and allocate capital to where it is useful for society. MPT fails at both purposes because its math is hermetically sealed away from the real economy. MPT performatively forces the focus onto relative risk/return; that is risk/return relative to a market benchmark such as the S&P 500. The lack of interaction with the real world also means MPT provides no tools to mitigate systemic risks, like climate change, financial crisis or gender discrimination. Yet systematic risk in the capital markets determines 75-94% of return and is often caused by risks to the environmental, social and financial systems.  But since MPT tradition says investors can’t affect systematic risk, the “MPT Paradox” forces investors to focus on that which matters least which is trying to match or beat relative return benchmarks. The authors challenge investing orthodoxy by demonstrating how investors can and do affect systematic risks. A short case study shows how the New York City pension funds created $132 billion in value using a systems-level investing technique called “beta activism”.In a secondary challenge to traditional investing dogma, the chapter shows how alpha and beta morph into each other over time. 
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Chapter 3: Short-termism
Delving into disciplines as varied as evolutionary neurology, technology and trading psychology, this chapter examines the causes and manifestations of short-termism in the capital markets. The results are striking, if toxic, stew of irrational hyper-discounting of future cash flows, excess trading, and degradation of returns; all aided and abetted by Modern Portfolio Theory’s focus on relative returns and alpha-seeking although not directly of Modern Portfolio Theory’s making 

Chapter 4: Everything Old Is New Again
Arguing that Modern Portfolio Theory is artificial in viewing investing as disjoint from the causes of value creation can be seen as innovative, but it reflects classical economics’ concern with the feedback loops that affect economic decision-making. The chapter begins with how five economists – Adam Smith, Karl Marx, Ronald Coase, Oliver Williamson and Milton Friedman – allowed for robust real-world feedback loops.  The authors then examine how risks and opportunities become financially material.They argue that materiality is not a “state of being” but a “state of becoming”; norms evolve in a “Values to value” progression.  They then explore the how some jurisdictions define materiality to be singularly related to the potential impact on an individual company, even though the vast majority of investors are broadly diversified. Other jurisdictions define a system of “dual materiality” to include both corporate-specific impacts and those that affect the environmental, societal and financial systems on which the capital markets rely. The chapter ends with a signature exploration of “extended risk” and “extended intermediation”, defined as considering the conditions in which financial returns will be expended and the result of intermediation on the providers and users of capital. 

Chapter 5: From Dividends in Nutmeg to Creating $5 Trillion: Welcome to the third stage of corporate governance
Summarizing 350 years of corporate governance history, the authors show how corporate governance has evolved from only considering individual company governance, to a wider Environmental/Social/Governance (ESG) focus, to concern with systems-level issues. Today, many investors act according to “universal owner” theory; they understand that the overall return of the market matters more than any possible skill they may have in security selection and portfolio construction. The authors show that investors act differently than traditional MPT investors, who focus on trading and portfolio risk issues. Using The Investment Integration Projects’ “tools of intentionality” taxonomy, this chapter examines six cases where investors (Blackrock, Church of England Pensions Board, Domini, Federated Hermes, Goldman Sachs Asst Management, Legal and General Investment Management, Nordea, State Street Global Advisors, Swedish AP Funds) mitigate various systemic risks through real-world interventions.  The issues spotlighted include: Artificial intelligence bias, anti-microbial resistance, climate change, deforestation, lack of gender diversity, mining safety. The authors conclude that third-stage corporate governance beta activism has created between $2-5 trillion in global wealth. Most importantly, systems-level investing and beta activism have the promise of helping to maintain the environmental, social and financial systems in the future.