The modern era
It was this theory that became established market practice, together with ad valorem charging practices. This benefitted investment managers, and helped introduce a variety of other specialist advisers, although always at the cost of reducing the marginal returns that can be expected within investment markets. But an unacknowledged weakness of all these theories is that everything is based on detailed history, and takes no account of the future, let alone human emotions.
Yet history shows markets are controlled more by emotion than facts. Since at least the late 17th century, natural science has worked on scepticism, and disproving proposed hypotheses, in the course of identifying what works, what is believed to work, and that which is based on facts and which on faith.
There is no concrete evidence that modern portfolio theory works and, compared with the earlier belief in income generation, much current thinking is more based on faith and authority than practical reality. So also is much economic theory, as is the political attitude to banking problems. Despite the 2008 crash, nothing has changed except for the worse – higher indebtedness, bigger banks, more extreme gearing. There will be another crash, but when exactly this will happen is, as ever, another unknown.
If financial advisers are to help clients, they need to rethink their own beliefs and concentrate on what has been proved to work, not on unsubstantiated promises. This means investment trusts, and using individual trusts to give real diversification, based both on future guesses as well as current reality.
This is what the portfolio outlined in Tables 1 and 2is designed to do, as I will explain in next month’s column.
