Markowitz for the Masses: The Risk and Return of Equity and Portfolio Construction Techniques

Markowitz analysis seeks to maximize return for a given level of risk, or minimize risk for a given level of return. Prior to Harry Markowitz, investments were often associated with returns and not risk. John BurrWilliams, in his seminal The Theory of Investment Value (1938), stated in his preface Investment Value, defined as the present value of future dividends or of future coupons and principal, is of practical importance to every investor because it is the critical value above which he cannot go in buying or holding without added risk. If a man buys a security below its investment value he need never lose, even if its price should fall at once, because he can still hold for income and get a return above normal on his cost price. But if he buys it above its investment value, his only hope of avoiding a loss is to sell to someone else who must in turn take the loss in the form of insufficient income (p. viii). Mr. Williams put forth a theory of investment value that influenced Mr. Markowitz profoundly. Let us review the work of Mr. Williams. For stocks, Williams calculated the present value of future dividends: $$V_0 = \sum\limits_{t = 1}^{\infty} d_t\left(\frac{1}{1 + i}\right)^{t}$$ (1.1) where V 0 = Investment value at start, d t = dividend in year t, and i = interest sought by investor.