The investment universe is filled with surprises, and perhaps the biggest shocker of all is the idea that the value strategies of Ben Graham and his disciples are in general agreement with modern portfolio theory (MPT).
Granted, it sounds absurd. MPT, after all, is the suite of financial theories that spawned index funds and the view that market prices are the best estimate of intrinsic value. Meanwhile, Graham’s value strategy asserts the opposite, advising that savvy investors on the hunt for bargains can do a better job of calculating fundamental value, a strategy that boosts the odds of generating market-beating returns.
MPT and value investing, it would seem, are natural adversaries. That was true, but the two ideas have become similar thanks to the evolution of MPT. But while the academic interpretation of MPT has changed, the popular perception remains stuck in the 1960s and 1970s, when two of its major components–the efficient market hypothesis (EMH) and indexing–first arrived on the financial scene. Recognized or not, there’s been a slow but steady accumulation of empirical research since the 1980s that’s altered financial economists’ view of capital markets. As a result, there’s a new MPT in town and it’s a lot closer in spirit to a Graham-inspired view of investing.
Ok, but why should investors care? Because if the classic strategies of active and passive investing are more closely aligned around value investing principles, the union lends more authority to value strategies generally. Indeed, if two formerly competing notions of money management–each commanding huge amounts of money under management–are now in basic agreement, it probably reflects a fundamental truth about how the capital markets function and how investors should build and manage portfolios.