Harry Markowitz, who more or less invented modern portfolio theory with his 1952 paper “Portfolio Selection,” talks finance in a new Q&A published by the Journal of Financial Planning. Asked if he thought MPT was fatally wounded from the dramatic market volatility of recent years, he said, No: still alive and kicking. “In fact, it proved itself in the crisis rather than disproved itself,” he asserted.

He then goes on to explain why modern finance is relevant…

Let me give you an example. There’s a simplified model of covariance, a simplified model of portfolio theory that Bill Sharpe published in 1963 that said, “Things go up and down, you know, just assume that things go up and down together because they go up and down with the market. But, the amount that they go up varies from one asset class to another, depending on their beta.”

So, the way they measure these things, the S&P 500 has a beta of one but the bonds have a much lower beta and emerging markets has a much higher beta. So, in 2008, the S&P 500 went down 38½ percent. Corporate bonds went down about 5 percent. Emerging markets went down about 60 percent. So, as things went up and down, roughly in proportion to their beta and people who had done a risk- return analysis and picked a portfolio high on the efficient frontier with a high beta, they got hammered a lot. But, on the average, over the long run, they should do better than the guys who are lower on the frontier, who got hammered less.

So, there was a risk-return tradeoff and things worked out, in accord to the beta of your portfolio. Things worked out as one would have anticipated.

He also noted that asset allocation—”top-down analysis”—has come a long way since his groundbreaking paper was first published. “People who have no more ability to pick stocks than I have are now able to do a risk-return analysis at an asset class level, and they get you on the right part of the [efficient] frontier. Then, they implement it in terms of mutual funds or ETFs. That was a stroke of genius.”