From Theory to Practice

The investment profession has experienced major changes in the short time since 1970—primarily because of advances in technology. We regularly use quantitative models, we have masses of data, and the world is our market. New financial paradigms have not, however, eliminated the challenges of investing. And in the future, we will need to deal with new as well as old issues. The investment profession has experienced major changes since 1970—primarily because of advances in technology. Theoretical work on various aspects of finance had been going on since 1900, but these early ideas did not gain traction until Markowitz wrote his dissertation examining the mathematics of portfolio risk in 1952.Until the arrival of the computer, no one had a means for testing or applying the theoretical ideas. The large advances in computer technology during the 1960s and 1970s made testing practical and fostered a growth in the quantitative content of economics and finance.In the nonacademic world, practice was often far removed from the textbooks. In the early 1970s, investors did not regularly calculate their performance and the performance numbers they did compute were simple estimates. Moreover, investments were usually not viewed as a portfolio.Today, we regularly use quantitative approaches; they have inspired new markets, and the models have changed how we look at finance and risk. Performance is measured frequently and carefully. We view the aggregate characteristics of portfolios with relative ease. We understand the diversification merits of global investing, indexing has become commonplace, the financial markets have become more efficient since 1970, trading is becoming automated, short-term performance has taken on too much importance, defined-benefit plans have peaked, and individual-directed investments are on the rise.New financial paradigms have not eliminated the challenges of investing. Booms and busts still occur. Throughout all the trends, investing remains a task that rewards merit and punishes the lack of merit. We need to efficiently use the masses of data we now have in combining investment information and using this information to build portfolios.In the future, new technologies will arise, old and new issues will challenge us. I hope for the following:Capital markets will increase everyone's overall welfare.Participation in the capital markets will be broad and thoughtful.The costs of investing will continue to fall.Information for all investors will be plentiful and of high quality.The average investing result of all investors, while remaining average, will be higher than ever before, and less risk will be involved in obtaining it.Access to capital markets will be fair, and ethical, high-quality advice will be available to all who need it.