Decision-making under uncertainty : Markowitz optimisation as a passive strategy on the JSE

Abstract

Noted economist and Nobel Prize winner, Harry Markowitz is often called the father of modern portfolio theory based on his 1952 article, Portfolio Selection. His innovative work provided a framework for investment managers and showed that it was possible to create and construct an optimal investment portfolio, offering the maximum possible expected return for a given level of risk. Markowitz showed that the risk of a security is not the risk of each security in isolation, but rather, the contribution of each security to the risk of the investment portfolio as a whole. This study endeavours to apply modern portfolio theory to the JSE. More specifically, the aim of the study is to establish whether a passive trading strategy based on the theoretical underpinnings of Markowitz can outperform the market index, represented by the FTSE/JSE Top 40 TR, on a risk-adjusted basis over a period of 19.5 years. To accommodate both risk-averse and risk-neutral investors, two Markowitz portfolios are constructed, tested and compared to the market index. The results from this study indicate that both of the Markowitz passively managed portfolios outperformed the market index by a significant margin. However, the portfolios are more volatile than the market, as subsequent analysis shows that the Markowitz portfolios unlock value over a longer time-period. The risk-adjusted outperformance does provide a strong case of momentum on the JSE, where securities that did well in a previous period continue to outperform in the next. Finally, the researcher found no conclusive evidence to factually state that the Markowitz portfolios are sufficiently diversified.