226 THE INTUITIVE INVESTOR
of a serious-minded physicist, the kind whose pocket protector says,
“Nobel Prize or Bust.” As remedial action, my cousin recommended
several books on physics, including The Tao of Physics and The
Dancing Wu Li Masters: An Overview of the New Physics.
What struck me as I read these books on the evolution of physics
were the similarities between physics and investing. Consider, for
example, the model for investing prior to Harry Markowitz’s Nobel
prize-winning work on efficient frontiers. Portfolio managers used
to construct their portfolios on a stock-by-stock basis, without
considering the effect of stocks’ interaction with each other. The
importance of the covariance between stocks and the resulting
benefits of diversification was often ignored, as Gerald Loeb’s dic-
tum from the 1950s indicates: “Diversification is undesirable. One
or two, or at most three or four, securities should be bought” (quoted
in Ellis, Classics, Dow Jones Irwin 1989).
With the advent of Modem Portfolio Theory (MPT), stocks
are no longer considered separate and distinct, but rather are evalu-
ated on the basis of how their interaction with other stocks in the
portfolio affects such variables as tracking error, beta, and alpha.
(In the 1950s, when my father managed money professionally, the
terms alpha and beta brought to his mind fond memories of Greek
fraternities, and “pairs analysis” was the favorite activity when
sorority women arrived at a party. To his last day, my father be-
lieved that “efficient frontier” had something to do with the Loui-
siana Purchase.)
Consider the parallels with the evolution of classical Newtonian
physics into modern quantum physics. Classical physics saw the
scientist as standing apart from the physical world, carefully mea-
suring its phenomena. It was thought that events were separate
and distinct and could be accurately quantified. The model for the
universe was that of a giant machine whose movements could be
studied and known with certainty. This view changed as Einstein’s
relativity theory and Heisenberg’s Uncertainty Principle became
accepted. Modern physics, like Modern Portfolio Theory, recog-26-29 ware 226 1/19/01, 1:19 PM