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Celebrating Groundbreaking Research with Giants of Finance: Robert C. Merton, Fama and French, and Robert Novy-Marx

How many investors appreciate the role financial science has had in the way we invest today? Before financial science emerged in the middle of the 20th century, there was only one way of investing—the traditional active way. People would research individual stocks and bonds and buy a few that they thought were underpriced.

That changed when Harry Markowitz, a Ph.D. candidate at the University of Chicago, introduced the idea of Modern Portfolio Theory in his 1952 paper “Portfolio Selection.” This theoretical paper suggests the steps an investor can take to build a portfolio that balances efficiently the tradeoff between expected return and volatility. It was the first big breakthrough in financial science and is still taught today as one of the cornerstones of financial theory. Markowitz later became a Nobel laureate for this work.

Traditional active stock picking, however, remained about the only investment approach until the early 1970s, when indexing emerged. This new approach offered broad diversification, low cost, and transparency by holding all securities in a market index. These characteristics appealed to investors who were familiar with the research of Michael Jensen, another Ph.D. student at Chicago, who in 1968 illustrated how few fund managers outperformed the market, especially after their fees and costs were deducted.


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