Harry Had it Right
In the late 1950s a brilliant man named Harry Markowitz ushered in the era of modern finance with his book Portfolio Selection: Efficient Diversification of Investments (Cowles Foundation for Research in Economics at Yale University, 1959). Harry won the Nobel Prize in Economics (1990) for his research in the field of investment diversification and is widely regarded as the father of modern portfolio theory. He also happens to be a very approachable and extremely kind man.
Harry’s work was groundbreaking and it is still the foundation for virtually all financial investment activity on the planet today. Prior to the (remarkably rapid) acceptance of Harry’s Portfolio Theory, the word ‘portfolio’ had no context in financial investing. Investment instruments, be they stocks, bonds, mortgages, principle protected etc., were viewed as individual ventures – no matter how many different investments a holder may control. At the end of any given time period their gains, losses and yields were added together yielding an investment result — a very simple approach but far from efficient and potentially very high risk.
While the math behind Harry’s Portfolio is very complex, the two essential points of his Theory are straightforward.
- Investors should select portfolios of securities based on their risk / return appetite — their ‘Efficient Frontier’.
- The performance of any one portfolio security affects the performance of all the others. Optimal return is achieved by managing these relationships
The mutual fund industry is the clearest example today of how portfolios (or funds) are managed to achieve a specific risk / reward profile, and optimum returns within that profile. Those optimum returns are achieved by the fund managers that understand the interrelationships between their portfolio securities.
In the past decade or so portfolio theory has moved well beyond financial investing. In Europe for example, many large corporates are using optimization software to measure and manage the relationships between both internal and external variables and bottom line results. It allows these corporates to effectively manage to their most efficient operating frontier (global consultants take note).
Portfolio theory has an equally apt application to building sustainability. Often, when thinking of building performance, we focus on individual pieces of equipment and technology that contribute to that performance. Typically, when tasked to improve building energy performance, the objective is framed in terms of upgrading individual pieces of equipment with more efficient models or products. Or, at best, an individual system — lighting, HVAC, controls is considered for upgrade; almost never is the building evaluated as an integrated whole.
In an operating building, as with an investment portfolio, there is a causal relationship between all systems, equipment and technologies. A change in one will affect the others; and not always positively. The increased use of energy models helps us to understand this relationship more clearly than we might have several years ago. And yet, most modeling focuses on a single element or is used to justify the engineer’s judgment, rather than as a tool that can find an optimal result.
So how do we allocate our sustainability budgets to greatest effect? First we need to know what specific upgrades and / or changes (within budget limitations) will have the greatest positive impact on the building’s entire portfolio of equipment and on the building owner’s return on capital. ECON Group believes that meaningful sustainability investments are made when they compare favorably with both competing uses of scarce capital and corporate capital investment return guidelines. Our LeenOps Strategy optimization engine can identify the equipment and processes that will deliver the greatest building-wide sustainability return, while also meeting corporate financial guidelines.
Sound portfolio strategy that meets investor return guidelines.
Harry would be proud.