ABSTRACT
Investing should generate a risk-adjusted return for investors and allocate capital to where it is useful for society. Modern Portfolio Theory (MPT) fails at both purposes because its math is hermetically sealed away from the real economy. MPT performatively forces the focus onto relative risk/return − that is, risk/return relative to a market benchmark such as the S&P 500. The lack of interaction with the real world also means that MPT provides no tools to mitigate systemic risks, such as climate change, financial crisis, or gender discrimination. Yet systematic risk in the capital markets determines 75–94% of return and is often caused by risks to the environmental, social, and financial systems. But as MPT tradition says that investors cannot affect systematic risk, the “MPT Paradox” forces investors to focus on that which matters least, which is trying to match or beat relative return benchmarks. The authors challenge investing orthodoxy by demonstrating how investors can and do affect systematic risks. A short case study shows how the New York City pension funds created $132 billion in value using a systems-level investing technique called “beta activism.”
