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How Modern Portfolio Theory Has Become Like Fantasy Football

As we watch GM side with Chinese Communists, seemingly adopting a new marketing slogan, “Bad-mitten, Dim Sum, rice cakes and Chevrolet...,” or Apple belligerently suggest its competitors Facebook and Google don’t protect your data as they do, even as they sidle up to the authoritarian communo-Communists in China, we also witness the renewal of a nationalist fervor across the world. Whether it be Trump in the US, or Brexit in the UK, or anti-immigrant sentiment and reemerging Nazi sympathies in Germany, nationalist fervor has been stoked. But why?

Could it be traced back to the advent of Modern Portfolio Theory, largely emancipated by the resurgent neoliberalist movement begun under Reagan and Thatcher? Let me explain.

Modern Portfolio Theory

Modern Portfolio Theory suggests stock ownership, in concentrated amounts, to be “risky, so much so that the risk should be diffused through “diversification” in an optimal risk-adjusted mix of stocks. Diversification, of course, is achieved by owning a “portfolio” of shares of companies across a broad spectrum of industries, locality, size and may even include dipping into other parts of the capital structure based on your age and needs. It simply views equities, or shareholder interests, as a commodity and not an investment in an idea, movement or community.

Before we venture further into this query, let’s first review the advent of a shareholder. First invented under a strong rule of law some might even discern as Socialist in structure, depending on centrally administered property rights, portfolio construction relies on corporate entities meant as “investments” in a venture, with limited liability for your willingness to put property at risk for mutually beneficial consequences, for the sanctioning jurisdiction and shareholder, but to include, for society, tax income on profits, employment of labor and money velocity - the multiplier effect of a dollar bouncing around the local economy. All of this worked nicely as companies grew, specialization increased, shareholders sought liquidity to monetize their investments. Eventually, exchanges formed to facilitate transfer of these ownership shares. Boards were required to answer to shareholders, who were relieved of the day to day oversight through previous concentrated interests, exerting maximum oversight the company, often aligning themselves with those in their community. There was a directed feedback as to how their limited liability was impacting those around them.

Then came Modern Portfolio Theory, which rightfully identified that shareholders, born of hereditary investments and not directly involved the founding or operational aspects of a corporation, or acquiring shares on exchanges removed from the social impact of operations, should reduce “risk” through diversification. An entire industry sprang forth focused on “wealth management,” effectively removing any alignment of shareholder with the community in which their firm located, produced,capitalized or sold. They became, in effect, Fantasy shareholders, much like the fantasy sports industry today. Portfolio theory pays little heed to what the impacts of a portfolio "position" might have on the economy, environment, end user or workforce, only that it's a round peg fitting in a round hole within the portfolio.

The most likely outcome of such, is to realize one could immunize the risk to replicate the overall economic performance of an economy, a sort-of immunized investment to perform as the overall economy performed, thus developing this notion of constant growth regardless of the means. This led to index funds which try to replicate industry growth, or some other aspect; national, regional or even global. The first index fund was founded by John Bogle who now questions their utility since seeing his brainchild now effectuate greater concentration of control into the hands of Index Fund purveyors who have become economic Czars of sorts, able to wield their influence over commerce through large holdings and board seats which come with concentrated ownership. A kind of cronyism allowing these entities to become so powerful and unaccountable through elections. Some in economics are now questioning whether this full-circle financialization is causing its own downfall.

Broken Corporate Chartering

Mentioned earlier, corporate charters haven't kept pace with a more globalized marketplace emphasized under neoliberalisim and necessitated by adherence to economic orthodoxy focused on the outcome (growth) versus the effect (happiness of the greatest number of the planet's inhabitants, across all species).

In January 2018, leading index fund operator CEO Larry Fink of Blackrock, issued an open letter to other CEO's of companies his firm owned shares of, to impress upon them the need to instill social responsibility into their business plans. The letter came with somewhat of a warning "they would be watching." Although emblematic of this notion of the unelected power of index funds, it was striking to see such a declaration - almost Jerry MacGuire-like in its scope. However, the timing was telling as it came on the heals of an affluent-friendly new tax bill passed under a political party rising out of deep distrust of the nation's political elites and the disarray occurring as deep truths were revealed. Mr. Fink clearly sensed a danger emerging for neoliberalism, or emancipated finance, that many in his industry and contemporary circles didn't perceive.

Although Mr. Fink's declaration was striking, it didn't go nearly far enough. What he suggested was self-imposed social justice for a decades old movement proclaiming corporate activity as amoral, apolitical and only accountable to shareholder's and boards. His letter was quickly ignored, and we see no evidence of Blackrock "watching," and certainly no evidence of actions taken. However, we did get a breath of confession, which directs us to what is likely the path to real adjustments needed to correct the disconnect between shareholder and social responsibility, evolution of the corporate structure, altering an implicit bargain to that of an explicit bargain.

Evolving Corporate Entities for the New Global Supply Chain

Now days, with a globalized marketplace evolving from the fall of Communism, with the exception of our subsidization of Mainland China's communo-capitalism for its labor arbitrage qualities, shareholders have the ability to capitalize where the rule of law is strongest, locate headquarter where tax rates are least, produce where labor and regulatory burden are most attractive, distribute to the most affluent and live where they can enjoy the highest standard of living. Quite literally, the corporate entity has been undermined in its original implied benefit exchanged for its existence. Time to make it an explicit bargain.

By instituting seven-year renewal mandates, whereby shareholders and boards must report on the return on the public's investment of granting limited liability, and tying tax rates to this return, shareholder interests would be realigned returning back to there original intention. There's certainly no difficulty in determining such "net ROI" through the robust analytics made available by financial technology - which even now uses satellite images from space to determine real growth/output.

Shareholders would become focused more on what the internal operations of their companies produce in terms of external costs for government to pickup. How degradation of the environment, impact on public health or social impact from their products/existence offset their profits, would have to be considered. Markets would begin to assess also, as they approach their seven-year reporting period. I foresee staged reports to calm investors when highly-charges industries like fracking, tobacco or privatized prisons are in the last two years of their "Jubilee" period.

Markets and Index funds would be made more responsible, knowing there's a "settling" of ill-gotten gains for financial entities, or possible outright revocation of shareholder limited liability - they could still operate, just without immunity against remuneration of societal costs to personal or familial wealth. No doubt, it would have a sobering effect on neoliberalism and an important government control without the need to litigate corporate free speech through the courts.

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