Mean Variance Optimisers are portfolio construction tools that construct portfolios that are meant to be efficient. 

That is they are designed to provide the best balance of risk and return for a given risk or return objective.

They state that the allocation to each security within a portfolio is determined by its risk, its return and by its relative price movement.

• The risk of each investment is often calculated using historical information of the volatility of the price of the investment.  The measure of risk they use is standard deviation, or volatility.  Volatility is discussed in the three investment risks.

  • Modern portfolio theory states that return is directly related to risk, so higher risk investments should produce higher levels of return and vice versa. 

  • The trouble with the above is that while historical risk has a bearing on the risk of an investment, it does not tell you how much risk an investment has at a given point in time.

• The return of each investment is calculated by using an historical average of the return of the investments to be included in the portfolio.

  • While average historical return is a good guide to the type of return you can expect from cash, fixed interest and equities over very long periods of time, they do not tell you the type of return you could expect at a given point in time. 

• The relative price movement of each investment tells you how each investment moves in relation to the other.  If one investment tends to move up when another moves down and both have the same return, then by combining the two investments in a portfolio, the risk of the portfolio will fall.

  • Historical information on how the price of an investment moves relative to other investments does not tell you the degree and the extent of the current price movement.

What mean variance optimisers allows financial advisors to do is to construct portfolios for individuals that take into consideration risk and return and to construct portfolios without needing to perform the involved and necessary valuation analysis.

As discussed in the portfolio problem, the primary reasons for the rise of these tools has been the lack of investment expertise and discipline at the point of product distribution. These systems control the distribution of investment products while limiting the damage that uncontrolled allocation of such would cause.

Mean variance optimisers may well be asset allocators but they do not embody the investment discipline needed to construct, plan and manage portfolios capable of meeting financial needs over time and managing risk and return at a point in time.

Only an analysis of current valuations and current relative price movements will give you a guide to the actual risk, return and potential relative price movements of securities.  

Fundamentally, mean variance optimisers do not have an input for financial needs.  This is probably the most important weakness of all and, is unfortunately a weakness the financial services industry at large as well as the financial services industry's educators are willing to ignore. 

Finally, many of these portfolio solutions purported as asset allocation solutions, actually contravene the basic rationale of asset allocation; that is, active management is not necessary.  Most retail portfolios deliver actively managed funds with high management expense ratios when they should really be delivering indexed investments with low expense ratios. 

A more detailed discussion of the weaknesses of modern portfolio theory can be found in the supporting technical documents.