You may be surprised to find out that PPM derives its beginnings from the world of financial investing. PPM leverages the work of a Nobel Prize-winning economist to bring balance to an organization’s project activities
Gantt Head about Dr Harry Markowitz
The World of Modern Portfolio Theory
In the early 1950s, Harry Markowitz–an economist at the City University of New York–created a theory about investment that would change the world. He created a unique approach to investing in stocks and other assets. Unlike traditional asset management, which focused on predicting individual stock price movements using fundamental or technical analysis, Markowitz focused on evaluating the performance of a portfolio of assets based on the combination of its components’ risk and return. His hypothesis and subsequent work were so revolutionary that Professor Markowitz was a joint Nobel Laureate for economics in 1990. This system has become known as the Modern Portfolio Theory (MPT).
However, this theory had to wait for advances in computer power to become fully available. Because of the complex financial analysis and models used to predict a stock’s potential risks and return within a portfolio, computers were needed to perform the analysis.
At the core of MPT is the concept of diversification. Diversification helps spread risks between investments while continuing to achieve returns. Modern portfolio analysis has shown that even a random mix of investments is less risky than putting all your money in a single stock. The crucial insight of MPT is that risks found in individual investments matter little when compared to its contribution to the risk of the portfolio.
Thus, diversification involves a trade off between risk and return. MPT makes some very reasonable assumptions about the way investors behave regarding risk. Although some investors can take more risk than others, investors are assumed to be risk-averse. A risk-averse person is one who, when faced with assets which promise to provide the same return, will choose the asset with the lowest risk. In order for investors to accept higher risk, they will want to be compensated with the potential for earning a higher return, and vice versa.
MPT and Project Portfolio Management
As the concept of MPT filtered into the investment world, giving investors and fund managers new tools for assessing risks and returns on a portfolio, business leaders and professors began to look at this theory and how it would apply to the corporate world. Early articles like the 1981 Harvard Business Review article “Portfolio Approach to Information Systems” by F. Warren McFarlan attempted to describe how creating a portfolio of projects and managing these projects together could minimize disasters and increase results from projects.
Project Portfolio Management takes the concepts of MPT and applies them to the three key evaluation criteria used to measure projects: the costs to undertake the project, the risks involved in the project and the potential returns on the investment. Portfolios are created of similar projects (projects of similar types, durations, requirements or goals) and are managed as a group.
By pooling the projects together, the risk of the portfolio can be managed by tweaking the projects within the portfolio. One project’s mix of high risk with high potential return may not be acceptable by itself, but when mixed with other low-risk projects, it may become acceptable to the company. Projects become investments to portfolio managers, and corporate approval for activities occur at the portfolio level and not at the project level.
