Why the Theoretical Market Portfolio Cannot Be Replicated
Summary
The document explains why the market portfolio in modern portfolio theory is a useful theoretical construct but not a portfolio investors can fully buy. A literal version would include assets beyond publicly traded securities, including private or otherwise unlisted holdings, which are not broadly available for investment or market capitalization measurement.
Even within public companies, a capitalization-weighted portfolio cannot hold firms before they become publicly investable. The response also describes a recognition problem: an asset often gains enough prominence to attract attention only after its value has grown, so a passive investor may miss early growth. Identifying such assets in advance requires active bets and risk-taking, which conflicts with the idealized passive market portfolio. The note gives conceptual reasons rather than a practical substitute, and does not assess funds that approximate the portfolio within a narrower, investable universe.
Key ideas
- The theoretical market portfolio includes assets that are unlisted or otherwise unavailable to ordinary investors.
- A public-market portfolio cannot own a company before it becomes publicly investable.
- Assets may become prominent only after substantial growth, causing passive portfolios to miss early gains.
- Selecting emerging assets in advance requires risk-taking, unlike the idealized passive portfolio.
Tags
Full text
# Can I invest in the market portfolio of modern portfolio theory? # Can I invest in the market portfolio of modern portfolio theory? According to the theory, the market portfolio is composed of all assets weighted by their market capitalization, and this is the portfolio one should own. Is there a way to build a portfolio close to the theory's market portfolio? This would imply owning stocks, real estate, commodities, cryptocurrencies, art, and perhaps even derivatives, from all over the world, weighted by their respective market capitalization. Is there an ETF or a mutual fund that approaches such market portfolio? If not, why not, given that it's optimal in first approximation? Is there at least easily accessible information of the respective market capitalization of all kinds of assets? ## Answer by lehalle (score 4) https://quant.stackexchange.com/a/69264 This "market portfolio" is a chimera: very useful for basic reasoning and teaching, but that cannot be traded. Here are three reasons why - the term "market" suggests that it is available on markets, but of course it is not: as you write in the question, you should invest in a lot of unlisted, hence not public, assets - even if you restrict to companies: the life cycle of companies prevent to invest in them at the beginning of their life, when did you needed to invest in Amazon and Facebook that are now giants? before their capital was open to public - there is in fact a structural impossibility: to spot an asset and decide it should go in your "market portfolio", it will have to grown first in capital so that you notice it (it is a matter of investors' attention), you will miss the ones that are rocketing the most (because you should spot them very quickly, indeed quicker than others). In short: you will have to take risks, to bet on the ones that should be part of your portfolio. But the whole idea of this market portfolio is that you can invest on it passively, i.e. without taking risk. For more details, see Financial Markets in Practice, From Post-Crisis Intermediation to FinTechs, by L and Raboun.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.