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EMH alive and well?


Evolveus
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I recently was on the receiving end of a presentation from a major fund company with billions of dollars under management that many here are probably familiar with, at least in name. Their whole premise and strategy is based on the market being totally efficient. I think it is to an extent, but not to the degree that they do. they hold between 800-1000 positions. I believe in diversification but not to the extent they do.  They have funds based on an efficient market theory with a "value" slant. If the market was totally efficient how could there be a vast existence of "value" stocks? 

 

I spoke to another local money manager who gave me a few book recs on EMH and suggested that evidence shows that zero managers have out performed indexes past 20 years.  He was a big proponent of ETF's which can play a part in overall portfolio strategy, but he was adiment about the Efficient Market Hypothesis and the lack of value provided by any active manger.

 

The point of my post is that I was shocked to still see such large pools of money strictly adhering to EMH. Like most on this board, I believe in a value philosophy as defined by Graham and Buffett. I read value blogs, boards, websites and publications on a daily basis, so as naive as it may sound, I was shocked to still hear folks trumpeting the unquestionable efficiencies of the market place. Is EMH as alive and well as it seems to be?

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Yes, it's alive but not very well IMHO.  Problem with the EMH is that it isn't totally falsifiable.  (It has to be married to a pricing model and so only joint tests can be made.)  As a result, it is hard to kill.  However, ask anyone who likes it to explain the persistence of momentum which trivially violates the weak form of EMH.  I've yet to get anything close to a clear response to that question.  (I'd have pointed them to value but a bunch of EMHers seem to have tried to appropriate value investing for themselves without so much as a mention of Ben Graham.  :o)   

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I recently was on the receiving end of a presentation from a major fund company with billions of dollars under management that many here are probably familiar with, at least in name. Their whole premise and strategy is based on the market being totally efficient. I think it is to an extent, but not to the degree that they do. they hold between 800-1000 positions. I believe in diversification but not to the extent they do.  They have funds based on an efficient market theory with a "value" slant. If the market was totally efficient how could there be a vast existence of "value" stocks? 

 

I spoke to another local money manager who gave me a few book recs on EMH and suggested that evidence shows that zero managers have out performed indexes past 20 years.  He was a big proponent of ETF's which can play a part in overall portfolio strategy, but he was adiment about the Efficient Market Hypothesis and the lack of value provided by any active manger.

 

The point of my post is that I was shocked to still see such large pools of money strictly adhering to EMH. Like most on this board, I believe in a value philosophy as defined by Graham and Buffett. I read value blogs, boards, websites and publications on a daily basis, so as naive as it may sound, I was shocked to still hear folks trumpeting the unquestionable efficiencies of the market place. Is EMH as alive and well as it seems to be?

 

The whole stock market and other financial markets are apparently becoming increasingly more efficient.  Spreads are narrowing, and it is becoming hard to find bargains as information assymetry is reduced, especially through the internet. 

 

However part of this apparent increased efficiency is an illusion.  In a parallel universe, so to speak, the tendency for markets to break down suddenly in a pattern called kurtosis that produces fat tails may be increasing.

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The market is pretty efficient. I don't think it's completely efficient though.  Even good value managers haven't beaten the market over the past 10 years.. Berkshire has trailed, Bill Nygren at OAKLX, the guys at Longleaf LLPFX,  Bill Miller at LMVTX, even the guys at Sequoia have barely squeaked past (SEQUX). Yeah, there are exceptions, but I'd think most people would think these guys would beat the market over 10 years or so.

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I think over the long term markets are efficient or value investing would not work.  I think the right way to think about efficiency is in degrees not either yes or no.  I have seen some of these EMH guys state that value, size and illiquidty are risk factors and thus with higher exposure to these factors you can get higher returns with commensurate higher risk ???.  You have whole shops AQR and DFA come to mind who orient portfolios to maximize exposure to these risk factors.  It is an interesting approach as the portfolios can be constructed at a lower cost than active management and get some of the returns associated with these factors. 

 

I think the evidence from Longleaf and some of the other managers mentioned illustrates that for the most part large caps are efficient and most of the misspricing should be in the small/micro-cap area.  The real question I ask is if the stock is a large cap and cheap why would somebody want to sell this asset to me?  I also try to find forced sellers but that is a difficult thing to do. 

 

With FFH you had short sellers which helped and with C and BAC you have alot of shares due to dilutive sales of equity.

 

Packer

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Even good value managers haven't beaten the market over the past 10 years.. Berkshire has trailed,

 

Google finance shows me that BRK has beaten both the SP500 and Dow Jones index over the past 10 years. Not by a lot, but it did better.

 

By my count it did much better when it comes to intrinsic value creation, and with much lower risk, but it might take a while for that IV to be recognized in the secondary market (who knows?).

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EMH works or the market is efficient because we have value investors.

 

EMH says that if there is a $20 bill on the ground its a mirage because the market is efficient and so there can t be a $20 bill on the ground because some one would have picked it up by now, that would be the value investor who pick up the values when available.

 

The small caps or certain large caps are roads that value investors have not cleaned up yet so there are $20 bills on the ground i.e values to be had

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Even good value managers haven't beaten the market over the past 10 years.. Berkshire has trailed,

 

Google finance shows me that BRK has beaten both the SP500 and Dow Jones index over the past 10 years. Not by a lot, but it did better.

 

By my count it did much better when it comes to intrinsic value creation, and with much lower risk, but it might take a while for that IV to be recognized in the secondary market (who knows?).

 

Liberty, does the Yahoo data include dividends on the S&P500? I was using morningstar. They compare the two with total returns. They have Berkshire at 5.56 annualized and S&P 500 at 6.44.

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Yahoo doesn't include dividends. But don't think it's a good comparison anyway. BRK's premium to book value has been declining, so that is distorting the picture how BRK has performed the past 10 years.

 

That's a bit of a slippery statement: according to EMH the premium to book value would probably depend on the performance of the business  :)

 

I think that the time frame for judging whether investors are good is so large that it is almost impossible to judge value investors on their results within a decade. Hence you should focus on their reasoning instead. That's why Buffett, Berkowitz or Einhorn are so great to learn from imho. You can read/hear their reasoning BEFOREHAND: I think GEICO is an excellent stock because of these reasons. We love See's Candy because of those reasons. Green Mountain Coffee Roast is a short because of these reasons. Bear Stearns will collapse because of these reasons. Most of their reasoning turns out to be correct, and thus I tend to believe they can outperform the market.

 

And personally I think that if you look at the pump-and-dump schemes and sky high valuations in Social Media and Cloud Computing, stuff like Sinoforest, the way stocks have been going up and down like crazy in the Euro-crisis, the endless speculation about QE or the Bank of America rollercoaster, the market seems hardly efficient at all.

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I hope EMH - the hypothesis - is alive and well.  EMH is a paradox - it can only explain market pricing if a sufficient number of investors are combing reports, news, etc. and attempting to find fundamental value and arbitrage away inconsistencies.  If enough investors think EMH is reasonably explanatory, they would abandon such efforts, which would lessen the market's efficiency.

 

I love EMH practitioners and preachers.  I wished everyone accepted EMH - everyone but me.  Kind of like I wish every male but me were gay.

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I think there is still a lot to be said for EMH.  Vanguard and Bogle have been preaching low cost index investing for decades, and honestly you, and the average Joe investor, could do a lot worse.  Consider that the vast majority of all fund managers don't beat the index over the long term, and also that with fees and taxes they'd have to beat the index by a large margin to even match a simple index fund strategy, and as I said, you could do a lot worse.  Also note that Buffett has said he thinks the average investor should just diversify widely and buy the S&P 500.  Add some simple dollar cost averaging and some asset allocation, and you get a reasonable return with some reduced volatility, and you beat the vast majority of managers out there.  Plus how do you account for all the time you spend researching companies, there's an opportunity cost to that...

 

Even with value managers I suspect you'd have a hard time consistently beating the index.  I think you'd need to not just look at the 'long term' but look at rolling long terms, since just picking this date and subtracting 10 years from today is really just taking one random 'long term' sample. 

 

WRT the BRK vs SP comparison I'm not sure if that's completely valid.  It is valid in that a retail investor can only buy BRK.  But really you'd want to either compare just Buffett's equity investments vs the S&P, or you'd also maybe want to somehow account for the extra leverage that BRK gets from its float, and maybe do some risk adjustment.. not sure.. maybe not..

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