Finance Quote of the week:
"Diversification serves as protection against ignorance. If you want to make sure that nothing bad happens to you relative to the market, you should own everything. There is nothing wrong with that. It's a perfectly sound approach for somebody who doesn't know how to analyze businesses. Modern Portfolio Theory will tell you how to do average. But I think almost anybody can figure out how to do average in the fifth grade."
(Warren Buffet, Outstanding Investor Digest, August 8, 1996.)
Efficient Market Theory (EMT)
Eugene Fama
Fama's message: Stock prices are not predictable because the market is too efficient. In an efficient market, as information becomes available, a great many smart people ('rational profit maximizers') aggressively apply that information in a way that causes prices to adjust simultaneously, before anyone can profit. Thus, predictions of the future have no place because share prices adjust too quickly.
EMT = Random Walk Theory
Reason EMT not defensible:
- Investors are not always rational.
- Investors do not process info correctly
- Short-term yardsticks dominate (How are managers evaluated? If you are focused on short-term, how can you outperform in the long term?)
Warren Buffet on EMT: "With each investment you make, you should have the courage and the conviction to place at least 10% of your net worth in that stock."
EMT disproved
1. John Keynes
From 1927 to 1945, Keynes had responsibility for Chest Fund at King's College in Cambridge. He was a focus investor - relied on fundamental analysis to select a few stocks to buy and hold - focused on high quality companies to manage risk. Average return of 13% vs UK market return flat. Standard deviation of 29% vs UK market 12%.
2. Buffet Partnership, Ltd
3. Charles Munger Partnership
4. Sequoia Fund (Bill Ruane)
5. Lou Simpson (Geico)
Other EMT 'anomalies'
- Super Bowl effect
- Mark Twain effect ('October effect')
- January effect
- Halloween indicator (sell in May and go away)
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