Most people say that the EMH is absolute bullshit. But I have come across opinions which say the markets over the years are getting more efficient and it gets difficult to beat it. Some say most fund managers too havent been able to beat the market last few years. Most major hedge funds havent been performing too well either.
I plan on registering for the CFA L1 this June. Asset Management is what I plan on doing but going by what I have been reading it doesnt look like the best place to be. Should I just screw the L1 and spend my time networking and look for opportunities in IB or do you guys feel the whole concept of EMH can never really work and fund managers do have the opportunity to beat the market?
The answer is clearly that it is getting more efficient. You need to work harder to make money, but there are still opportunities out here. There's certainly not easy money out there just waiting to get found.
There's no question that the stock market is more efficient than it was before the current age of mass computing power. The digital age has increased the availability and the quantity of relevant information and has made it easier for investors of all types and sizes to transact in the markets. Quant funds have sprung up to exploit other investors to some degree. Anything that can easily be screened for or quantified is impacted into prices almost immediately.
But, that being said, the market is still not efficient and will remain at least somewhat inefficient in the future. It's not possible for the market to be perfectly efficient because not all investors transact based on the same time horizons, information, or strategy. If you look at run-of-the-mill value investors, they make up only a small portion of all of the volume in the market (which is primarily automated trading by quant funds). Technical analysis investors, swing traders, day traders, etc. also make up a portion of the volume and influence prices based on completely different information.
Net, net, the market is and will remain inefficient, but the key is knowing how to identify and exploit the inefficiencies. I'm sure someone's going to be like, "Bro, it's efficient, teh math told me so" but that's wrong. I've seen lots of stocks double or triple in 12 months or less in low risk fashion, and that's simply not possible in a perfectly efficient market (and I'll just stop the non-debate short right here: many of these picks were knowable ex-ante, that's what investing is). The only people who truly think the market is efficient are people who don't know very much about the market -- but it is very competitive, so in most cases it's close to functionally efficient.
On my way! It might be hard to put a billion to work in small caps though, I'll have to find another strategy after I clear my first $500,000,000.
Thanks for your support, xoxo
The way I think about it is you make a bunch of bets with positive expected value that are not perfectly synchronous. If you're right more often than not or your winners are bigger than your losers, you add value. If not, you subtract value. But, consistently being able to identify doubles and triples in advance is not possible. No fund has annualized at 200-300% per year over any significant period of time.
Some people reading this may not realize what you're saying is hyperbole so I'm just trying to point that out. No investor wins on every trade and virtually nothing about the future (that involves people) is knowable.
I completely agree that it is not always knowable when they will double, but it is possible to find situations where that conclusion is so likely that it becomes essentially a matter of time (almost always based on structural factors). The timing is always the key question, which gets back to my original post about efficiency being impossible due to different time frames and strategies. The only way the market could be efficient is if every market participant were focusing on the same approach and the same information, and that's clearly not the case.
In one case last year, I actually talked to the CFO of a public company who has been at the company for over two decades -- he knows the business well. I asked him how long the inevitable outcome would take (which implied a 300% return), and he said, probably 3 years based on industry factors. A three year triple is still an amazing stock pick, and yet, most investors cannot look out that long due to institutional constraints and personality factors, and hence, inefficiency (especially when combined with this being a $150 million market cap stock with zero analyst coverage in a very boring business). As it turned out, he was dead wrong and it took a year to increase 300% because the industry cleaned up faster than he expected.
Point is, if you have the smartest person about this particular business with the best (inside) information, and even he can't get it right, how can anyone else be expected to nail the timing? But it doesn't matter, the stock was still a long on a three year basis because in this particular case of industry consolidation, there was only one natural conclusion about the outcome. It was a bonus that it worked out faster.
You diversify because anything can and does happen and to reduce volatility of returns. It would be insane to own a portfolio of 5 microcaps because the stocks are often very volatile on no news because they are thin.
The fund has annualized returns in excess of 40% a year for more than 15 years. It may be the best small cap fund in the world. The strategy is not replicated by everyone since, 1) it doesn't scale past about $300 million which is nothing in the hedge fund world, 2) there are significant proprietary elements that are outside of the traditional discipline that Wall St. uses, and 3) it requires long-term capital, which is not in effect at some huge majority of funds that are operating on a quarterly basis. If you're wondering how that math works, the firm was founded on a very low capital base and has historically not managed outside capital (i.e., not at $300 million until recently).
This firm is a mini Tiger, and as far as I know, none of the "cubs" using a similar system of 100 longs and 50 shorts has produced less than 30% gross returns over a 5-10 year time period using the same or a very similar system. You can have several stocks double within your 100 and still not get 200 to 300% returns overall, but it's clearly insane to suggest that if you have a significant number of doubles out of 100 longs in a universe of 10,000 stocks that it's merely luck.
It's not hyperbole unless you read it to mean that I'm suggesting every single stock doubles. I'm not, and I was referring to a multi-year horizon in which I have seen many stocks double in 12 months or less (that wasn't clear in my first post). What I'm saying is that there are many every year, some of them are knowable with high conviction, and that if you hold a portfolio of odds-on favorites, you will very likely own some of these if you have an effective sorting mechanism to find them. Most people are using tired value screens such as low P/E, P/B, etc. and I'm saying that's not only ineffective, but actually dangerous. There is a better way. Obviously it is not in my interest to elaborate on what that might be because people are smart and the barriers to entry are not enormous. But what I would say is that if you do the same thing that 90% of funds out there are doing, you will probably get the same results, and you might even falsely conclude that the market is efficient as you would, in fact, be playing in the most efficient part of the market (i.e., the same thing everyone else is doing).
Asking whether "markets are becoming more efficient" is too broad a question. I'll assume that you're referring to the semi-strong type. Market efficiency is facilitated by liquidity and information. These are generally most available for large cap equities in mature markets and high grade debt. They're liquid because they're highly traded and there's plenty of information because lots of analysts cover them.
There are pockets of inefficiency, though. For example, distressed debt is very illiquid since institutional investors generally can't invest in it. Small cap stocks don't have a lot of coverage, so it's harder to estimate their value. And, of course, private firms are neither liquid nor informationally efficient.
But even if the market were perfectly strong form efficient, there would still be a need for fund managers because of the other side of the coin: risk. Different types of portfolios need different levels of risk associated with them. A pension fund needs a very different mix of assets than a hedge fund. The goal isn't always to "beat the market". Often the goal is to protect assets.
Computing power can also work vice versa. A fundamentalist sitting in front of their computer during the flash crash probably saw an alpha generating opportunity.
It's definitely more efficient, but unless all market participants have perfect information, which is pretty much impossible, you will not have a perfectly efficient market.
So, as knowledgeispower asks, do you see future in asset manager or are we (CFA L1 candidates) wasting our time? I don't like IB nor Consulting, but if there are no job opportunities...
I think a lot of people are missing the boat here. "Efficient" through the lense of the EMH deals with the types of analysis that produce abnormal returns. In this regard, "efficiency" deals with "information efficiency" or how markets absorb information via price. Taking a step back, if you look at some of these HFT machines, what kind of analysis are these machines performing on such short time scales? If all they're looking at is past price, markets are actually getting LESS efficient, not more.
That being said, I'm not a quant or run an HFT machine so I really have no idea, but it is an interesting question.
I'm familiar with what you're talking about, but I'm not familiar with the mechanics. Just out of curiosity, if I'm interested in getting into spot-future arbitrage, what am I looking at to determine if an opportunity exists? I think the question of "are markets becoming more efficient" is particularly interesting, and in order to determine it one way or another, the information being utilized is what's important. If what is being considered in spot-future arbitrage is effectively, "past rates are trending in some direction," then it seems like there's a good case to be made that markets are becoming less informationally efficient. That would be very peculiar in the "information age" I keep hearing about us living in...
Markets EFFICIENT????????????? Not until the central banks/govt's take their trillion dollars, YES TRILLIONS OF DOLLARS, worth of liquidity out, I hope this comment was a joke
Perfect Information creates an efficient market. Technology has sped up the pace of this information cycle. However, new information is always being created and thus inefficiencies will exist. I think OP was trying to make the point is that when will this cycle be so small that return will not outweigh the risk? Or do these new faster cycles make it harder to make money?
Harder? Thats subjective. Faster? Yep. Impossible? Nope. No algorithm can protect from a naturally occurring random event i.e. e.coli outbreak.
I feel like a lot of people arguing for or against market efficiency, don't really understand the theory well. It certainly doesn't claim that all stocks (or other securities) will have the same return going forward. Generally, I think of it as a bunch of people making the best decisions they can with the information they have available at the time. I think it's hard to argue that this is not the case.
Think of it like setting the line on a sports book. Everyone is trying to make money off of one another with the information they have. You can look at reams and reams of data. If new information comes out (like Tom Brady injured his groin banging Gisele and won't be playing), the line gets adjusted. Some people can win consistently, but it's ridiculously difficult. It's not like you can just screen for low PE stocks (or bet on the underdogs) and expect to be able to perform well consistently.
I wish someone here would detail the hypothesis so everyone can argue for or against it with full knowledge of the hypothesis.
PS -- the reason I say I think the market is becoming more efficient is because of the increased speed at which information is disseminated, the larger number of market participants, and lower bid ask spreads compared to 20 years ago.
I really only monitor energy markets, but if someone could touch on the effect of central banking on market fundamentals I think it'd be pretty helpful. It seems to me that a market cannot be truly efficient as long as the Fed assumes as active a role as it has the past four years, notwithstanding bailouts and government subsidies. Or are those simply examples of market failures?
dont you think market failures are part of efficient markets? and its not just the fed, every central bank
I do consider market failures a component of efficient markets--I'm just wondering how central banks fit into the equation, since information and market access are seemingly irrelevant when you consider the amount of liquidity funneling in from an extraneous third party
But maybe someone can frame it better.
I would think that when arguing about the efficiency of the market if would be helpful to distinguish which markets we are referring too. Yes as a entirethe market is getting more efficient but if you think about emerging markets there is still a big gap as far as efficency compared to the developed markets so I would think that there are some opportunities there. What do you guys think?
I don't think most people here really get what market efficiency is. It's basically the idea that the market quickly reacts to available information. The level of that information depends on the type of efficiency (weak form pertains to market data, semi-strong form pertains to fundamental analysis, and strong form to insider information).
Earning a 300% period return on a small cap stock investment does not an inefficient market make. Such an investment undoubtedly carries a lot more risk than a blue chip, so one would expect a higher return. Or a much lower return (Ravenous didn't mention his duds).
When discussing semi-strong efficiency (the type of efficiency that is most broadly accepted), the question is whether or not markets absorb information and adjust prices as it is made publicly available. In most cases this is true. If a stock rises quickly, it just means that the perception of that information was incorrect. Not that the market is ineffecient.
excellent points, but when I think about a market being enefficent, i think of central bankers providing unlimited liquidity and propping up companies that should have fell,...hard
This is true and this is what the textbook says. However, this is my issue with EMH is that it is the most flexible theory ever. Everytime some example is used as evidence to disprove the EMH the proponents of the theory just move the goalposts.
By saying that when public information is available and it was not priced in at the time is not a failure of the EMH but of investors perceptions may be true, but there will in most cases be someone somewhere who had a better grasp of the information and traded off it and generated alpha.
Not specifically arguing with you, I agree markets are enrally semi-strong, I just thought your post offered a good opportunity to highlight my thoughts.
Market efficiency is determined by the velocity of price convergences. Obviously, the lesser-known and small cap stocks will be more efficient, since their trading volumes are low. Basically, it's a trick question.
They are definitely getting more efficient in the sense of available information being priced in more quickly, tighter spreads etc...
This doesn't mean that the markets are "right" though. The internet bubble is one example. The underlying companies didn't matter anymore, it became pure speculation.
the internet bubble is arguable though.. efficiency isnt just about response to news, it's also about underlying valuation reflecting all available information about the company. if the tech bubble was just investors expecting other investors to be stupider than them, then it is a failure of semi-strong efficiency. if it was about genuinely expecting earnings to grow that fast, it was just poor information. but it isn't the run up in prices that's usually cited as inefficiency, it's the quick fall after - what information changed in the days that led to the fall? alternatively, why was there a sudden increase in equity risk premia? that's the explanation that's normally given (increase in risk premia due to worsening economy)
My comment is that it is hyperbole to say that a future stock price is knowable in advance. You might say likely, very likely, or whatever you choose, but there are no certainties in the market. You could even say you know it's undervalued by 70% and that wouldn't bother me....because even then, it doesn't mean it will ever get fairly valued by your measurements.
I don't find it surprising at all that many micro-caps can double in a year or that many can cut in half virtually overnight. If you guys are able to pick them so well that you're annualizing at 40% or more then, that's great for you.
I have no way of confirming your return level or not, but a 40% return over 15 years would turn $2 million into $311 million over 15 years which strains the boundaries of believability.
I'd take a lot more than that with a grain of salt. This guy's ability to do "back the envelope" math isn't the strongest, suggesting that a lot of these numbers seem to be made up.
For example: "You can have several stocks double within your 100 and still not get 200 to 300% returns overall" - well no shit, seeing as if you have several stocks double, those stocks themselves are up only 100% and the incremental return of each of those to your portfolio is 1%. Assuming no gains anywhere else in your portfolio, your 40% return would require 40 stocks to double in price... Ignoring the short aspect of your portfolio, even if EVERY stock you had increased in value by at least 20% (which would be an excellent portfolio for pretty much any manager), you'd need 25 of those stocks to have doubled in the year to achieve 40% annualized. Ofc you had your shorts and the rest of your portfolio could have moved by more than 20%, but it's more than likely that you're actually a sad man who feels the need to embellish return data on an online forum mainly for college kids to try to prove some ridiculous point.
I agree it's "no shit" -- I'm not sure why the other person had some much difficulty with that concept, so I clarified it for them.
In terms of the back of the envelope, the firm started with about $20 million and has farmed some of the capital out to other hedge funds with differing strategies over time. The returns have been audited and are legit. There's no need to exaggerate on an anonymous forum. Sorry you work for a crappy fund?
At the end of the day markets will never be entirely "efficient" because the driver to growth is... Real and new game changing products.
In addition, laws regulations, diseases, trade all change daily.
So the information surrounding a new offering will not become 100% fluid.
The rate at which you can invest in an opportunity is increasing, ie: practically all of us can invest in even start up companies now. The ability to understand the long-term impact is what will set you apart.
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