Dollars and Jens
Friday, December 21, 2007
Michael Lewis has a long, but worth it, article on efficient markets, essentially.
“If you wake up in the morning and see Warren Buffett's face in the bathroom mirror,” Wellington says, “go ahead and buy some stocks. If you see anyone else’s face, diversify.”Certain derivatives markets are potentially inefficient. The market for large cap stocks is probably hyperefficient; if an extra $1,000,000 in economic resources were put into chasing its inefficiencies in any way in which it would be reasonably likely to be deployed, it would probably result in less than $1,000,000 worth of extra efficiency. As a whole, markets, on a large scale, are efficient, much the way an Iowa winter is cold; in principle it would be possible for them to be more efficient, but compared to the standards that one is likely to compare them to (or find it useful to do so), they're efficient.
And on he goes, persuasively, but as he does, his comments evoke an obvious question, one that no D.F.A. financial adviser dares ask: If all financial advice is worthless and the only sensible strategy is to buy an index fund that tracks the market, why would anyone need a D.F.A. financial adviser? Why, for that matter, should anyone pay D.F.A. the 50 basis points it takes off the top of its oldest fund? D.F.A.'s answer to this is interesting: It can beat the index. The firm doesn't ever come right out and say, "We can beat the market," but over and over again, the financial advisers in attendance are shown charts of D.F.A.'s large-cap funds outperforming Standard & Poor’s 500-stock index and D.F.A.'s small-cap fund outperforming the Russell 2000.
In each case, the reason for D.F.A.'s superior performance is slightly different. In one instance, D.F.A. found a better way to rebalance the portfolio when the underlying index changes; in another, it came up with improvements in capturing small-cap risk. All these little opportunities can be (and are) rationalized as something other than market inefficiency, but they are hard to exploit, even with the help of D.F.A.