Suppose that you have just read in the "heard on the street" column of the Wall Street Journal that investment advisers are predicting a boom in oil stocks because an oil shortage is developing. Should you proceed to withdraw all your hard-earned savings from the bank and invest it in oil stocks?
Efficient markets tell us that when purchasing a security, we cannot expect to earn an abnormally high return, a return greater than the equilibrium return. Information in newspapers and in the published reports of investment adviser is readily available to many market participants and is already reflected in market prices. So acting on this information will not yield abnormally high returns, on average. How valuable then are published reports of investment advisers? The answer is "not very".
How valuable are Published Reports of Investment Advisers?
Do investment advisers beat the market?
The implication of efficient markets theory that published reports of investment advisers are not valuable indicates that their published recommendations cannot help us outperform the general market. Many studies shed light on whether investment advisers and mutual funds (some of which charge steep sales commissions to people who purchase them) beat the market. One common test that has been performed is to take buy and sell recommendations from a group of advisers or mutual funds and compare the performance of the resulting selection of sticks with the market as a whole. Sometimes the advisers' choices have even been compared to a group of stocks chosen by putting a copy of the financial page of the newspaper on a dartboard and throwing darts. The Wall Street Journal, for example, has a regular feature called :Investment Dartboard", which compares how well stocks picked by investment advisers do relative to stocks picked by thrown darts. Do the advisers win? to their embarrassment, on average they do not. The dartboard or the overall market does just as well even when the comparison includes only advisers who have been successful in the past in predicting the stock market.
In studies of mutual funds performance, mutual funds are separated into groups according to whether they had the highest or lowest profits in a chosen period. When their performance is compared to a subsequent period, the mutual funds that did well in the first period do not beat the market in the second.
The conclusion form the study of investment advisers and mutual funds performance is this: Having performed well in the past does not indicate that an investment adviser or a mutual fund will perform well in the future. This is not pleasing news to investment advisers, but it is exactly what the theory of efficient markets predicts. IT says that some advisers will be lucky and some will be unlucky. Being lucky does not mean that a forecaster has the ability to beat the market.
Orangutan Vs Financial Advisers
The San Francisco Chronicle has come up with an amusing way of evaluating how successful investment advisers are at picking stocks. They ask 8 analysts to pick 5 sticks at the beginning of the year and then compare the performance of their stock picks to those chosen by Jolyn, and orangutan living at Marine World/Africa USA in Vallejo, California. Consistent with the results found in the "investment dartboard" feature of the Wall Street Journal, Jolyn beats the investment advisers as often as they beat her. Given this result, you might be just as well off hiring an orangutan as your investment adviser as you would hire a human being!
“When the fiduciary responsibility to produce high-risk adjusted returns for investors inevitably comes into conflict with the profit motivation to provide substantial revenues for funds management companies, investor returns lose and company profits wins. Mutual fund investors consistently fail to achieve investment objectives. “
David F Swenson, Unconventional Success, 2005. Swenson manages over $14 Billion for Yale endowment
“the industry has lost its way. We have turned a very good profession into a business which is good for the business but not for the investor.
John Bogle. Founder and former CEO Vanguard.
The problem with mutual funds is that they are rewarded for the money they attract, not for the money they earn.
I suppose if I were to give advice it would be keep out of Wall Street
John D. Rockefeller
Few people actually make their millions in mutual funds. Unfortunately, mutual fund investors chase returns and barely keep in tow with inflation.
The average equity investor earned a paltry 2.57% annually.
The average fixed income investor earned a 4.24% annually.
Dalbar Inc. National research firm.