darkness39[at]yahoo.com wrote:

- quote -

Illiquidity cannot be the only explanation for the outperformance of
small cap value companies. While it is true that some of the smallest
stocks are highly illiquid, empirical evidence shows that the
outperformance of the typical small cap value portfolio does not hinges
on the performance of these illiquid stocks. Also, as capital markets
develop, this would imply higher liquidity of small cap value stocks,
and therefore smaller outperformance of small cap value stocks. There
is no evidence of such an effect, if you look at the data
(http://mba.tuck.dartmouth.edu/pages/...a_library.html).
Finally, if the liquidity of small caps were the reason of their
outperformance, then small growth stocks will also outperform large
growth stocks. In fact, small growth stocks underperform all other
investment styles, including large growth stocks (see
http://www.moneychimp.com/articles/i...portfolios.htm).

For what its worth, the efficient market _________ is usually
considered a hypothesis by financial academia.

To be considered theory, a statement must be substantiated by multiple
examples and facts. Theories are often regarded as stated fact or
truths. Furthermore, most theories only fall short of "law" status,
because every possible variable and/or condition to the theory has not
yet or cannot be tested. If a theory can be found not to hold true in
even one instance or set of circumstances, it is no longer a theory and
must be revised.

It is this last criteria that makes the EMH a hypothesis (in most
people's opinion). Bubbles, crashes, the small firm in January effect,
insider trading, and value stocks are arguably all deviations from the
hypothesis statement, which make it untrue in certain
circumstances(which rule out "theory" status).

Paradoxically Buffet has in the past stated "I'd be a bum on the street
with a tin cup if the markets were always efficient" (an obvious
rejection of EMH) but he refers to market efficiency as "a theory"
(which it cannot be if he rejects it on fact).

Jose Bailen wrote:
- quote -

(small cap and value effects)

There are (at least) 2 as yet unexplained anomalies in Efficient
Markets theorem:

- small capitalisation stocks outperform large capitalisation stocks

- 'value' stocks (usually measured as Market Cap to Book Value, but we
would think of it as Price to Book) on a number of criteria outperform
'growth' stocks by a substantial margin

Neither of these anomalies appears to be fully explained by higher
volatility of returns. In the case of the Small Cap effect, it may be
entirely an artefact of the data, (investors couldn't actually trade
those stocks, at those prices, they are too illiquid).

There are other unexplained anomalies (January effect, closed end
company effect), equity risk premium puzzle (equities have returned
much higher over the last 100 years than theory would predict).

Nonetheless the small cap effect and the value effect are the ones that
most vex the finance researchers.

Warren Buffet it is best to view as a private equity investor-- he
substantially deals in unlisted companies. Most PE firms underpform an
*equivalently levered* index of the SP500 (ie an SP500 with 80%
borrowing). But a significant portion of PE firms do not underperform,
and the performance has a tendency to persistence within a firm in
successive generations of fund.

(see David Swensen's books for more explication).

It's not really possible for US investors (private individuals) to gain
access to top performing PE funds, *except* by investing in certain
closed end UK funds (investment trusts) with a good long term record--
names to research include 3i, Candover, Electra, Permira, HG Capital.
It's also worth knowing UK private equity returns are likely to be
lower in the future than in the present.

KKR and Apollo also launched Dutch Listed Vehicles, but I recommend
checking the fees.

Will Trice wrote:

- quote -

"efficient market hypothesis" = 182,000 google hits
"efficient market theory" = 67,300 google hits.

I'm with Elle on this, although I didn't give it much thought till she
brought it to our attention.
JOE

Elle wrote:

- quote -

I've seen it called both a theory and a hypothesis. The OP called it
both. I wonder which is more common?

-Will

"Will Trice" <wwtrice[at]paragondynamics.com> wrote
- quote -

Nope, not you. ;-)

I agree the original post and its follow ups were fine,
except for the nigglingly incorrect subject line, which I
have now repaired. Want to argue about it? :-)

Actually, in its purest (or strongest) form EMH almost certainly does
not exist and is rather just a "utopia" of assumptions. It is similar
to a "perfectly competitive market" in microecon. It is important to
understand that most theorists do not believe we operate in a perfectly
efficient market. EMH only outlines the rules for an efficient market
and is often used for study/analysis in acedemics to prevent
overcomplication and undue influence from unmeasureable variables.

Both ideals require, among other things, all available information
delivered instantaneously to market participants. One of the most overt
evidences of this is market bubbles and crashes. A perfectly informed
investor would recognize a bubble build-up and immediately take an
opposing position that would in turn help reduce the overinflation of
the bubble itself. If ALL investors were perfectly informed, as assumed
in the EMH, the bubble would never burst due to the recognition of the
bubble and the opposing positions that mitigate it. As a matter of
fact, the bubble would never form. A bubble/crash is really nothing
more than investors acting on bad information, assumptions,
rationalizations, lies, and/or hopes long enough to cause the market to
be heavily tipped in one direction. EVENTUALLY, everyone realizes this
and jumps to the other side to correct (and often end up
overcorrecting).

Buffet and Lynch outperform the market because they invest in markets
where the information (publicly available or not, I can't say) is not
accurately reflected in stock price. That also reminds me, insider
trading and "hot stock tips" (particularly when they are never
discovered) are two of the best examples of EMH malfunction. Because
the diffusion of information trickles down and is not immediately
released upon the entire market at once, a few are able to benefit from
information that should be reflected in stock price, but is not yet.

There are actually three degrees to the EMH, each one being less
restrictive. In reality our market probably operates as a weak-form EMH
and we are striving towards a strong-form EMH.

beliavsky[at]aol.com wrote:

- quote -

Indeed, the follow-up question seems to indicate that the OP has a
genuine interest. I don't think he was just trying to be argumentative
or disruptive. That would be me

-Will

John Gunn wrote:

- quote -

I think the original post was reasonable for this forum, as did the
moderators, apparently. I don't think accusations of trolling should be
made lightly.

Turtle <mhauser-rite-on[at]arcor.de> wrote in
news:815a3$4590efd2$543ae126$16882[at]news1.surfino.com:

- quote -

Nice Troll.

John

Will Trice wrote:
- quote -

I made this claim much too wide. Buffett's claim was that all of the
folks that he personally knew that followed Graham's principles became
coin-flipping stars.

-Will

"Rich Carreiro" <rlcarr[at]animato.arlington.ma.us> wrote
- quote -

256/1,048,576 = (of course) 1/(2^12) = 1/4096

"Rich" is insisting former Fidelity Magellan fund manager
Peter Lynch is the 1 of, say, 4096 mutual fund managers who
beat the S&P 500 something like 12 years in a row,
specifically from about 1977-1990, when he ceased to
manage it.

The biggest problem with the analogy to me is that Lynch did
not simply beat the S&P 500 for nearly 12 years in a row. He
beat it by a lot.

Also, I am not sure exactly how many funds existed from
1977-1990, but it seems it would be between about 270 (end
of 1960s number of mutual funds that is much quoted) and
10,000 (number today). One report
(http://www.fpanet.org/journal/articl...0498-art12.cfm)
puts the number of equity funds at under 300 in 1980.

So it would seem more like Lynch was 1/1000 (to be generous)
to have achieved immense success at "coin tossing," when in
fact probability predicts the odds of this happening to be
much lower. Remember, also it was a single round of 1000
people "tossing a coin" some 12 years in a row. This reality
also raises the statistical significance of Lynch's feat. I
think fairness demands at least the suggestion that Lynch
had unique skills as a fund manager.

Reality also demands an acknowledgment that Lynch's feat
absolutely has not been repeated. In other words, investors
should not go around betting their life savings on a certain
mutual fund or ETF, believing its manager is the next Peter
Lynch.

Turtle wrote:

- quote -

Hi John,

I didn't do either of these things, I stayed ~100% invested in equities
all the way down, and I continued to invest new money, too. Moving into
bonds or getting out of the market only makes sense if I believed that
the market was going to continue to go lower. But I never have any idea
which way the market is going to go. I do believe that the shares of
the companies I buy will increase in value over time, otherwise why
would I buy them? But I don't know when. So I largely ignore the
market as a whole. As a result, I bought a lot of cheap securities
during the bear market (judging from their value now), was fully
invested at the bottom, and made back my losses before the end of 2003
(this is not the same as my portfolio reaching its pre-bear level, I am
not booking new investment money against losses here, only earnings
against losses).

Have a happy and profitable new year!
-Will

Jacob Marley wrote:

- quote -

Not according to Siegel. Presumably Lynch's record was some significant
number of standard deviations away from the mean during his tenure at
Magellan to make Siegel say this. Siegel did mention that the odds of
Lynch achieving his record by luck were 1 in 500,000, but as I mentioned
earlier, he presents no further evidence than this.

- quote -

Right. I wasn't suggesting that Magellan was an example of beating the
market by picking the right mutual fund. My point was that at least one
person (Lynch) has been able to beat the market in a way that suggests
it was not luck. Given that, it may be possible for others to beat the
market.

-Will

Rich Carreiro wrote:


- quote -

The coin-flipping analogy goes back to Buffett himself (he may have
stolen it from someone else, however): "The Superivestors of
Graham-and-Doddsville". I inadvertantly plagiarized this example
sometime back on this newsgroup. In any case, to finish Buffett's story
of the contest, what would you conclude if the 256 most successful
flippers all studied under the same coin-flipping master? Buffett
claims as part of this story that most or all of the folks who studied
under Benjamin Graham make it into coin-flipping stardom, despite the
fact that these folks use widely varying stock-picking methods.

-Will

Beating the index consistently doesn't mean that the EMT is not
correct. You need to consider also the volatility -i.e., riskiness- of
those portfolios which beat the market. For instance, Warren Buffett
has beaten the market by a wide margin, but the riskiness of his
portfolio -as measured by its standard deviation- is also much higher
than the market's.

What the EMT says is that, once you take into account information costs
and other costs, the only way you can beat the market is if you are
willing to accept a higher risk. An example is that the typical
portfolio of small cap value stocks has a higher long term rate of
return that the market's benchmark, but also a higher standard
deviation. You can check these hypothesis with the historical data
provided here:

http://mba.tuck.dartmouth.edu/pages/...a_library.html

Rich Carreiro wrote:
- quote -


======================================= MODERATOR'S COMMENT:
Please trim the post to which you are responding. "Trim" means that except for a FEW lines to add context, the previous post is deleted.

"Jacob Marley" <hatespam[at]hatespam.com> wrote in message
news:45919360.9703584[at]news.houston.sbcglobal.net...

- quote -

That is very true. Still, there is an element of chance in business success
just as in stockpicking. What may look like a string of shrewd decisions may
in truth be a run of luck. Not always but sometimes. Maybe a whole lot of
business people start with superior abilities and produce good records, but
only one or two, with the help of chance, produce super-spectacular records.

Rich Carreiro wrote:

- quote -

But there aren't 1 million known mutual fund managers. If I came to you
and spoke of my flipping ability, then asked for a coin from your
pocket, and proceeded to flip heads 90% of the time, you would at least
have to question your own senses.

Your analogy works for those who claimed to forsee the crash of 87 or
2000, on any given day, some advisors claim we are heading for a crash,
and when it happens, well, there's Elaine Garzarelli claiming to be one
of the clairvoyant. Whether she provided any valuable info before or
since, I don't know.

I know that statisics only offer probability, not a definite answer.
That many outcomes are considered 'no better than chance'. I'd need to
understand the math a bit better to answer Gil and others as to whether
a particular track record appears to be better than random.

JOE

"joetaxpayer" <joetaxpayer[at]nospam.com> wrote in message
news:8uGdncauU74o-AzYnZ2dnUVZ_ternZ2d[at]comcast.com...
- quote -

It is still possible that Buffet's record is just luck. Nobody knows. Maybe
chances of a distinguished record are one in a million, but if a few million
people are making the choices, it is entirely possible that one or two will
have produce that record by chance.

joetaxpayer <joetaxpayer[at]nospam.com> wrote:
- quote -

The statistics show that runs like Lynch's, while rare, are not
entirely unexpected. The trick, or course, is to identify such runs
*in advance.* If you can do that, then you can beat the market. The
Efficient Market Hypothesis says you're very unlikely to be able to do
that, though. Note that the Fidelity Magellan fund that he ran has now
essentially reverted to the mean, and the long term returns are fairly
consistent with the market as a whole.

- quote -

Couple of points here: Buffet himself has said that most folks would
be better off with index funds. This is due, in large part, to the
fact the Mr. Buffet of more of a businessman (and a darn good one)
than an investor. Most of his success is due to this, rather than some
extraordinary stock picking ability.

When Buffet buys a stock, he doesn't just buy a few hundred shares
like you or I do. He buys a significant position - enough to get him
seats on the board and a say in how the company is run. By identifying
companies with good prospects that aren't being well run, he can get
in cheaply and then bring his considerable business talents to bear.
This has proven a successful formula for him, and he's done
extraordinarily well. But, this should never be confused with
stockpicking.