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FINA 4310 Spring 2002 9(d) Market Efficiency Performance of Professional Portfolio Managers Beating the Market Suppose that markets are inefficient, and it is possible to beat the market Can it be possible for everyone to beat the market at the same time?
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FINA 4310Spring 2002 9(d) Market Efficiency Performance of Professional Portfolio Managers
Beating the Market • Suppose that markets are inefficient, and it is possible to beat the market • Can it be possible for everyone to beat the market at the same time? • No, because the market return is the average of individual investors returns. • By definition, not everyone can be above average.
Some winners, some losers • Suppose you follow a strategy that beats the market. • Every time you buy, somebody is selling • Every time you sell, somebody is buying • So for you to beat the market, somebody else has to underperform the market
However... • It may be possible for all traders to underperform the market at the same time, because of • Transaction costs • Resources spent on research • Example: • Jones Trading Company spends $10,000,000 to hire a team of analysts. • Ends up making $5,000,000 of trading profits • Daytraders around the country lose $5,000,000
Who will it be? • Let’s say you think markets are inefficient and it is possible to beat the market • Who will be most likely to beat the market • Professional fund managers, supported by an experienced research team, with access to the best information technology and most efficient trading platforms, or • You
Professional Managers • One might think that if anyone can beat the market, professional fund managers can. • In fact, actively managed mutual funds on average tend to underperform passive index funds. • See graph on page 113 of the book, or see Bogle’s graph
Hot Hands • Maybe some managers are good and some are bad. • If so, you would expect to see performance persistence • Funds that beat the market last year are more likely to beat the market this year • “Hot Hands” • But the evidence for hot hands is very weak.
Hard to Measure • As we have seen before, there are measurement problems • Survivorship bias • Accounting for Risk • Distinguishing Luck from Skill • Window Dressing • Gaming Benchmarks • Changing Fund Managers
Another Problem • Winning strategies will not persist • Funds that are highly successful attract so much money that they are forced to become more like the market portfolio • Generate copycats.