Global Market Efficiency or Distortion

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Johnathon Livingston
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Global Market Efficiency or Distortion

Post by Johnathon Livingston »

One of the tenets of index investing is that markets are efficient. Therefore, market capitalization weight should reflect business performance. That being said, how do you reconcile efficient market theory with home country bias? Efficient market theory seems to rest on people making rational investment choices based on all available information. The market rewards performance and cuts loss. But when you define the “market” globally you run into bias—which would seem to undercut the foundation of efficient market theory. Vanguard reports major home country bias in investing. For example, Italians invest in Italian companies at over 31 times their global market weight. Germans invest in German companies at nearly eight times their global market weight. And Americans invest in US companies at 1.4 times global market weight. https://personal.vanguard.com/pdf/ISGGE ... Online.pdf

I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?
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Re: Global Market Efficiency or Distortion

Post by jjj_22 »

EMH just means that available information is rapidly and efficiently incorporated into prices.

It doesn't say anything about how that information is used or ignored by market participants to effect prices.

So this
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am Therefore, market capitalization weight should reflect business performance.
I think is not quite right. Market valuations reflect business performances some, but also reflect the whims and biases of investors. That's not inconsistent with EMH.
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Re: Global Market Efficiency or Distortion

Post by cos »

It's important to remember that a surprisingly small fraction of market participants are collectively responsible for setting prices. It takes only a handful of active traders to make a market.
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Re: Global Market Efficiency or Distortion

Post by Johnathon Livingston »

jjj_22 wrote: Tue May 18, 2021 11:22 am EMH just means that available information is rapidly and efficiently incorporated into prices.

It doesn't say anything about how that information is used or ignored by market participants to effect prices.

So this
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am Therefore, market capitalization weight should reflect business performance.
I think is not quite right. Market valuations reflect business performances some, but also reflect the whims and biases of investors. That's not inconsistent with EMH.
I think that’s true, but regression to the mean ensures that fundamentals win over speculation, whims, hype. So, yes, bias and emotions etc are baked into the theory, but home country bias results in populations of people not participating in other markets or “under participating.” Or, you could say they are over participating in their home market. However you look at it, I think home country bias could be argued to uniquely undercut market efficiency because of its effect on participation. E.g. a lot of people from country X that “should be” or “would be” buying stock in country Y don’t even participate in that market.
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Re: Global Market Efficiency or Distortion

Post by nisiprius »

First, the proof of the pudding.

Emerging markets are often suggested as an area of market inefficiency. If so, that should be an area in which active managers can shine. Then why did 92% of all actively managed emerging markets fund underperform their index over the last twenty years? If they are inefficient, why were 92% of professional fund managers unable to make money for their clients by exploiting that inefficiency?

Source

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Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."

The only place the word "efficient" occurs in the Bogleheads' Investment Philosophy is in the phrase "tax-efficient."
...I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?...
Let's suppose a market is inefficient. To me, what it means is that
  • there are information asymmetries,
  • some investors know more than others,
  • some investors are able to exploit what they know,
  • some are able to use take legal (but unfair) advantage of other investors, and make money by taking it way from other investors. For convenience I'll call this "robbery."
Let's say it's true.

Why on earth would I believe that I would be one of the robbers rather than one of the robbed?

Now suppose someone says "just give me your money and I will go into the inefficient market for you and rob, and share my take with you after taking out just a little for my trouble..." Why do I think I can tell the skillful robbers from the posers, and the honest robbers from the dishonest ones?

But if I hold the whole market, I am on both sides of every trade. If there are successful robbers within the market, I am simultaneously victimized by them and share in their unfairly-gotten gains. For a total market investor, it balances out. Not because the market is efficient, but because it is somewhat contained.
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Re: Global Market Efficiency or Distortion

Post by vineviz »

Johnathon Livingston wrote: Tue May 18, 2021 11:42 am
jjj_22 wrote: Tue May 18, 2021 11:22 am EMH just means that available information is rapidly and efficiently incorporated into prices.

It doesn't say anything about how that information is used or ignored by market participants to effect prices.

So this
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am Therefore, market capitalization weight should reflect business performance.
I think is not quite right. Market valuations reflect business performances some, but also reflect the whims and biases of investors. That's not inconsistent with EMH.
I think that’s true, but regression to the mean ensures that fundamentals win over speculation, whims, hype. So, yes, bias and emotions etc are baked into the theory, but home country bias results in populations of people not participating in other markets or “under participating.” Or, you could say they are over participating in their home market. However you look at it, I think home country bias could be argued to uniquely undercut market efficiency because of its effect on participation. E.g. a lot of people from country X that “should be” or “would be” buying stock in country Y don’t even participate in that market.
I’ll reiterate the crucial point which jjj_22 made that none of that is related to market efficiency. The effect you’re postulating has to do with asset pricing, not market efficiency.

Moreover, observing that a home bias exists isn’t sufficient to argue , as in your example, that the stocks of country Y are underpriced because investors from country X avoid them.

You’d also have to examine whether or not investors in country Y also have a home bias. If so, those investors avoidance of stocks from country Y would produce an offsetting pricing effect that must be accounted for.

And if the goal is to use this information to set EXPECTATIONS of future returns, you’d also need to account for differences in wealth growth etc.

In short, it’s not a question that easily lends itself to a simple thought experiment.
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Re: Global Market Efficiency or Distortion

Post by DB2 »

I know some consider 10 years to be "noise" but the Vanguard Actively managed EM fund has outperformed their index. Is it just luck or skill at play?

https://www.portfoliovisualizer.com/bac ... ion2_2=100
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Re: Global Market Efficiency or Distortion

Post by NiceUnparticularMan »

The assumed mechanism of efficient pricing in liquid markets is a few arbitrageurs with supercomputers, PhDs on staff, leveraged billions to invest, and faster trading are competing against each other to exploit any identifiable pricing inefficiencies that may temporarily crop up before the other arbitrageurs get to it. Small individual investors with all their various biases are expected to pay no significant role in that process.

As applied to home country bias: if, say, stock in Company X in Country Y "should" have a price of $100, but excess demand due to the home bias of Country Y's investors combined would drive it up to $110 if left unaddressed, the arbitrageurs are assumed to immediately recognize this is starting to happen, and to compete with each other to short Company X's stock, until the price gets back down to $100. Note they are assuming the price will in fact quickly go down, so that they can quickly profit on their short without much risk.

I note one of the ways this whole theory could go wrong is if whatever efficiency in question is so large that it is simply impossible for the arbitrageurs to be able to quickly undo it. I believe there are some who think that home country bias as applied to the United States might possibly be an example of such a case, meaning even if arbitrageurs were confident the U.S. stock market as a whole was overpriced, they would not collectively have the means to compete down the price of the entire U.S. stock market to what it "should" be. In which case none of them would try, as it would be far too risky to try to short the U.S. market as a whole without knowing that they could collectively drive down the price quickly.

So take that as a cautionary note on assuming home country bias is always correctible by the normal mechanisms of efficient markets.
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Re: Global Market Efficiency or Distortion

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nisiprius wrote: Tue May 18, 2021 11:51 am
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."
While Bogle was a great man, he was not known for his work on theory. I can't remember a time when I have seen somebody cite that hypothesis outside of Bogleheads due to serious flaws. I put Bogle along side Christopher Columbus, people who where great in spite of their theories.

EMH is constantly cited and picked apart in the journals. David Booth (of University of Chicago Booth School of Business), specifically cites EMH and his work with Eugene Fama (the originator EMH) for the launch of the first index fund - 2 years before John Boggle launched his.
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Re: Global Market Efficiency or Distortion

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Johnathon Livingston wrote: Tue May 18, 2021 11:14 am I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?
I think of 'the market' as all the liquid, securitized, publicly tradeable assets available to all people on the planet.

That includes their biases, relative currency valuations, differences in local tax laws favoring certain kinds of investments over others, restrictions on what is or isn't available to invest in, capital controls, remittances, etc, etc.

Attempting to remove those local idiosyncrasies and 'distortions' is attempting to force-fit reality into some theoretical academic model, instead of reflecting the world as it really is.

It's all part of the complex economic machine of earth.
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Re: Global Market Efficiency or Distortion

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watchnerd wrote: Tue May 18, 2021 1:08 pm
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?
I think of 'the market' as all the liquid, securitized, publicly tradeable assets available to all people on the planet.

That includes their biases, relative currency valuations, differences in local tax laws favoring certain kinds of investments over others, restrictions on what is or isn't available to invest in, capital controls, remittances, etc, etc.

Attempting to remove those local idiosyncrasies is attempting to force the world into some theoretical academic model, instead of reflecting the world as it really is.

It's all part of the complex economic machine of earth.
I would not put it so harshly. So 2 points.

First, the world is moving in this direction. Markets are integrating, Restrictions are falling. They are much more integrated then they were 40 years, or even 20 years, ago. This is particularly true of DM and large multinational EM companies. Sure, local tax laws makes things interesting - but they can be accounted for.

Second, of EM to hold true you only need for the price to be correct, not market allocation. Price is set at the margin. So a relative small but active foreign investors can heavily influence the price.
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Re: Global Market Efficiency or Distortion

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alex_686 wrote: Tue May 18, 2021 1:16 pm

I would not put it so harshly. So 2 points.

First, the world is moving in this direction. Markets are integrating, Restrictions are falling. They are much more integrated then they were 40 years, or even 20 years, ago. This is particularly true of DM and large multinational EM companies. Sure, local tax laws makes things interesting - but they can be accounted for.

Second, of EM to hold true you only need for the price to be correct, not market allocation. Price is set at the margin. So a relative small but active foreign investors can heavily influence the price.
What was harsh about it?
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Re: Global Market Efficiency or Distortion

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watchnerd wrote: Tue May 18, 2021 1:18 pm
alex_686 wrote: Tue May 18, 2021 1:16 pm I would not put it so harshly. So 2 points.
What was harsh about it?
watchnerd wrote: Tue May 18, 2021 1:08 pm Attempting to remove those local idiosyncrasies and 'distortions' is attempting to force-fit reality into some theoretical academic model, instead of reflecting the world as it really is.
The world is not being forced into a particular mold. Rather as the world grows bigger and more complex it benefits everybody that restrictions are removed. As restrictions are eased, the world falls into a more natural state - one of EMH.
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Re: Global Market Efficiency or Distortion

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alex_686 wrote: Tue May 18, 2021 1:26 pm

The world is not being forced into a particular mold. Rather as the world grows bigger and more complex it benefits everybody that restrictions are removed. As restrictions are eased, the world falls into a more natural state - one of EMH.
Yes.

Where are not in disagreement.

As the world evolves and restrictions are removed, it will be reflected in the market reality.

Perhaps when I said "theoretical academic model" you thought I meant a coercive process, as opposed to pointing out a flaw in modeling.
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Re: Global Market Efficiency or Distortion

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Who owns Italian corporations and I mean major owners ? Chances are they are Italian. Mystery solved; it has nothing to do with home-market bias, which certainly exists, but originates from causes which are becoming less and less relevant.
Last edited by Thesaints on Tue May 18, 2021 2:20 pm, edited 2 times in total.
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Re: Global Market Efficiency or Distortion

Post by Northern Flicker »

Jonathan Livingston wrote: One of the tenets of index investing is that markets are efficient. Therefore, market capitalization weight should reflect business performance.
That is not the definition of market efficiency. Market efficiency means that all publicly available information is priced in very rapidly. Past business performance is only one such piece of information.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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Re: Global Market Efficiency or Distortion

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Thesaints wrote: Tue May 18, 2021 2:10 pm Who owns Italian corporations and I mean major owners ? Chances are they are Italian. Mystery solved; it has nothing to do with home-market bias, which certainly exists, but originates from causes which are becoming less and less relevant.
Yes and no.

40 years ago everybody basically invested domestically because the costs of going international where high. As costs dropped people drifted into international. Old money stayed where it was, new money was more widely invested.

Italian corporations tend to family affairs. So old money. You pass shares to your children not because you are looking to maximize portfolio return, rather to maintain control of the family company. The children tend to keep their shares. That is, they make a conscious choice to be undiversified.

There are interesting nuances to this. However, since price is set at the margin it is not a primary driver.
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Re: Global Market Efficiency or Distortion

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alex_686 wrote: Tue May 18, 2021 2:26 pm
Thesaints wrote: Tue May 18, 2021 2:10 pm Who owns Italian corporations and I mean major owners ? Chances are they are Italian. Mystery solved; it has nothing to do with home-market bias, which certainly exists, but originates from causes which are becoming less and less relevant.
Yes and no.

40 years ago everybody basically invested domestically because the costs of going international where high. As costs dropped people drifted into international. Old money stayed where it was, new money was more widely invested.

Italian corporations tend to family affairs. So old money. You pass shares to your children not because you are looking to maximize portfolio return, rather to maintain control of the family company. The children tend to keep their shares. That is, they make a conscious choice to be undiversified.

There are interesting nuances to this. However, since price is set at the margin it is not a primary driver.
ENI is the largest listed Italian company. 30% of it is held by the Italian state, under one form or another, and another 30% is held by other Italian subjects. Of the latter, only a small part is individual investors.
It is not so much as "family affairs", as the fact that all corporations of strategic interest have large institutional components because back in the days foreigners would not be allowed in. The same is largely true for France and Germany.
The family business component is also there and that adds to this apparent domestic market skew. I'm saying "apparent" because an individual retail investor today really has no reason, nor incentive, in limiting themselves to buy stocks within their own country.

Interestingly, 31x, 8x, and 1.4x mentioned by the OP, weighted by the respective market sizes give similar numbers.
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Re: Global Market Efficiency or Distortion

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nisiprius wrote: Tue May 18, 2021 11:51 am Source

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Performance seems to include the fees. With a 0% hypothetical fee, it would be lower, no?
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Re: Global Market Efficiency or Distortion

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Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No. Index investing depends on the investor not being able to beat the market consistently, after costs.

If you can consistently do better than the market, you should do so rather than index investing. Doing better than the market might involve picking investments or picking managers. History shows that the number of investors who can do this is rather small.
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Re: Global Market Efficiency or Distortion

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Seasonal wrote: Tue May 18, 2021 4:51 pm If you can consistently do better than the market, you should do so rather than index investing. Doing better than the market might involve picking investments or picking managers. History shows that the number of investors who can do this is rather small.
Not that small. The issue is rather than almost none of them could tell in advance.
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Re: Global Market Efficiency or Distortion

Post by nisiprius »

alex_686 wrote: Tue May 18, 2021 12:53 pm
nisiprius wrote: Tue May 18, 2021 11:51 am
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."
While Bogle was a great man, he was not known for his work on theory. I can't remember a time when I have seen somebody cite that hypothesis outside of Bogleheads due to serious flaws. I put Bogle along side Christopher Columbus, people who where great in spite of their theories.

EMH is constantly cited and picked apart in the journals. David Booth (of University of Chicago Booth School of Business), specifically cites EMH and his work with Eugene Fama (the originator EMH) for the launch of the first index fund - 2 years before John Boggle launched his.
I don't think he meant "CMH" to compete as an academic theory, it was his way of thumbing his nose at theoreticians--and intentionally rhyming with "EMH."

He was asserting that costs were more important than theoretical niceties.

And while you sneer at it, it is still the case that year after year, Morningstar--which makes its living from trying to evaluate mutual funds--keeps finding out again and again that Fund Fees Predict Future Success or Failure.
The expense ratio is the most proven predictor of future fund returns. We find that it is a dependable predictor when we run the data. That's also what academics, fund companies, and, of course, Jack Bogle, find when they run the data.
And there is darn little in investing that has proved to be a dependable predictor of future fund returns.
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Re: Global Market Efficiency or Distortion

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international001 wrote: Tue May 18, 2021 4:38 pm Performance seems to include the fees. With a 0% hypothetical fee, it would be lower, no?
Yes, but EM is not a good category. The EM indexes tend to be flawed.

The indexes being cited are "investable indexes". i.e., securities that a fund can go out and buy in large quantities without distorting the market, lots of trades so the indexer can get good price data to publish index data. This means that the indexes are limited to only the largest and most liquid companies. And if that is the market you are targeting these indexes work fine.

However many of them are buying securities outside of the index. They are ignoring the big companies and are trying to get local exposure. This is where you actually get some low correlations with US markets, and thus good diversification And while they can present other indexes, they have to present one investable index to the SEC in its reporting.
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Re: Global Market Efficiency or Distortion

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You generally have no control over the laws or actions of foreign countries and their laws are generally not written with your best interest in mind.
E.g. a government of some country may decide to seize assets held by foreign investors or default on its foreign debt.
Which is why people tend to to invest within their country where the government is accountable to them.
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Re: Global Market Efficiency or Distortion

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nisiprius wrote: Tue May 18, 2021 5:03 pm I don't think he meant "CMH" to compete as an academic theory, it was his way of thumbing his nose at theoreticians--and intentionally rhyming with "EMH." ... And while you sneer at it,
I take offensive at this characterization. I am strongly for passive investing for various reasons. In large part due to theory, practice, and results lining up.

And if CMH is not a academic theory then what? I mean, the point of academic theory is to build up a systematic rational internally consistent theory of the world. If CMH is not that then what is it? Dogma? I don't think so.
nisiprius wrote: Tue May 18, 2021 5:03 pm He was asserting that costs were more important than theoretical niceties.

And while you sneer at it, it is still the case that year after year, Morningstar--which makes its living from trying to evaluate mutual funds--keeps finding out again and again that Fund Fees Predict Future Success or Failure.
The expense ratio is the most proven predictor of future fund returns. We find that it is a dependable predictor when we run the data. That's also what academics, fund companies, and, of course, Jack Bogle, find when they run the data.
And there is darn little in investing that has proved to be a dependable predictor of future fund returns.
So let us break this down.

EMH implies that in efficient markets you will get the market return, ignoring price discovery. You have picked a study that looks at lots of funds operating in a efficient market get the market return. So this really is a wash when it comes to CMH v EMH.

The problem with CMH is that is fails is so many ways. Expand the data set and start digging deeper and you start finding loads of example where CMH fails but EMH works. i.e., where the market is not efficient or price discovery is high. For example, there is a positive correlation for commodity funds between a fund manager's expenses and their net return.
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Re: Global Market Efficiency or Distortion

Post by abuss368 »

TheHiker wrote: Tue May 18, 2021 6:18 pm You generally have no control over the laws or actions of foreign countries and their laws are generally not written with your best interest in mind.
E.g. a government of some country may decide to seize assets held by foreign investors or default on its foreign debt.
Which is why people tend to to invest within their country where the government is accountable to them.
Hi TheHiker -

There is a lot of logic and common sense to your reasoning. Investors would be wise to listen.

David Swensen (RIP) after referenced this when discussing why international bonds have no place in a globally equity oriented portfolio.

Best wishes.
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Re: Global Market Efficiency or Distortion

Post by watchnerd »

abuss368 wrote: Tue May 18, 2021 6:22 pm
TheHiker wrote: Tue May 18, 2021 6:18 pm You generally have no control over the laws or actions of foreign countries and their laws are generally not written with your best interest in mind.
E.g. a government of some country may decide to seize assets held by foreign investors or default on its foreign debt.
Which is why people tend to to invest within their country where the government is accountable to them.
Hi TheHiker -

There is a lot of logic and common sense to your reasoning. Investors would be wise to listen.

David Swensen (RIP) after referenced this when discussing why international bonds have no place in a globally equity oriented portfolio.

Best wishes.
Tony
Swensen actually recommended international equities.

You're talking about international bonds, and Swensen was a Treasuries guy.

But he was in favor of individual investors holding foreign equities:

http://www.lazyportfolioetf.com/allocat ... endowment/

So I don't think Swensen's retail investor portfolio supports the 'US stocks only' POV at all.

It has specific allocations to Developed and Emerging foreign markets.
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Re: Global Market Efficiency or Distortion

Post by abuss368 »

Correct. David Swensen recommended international stocks and advised to avoid international bonds. The international bonds discussed was in the chapter asset classes to avoid in the excellent book “Unconventional Success”.

I was fortunate to have attended a lecture of David Swensen’s at my University years ago. I learned a lot.

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Re: Global Market Efficiency or Distortion

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Re: Global Market Efficiency or Distortion

Post by Johnathon Livingston »

nisiprius wrote: Tue May 18, 2021 11:51 am First, the proof of the pudding.

Emerging markets are often suggested as an area of market inefficiency. If so, that should be an area in which active managers can shine. Then why did 92% of all actively managed emerging markets fund underperform their index over the last twenty years? If they are inefficient, why were 92% of professional fund managers unable to make money for their clients by exploiting that inefficiency?

Source

Image
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."

The only place the word "efficient" occurs in the Bogleheads' Investment Philosophy is in the phrase "tax-efficient."
...I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?...
Let's suppose a market is inefficient. To me, what it means is that
  • there are information asymmetries,
  • some investors know more than others,
  • some investors are able to exploit what they know,
  • some are able to use take legal (but unfair) advantage of other investors, and make money by taking it way from other investors. For convenience I'll call this "robbery."
Let's say it's true.

Why on earth would I believe that I would be one of the robbers rather than one of the robbed?

Now suppose someone says "just give me your money and I will go into the inefficient market for you and rob, and share my take with you after taking out just a little for my trouble..." Why do I think I can tell the skillful robbers from the posers, and the honest robbers from the dishonest ones?

But if I hold the whole market, I am on both sides of every trade. If there are successful robbers within the market, I am simultaneously victimized by them and share in their unfairly-gotten gains. For a total market investor, it balances out. Not because the market is efficient, but because it is somewhat contained.
The rationale for index investing does include cost as Jack Bogle said many times. But it also rests on the notion that you are highly unlikely to beat the market because prices reflect all available information, which is the essence of EMH. That’s not subject to dispute. I think Bogle was being somewhat tongue in cheek with that quote and taking a jab at active fund managers. Regardless, I think my statement is accurate.
Thesaints
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Re: Global Market Efficiency or Distortion

Post by Thesaints »

TheHiker wrote: Tue May 18, 2021 6:18 pm You generally have no control over the laws or actions of foreign countries and their laws are generally not written with your best interest in mind.
E.g. a government of some country may decide to seize assets held by foreign investors or default on its foreign debt.
Which is why people tend to to invest within their country where the government is accountable to them.
I suspect that any country where the government is capable of seizing foreign investors' assets also has a form of government that is not very accountable to its citizens.
jjj_22
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Re: Global Market Efficiency or Distortion

Post by jjj_22 »

Johnathon Livingston wrote: Tue May 18, 2021 11:42 am E.g. a lot of people from country X that “should be” or “would be” buying stock in country Y don’t even participate in that market.
Why "should" someone in country X buy stock from country Y?

It sounds like you're saying that the market is only efficient if everyone in the world buys all stocks at global market weight. I mean, you're not saying that, but that is the logical consequence of what you're saying.

EMH makes no statement about how capital is allocated, i.e about who "should" buy what. Many people seem to think this, but that's just not what it says.

All EMH says is that you can't reliably profit from an informational advantage (where information is public) because all information about the market is rapidly and efficiently incorporated into prices.
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watchnerd
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Re: Global Market Efficiency or Distortion

Post by watchnerd »

jjj_22 wrote: Tue May 18, 2021 9:25 pm

It sounds like you're saying that the market is only efficient if everyone in the world buys all stocks at global market weight. I mean, you're not saying that, but that is the logical consequence of what you're saying.
Well, that's not far from William Sharpe's POV:
In a simple world, the market portfolio would include every publicly traded security, with each
held in proportion to the total amount outstanding. An investor could hold his or her version of
the market portfolio by purchasing x% of the outstanding shares of every traded stock and x%
of the outstanding number of bonds for every traded bond, where x is the ratio of his or her
invested wealth to the total value of the amounts invested by everyone.

Importantly, it would be possible for each investor to hold such a market portfolio. The market
would clear, since for each stock or bond the total quantity demanded would equal the amount
available
. Moreover, a recommendation that each investor put his or her “at risk” assets in the
market portfolio would be macro-consistent advice, in the sense that everyone could implement
such a strategy.
https://web.stanford.edu/~wfsharpe/RISMAT/RISMAT-7.pdf
60% Global Market Stocks (VT,FM) | 38% Global Market Bonds | 2% crypto & securitized gold || LMP TIPS/STRIPS || RSU + ESPP
Northern Flicker
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Re: Global Market Efficiency or Distortion

Post by Northern Flicker »

nisiprius wrote: No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."

The only place the word "efficient" occurs in the Bogleheads' Investment Philosophy is in the phrase "tax-efficient."
This is a position that if active management can be executed at cost similar to, or not too much higher than indexing, then you probably can beat the market with active management.

The position that flows from EMH is that active management will not beat the market on average even before cost is considered because any public information on which to base active management decisions is already priced in.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
Northern Flicker
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Re: Global Market Efficiency or Distortion

Post by Northern Flicker »

DB2 wrote: Tue May 18, 2021 12:15 pm I know some consider 10 years to be "noise" but the Vanguard Actively managed EM fund has outperformed their index. Is it just luck or skill at play?

https://www.portfoliovisualizer.com/bac ... ion2_2=100
There is a 3rd option: the portfolio was riskier. It did have a max drawdown 4 percentage points greater in magnitude than did VEMAX.

About 71% of the market cap of the index tracked by VEMAX is now composed of equities from three countries (China, Taiwan, India).
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
dsasdg
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Re: Global Market Efficiency or Distortion

Post by dsasdg »

DB2 wrote: Tue May 18, 2021 12:15 pm I know some consider 10 years to be "noise" but the Vanguard Actively managed EM fund has outperformed their index. Is it just luck or skill at play?

https://www.portfoliovisualizer.com/bac ... ion2_2=100
If you can't distinguish, you can't take advantage of it.
Derpalator
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Re: Global Market Efficiency or Distortion

Post by Derpalator »

nisiprius wrote: Tue May 18, 2021 11:51 am First, the proof of the pudding.

Emerging markets are often suggested as an area of market inefficiency. If so, that should be an area in which active managers can shine. Then why did 92% of all actively managed emerging markets fund underperform their index over the last twenty years? If they are inefficient, why were 92% of professional fund managers unable to make money for their clients by exploiting that inefficiency?

Source

Image
Johnathon Livingston wrote: Tue May 18, 2021 11:14 am One of the tenets of index investing is that markets are efficient.
No, it isn't. I don't know why people keep saying that. John C. Bogle famously said that it is not based on the EMH but the CMH: not the efficient market hypothesis, but the "cost matters hypothesis."

The only place the word "efficient" occurs in the Bogleheads' Investment Philosophy is in the phrase "tax-efficient."
...I have no doubt that efficient market theory holds true within a country. But how can it hold true globally when investors allow home country bias to significantly affect how they invest instead of pure stock valuation? Your thoughts?...
Let's suppose a market is inefficient. To me, what it means is that
  • there are information asymmetries,
  • some investors know more than others,
  • some investors are able to exploit what they know,
  • some are able to use take legal (but unfair) advantage of other investors, and make money by taking it way from other investors. For convenience I'll call this "robbery."
Let's say it's true.

Why on earth would I believe that I would be one of the robbers rather than one of the robbed?

Now suppose someone says "just give me your money and I will go into the inefficient market for you and rob, and share my take with you after taking out just a little for my trouble..." Why do I think I can tell the skillful robbers from the posers, and the honest robbers from the dishonest ones?

But if I hold the whole market, I am on both sides of every trade. If there are successful robbers within the market, I am simultaneously victimized by them and share in their unfairly-gotten gains. For a total market investor, it balances out. Not because the market is efficient, but because it is somewhat contained.
Absolute gold. Bravo Nisiprius.
acegolfer
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Re: Global Market Efficiency or Distortion

Post by acegolfer »

EMH doesn't imply everyone should hold market portfolio. So tilting in any direction (such as SCV or home bias) is not against EMH. Even Fama (who coined EMH) is okay with tilting.
alex_686
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Re: Global Market Efficiency or Distortion

Post by alex_686 »

Northern Flicker wrote: Wed May 19, 2021 12:33 am The position that flows from EMH is that active management will not beat the market on average even before cost is considered because any public information on which to base active management decisions is already priced in.
The his is false.

EMH versions ranges from the week to strong. However, even under the strong version there is a allowance for price discovery. Superior management and research will result in superior results.

This is born out empirically. There is a positive relationship between portfolio management fees and gross returns.

That the managers take the lion’s share of returns is another story.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
Northern Flicker
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Re: Global Market Efficiency or Distortion

Post by Northern Flicker »

alex_686 wrote: Wed May 19, 2021 7:32 am
Northern Flicker wrote: Wed May 19, 2021 12:33 am The position that flows from EMH is that active management will not beat the market on average even before cost is considered because any public information on which to base active management decisions is already priced in.
The his is false.

EMH versions ranges from the week to strong. However, even under the strong version there is a allowance for price discovery. Superior management and research will result in superior results.

This is born out empirically. There is a positive relationship between portfolio management fees and gross returns.

That the managers take the lion’s share of returns is another story.
For most of EMH's life there were two versions-- regular EMH (all public info already is priced in) and strong EMH (all known info, public or private, is priced in). Various other gradations have been been published over time, generally of minimal impact or consequence, but some are treated as the equal of the first two by wikipedia, which is not an authoritative source for many topics.

When people just state EMH in an unqualified manner, the overwhelming historical precedent is meaning that all public info is priced in. This is not inconsistent with price discovery. Different market participants price info in differently, and new information to price in may become publicly available by the minute.

If all publicly known information is priced in, you can only have a better than 50% chance of beating the market if you have a more accurate pricing in than the market of some public information or can predict the future and know and trade on what information will become public (which would be illegal if you had the information before it became public, as opposed to having predicted it) or be the first market participant to trade on new information that becomes public.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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