Are all markets efficient?

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Runalong
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Are all markets efficient?

Post by Runalong » Tue May 23, 2017 10:41 pm

I only check in here once every other month or so so pardon me if this has been covered in depth.

In particular I wonder if VINEX (International small caps, 0.4% expense ratio) is a good investment on the assumption that the non-US small cap market does not get near as much attention as say, the S&P 500, therefore bargains can be found by those who search for them, thus justifying the extra 0.25% per year.

In a simlar vein,could VMMSX (actively managed EM - I originally wrote VEMAX by mistake) possibly be better than VWO in spite of charging 0.75% more per year if the managers can find bargains in emerging markets by avoiding the typical stocks favored by EM index funds and applying due diligence to the remaining universe of available equities?

Are there markets today where alpha is still a realistic possibility?
Last edited by Runalong on Wed May 24, 2017 11:12 am, edited 1 time in total.

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Re: Are all markets efficient?

Post by whodidntante » Tue May 23, 2017 10:48 pm

VEMAX is identical in cost and holdings to VWO.

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Re: Are all markets efficient?

Post by whodidntante » Tue May 23, 2017 10:51 pm

Small, value and other factors are not sufficient to refute the EMH. If you could reliably train stock pickers to beat the market by acting on information in 10ks then you will have disproven the EMH.

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Re: Are all markets efficient?

Post by avalpert » Tue May 23, 2017 11:24 pm

Runalong wrote:I only check in here once every other month or so so pardon me if this has been covered in depth.

In particular I wonder if VINEX (International small caps, 0.4% expense ratio) is a good investment on the assumption that the non-US small cap market does not get near as much attention as say, the S&P 500, therefore bargains can be found by those who search for them, thus justifying the extra 0.25% per year.
In the last 5, 3 and 1 year performance VINEX trails SCZ (which tracks non-US small index) though they track very closely and that is without a real expense difference - so no, doesn't seem like a sound assumption.

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Re: Are all markets efficient?

Post by Wagnerjb » Tue May 23, 2017 11:39 pm

whodidntante wrote:Small, value and other factors are not sufficient to refute the EMH. If you could reliably train stock pickers to beat the market by acting on information in 10ks then you will have disproven the EMH.
Well said.
Andy

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Re: Are all markets efficient?

Post by Runalong » Wed May 24, 2017 1:30 am

My mistake, I meant VMMSX, the actively managed EM fund, not VEMAX the (VWO-equivalent) index.

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Re: Are all markets efficient?

Post by Runalong » Wed May 24, 2017 1:38 am

whodidntante: your argument then is that all markets everywhere are always efficient?

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Re: Are all markets efficient?

Post by JoMoney » Wed May 24, 2017 2:03 am

Runalong wrote:...your argument then is that all markets everywhere are always efficient?
I believe saying there is no asymmetric information within most markets can be proven false.
I believe saying there are no traders with positional advantages (like trading faster, front running, acting as a middle man) can be proven false.
I believe if you can look at all the work done in behavioral economics and psychology and the whole profession of marketing, and somehow think these factors don't impact investment markets, you're in denial of reality... I think the psychologists might say "cognitive dissonance".
That being said....
I believe it's a tautology to say aggregate performance of investors in a market (however you want to define the boundaries of 'the market') will always equal that of the market.
I believe markets are extremely competitive, and if you want something extra, you have to be able to bring something extra to the game... But by definition we can't all be above average, and most aren't prepared to play against the pros (i.e. Winning the losers game). Very few teams will finish a season competing for the top ranks. But the market makes it very simple, easy, and low cost to guarantee 'average'.
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Re: Are all markets efficient?

Post by lazyday » Wed May 24, 2017 4:49 am

Some markets are less efficient than others, but I wouldn't expect any alpha after expenses.

If there's a manager who produces alpha after expenses, they will likely increase fees and/or attract more money until performance suffers.

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Re: Are all markets efficient?

Post by carolinaman » Wed May 24, 2017 7:17 am

lazyday wrote:Some markets are less efficient than others, but I wouldn't expect any alpha after expenses.

If there's a manager who produces alpha after expenses, they will likely increase fees and/or attract more money until performance suffers.
+1. Markets can be less efficient in the short term, but long term they tend to be efficient.

There are many examples of funds with great records who eventually imploded because of greatly increased size and/or also because manager's strategy went out of favor.

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Re: Are all markets efficient?

Post by NiceUnparticularMan » Wed May 24, 2017 7:43 am

So pricing efficiency is a relative concept, of course, and it depends on what sort of information you are talking about (say, public versus private).

What I would suggest is that if certain assets are relatively easy to invest in at relatively low costs, it is likely pricing will be pretty efficient at least with respect to public information. That is because the main driver of market efficiency is well-funded global arbitrageurs using supercomputers, higher-speed information links, higher-speed trading mechanisms, and so forth competing with each other to exploit transient pricing inefficiencies. And so if the assets in question are relatively easy to invest in, probably these global arbitrageurs will be operating in that space too.

This is a problem for, say, mutual fund companies investing on behalf of U.S. investors. Generally they will want to limit their investments to assets that are relatively easy to invest in at relatively low costs. Which means the arbitrageurs will likely be there too.

And no, I wouldn't expect active mutual fund managers to provide a predictable advantage in these spaces. The true arbitrageurs are not mutual funds because all those nasty disclosure requirements and such are inconsistent with the basic business model, and there is plenty of capital available outside of mutual funds for these activities. Active mutual funds investing in these spaces are therefore prey, not predators--they are just introducing the pricing inefficiencies the true arbitrageurs are competing to exploit.
Last edited by NiceUnparticularMan on Wed May 24, 2017 8:55 am, edited 1 time in total.

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Re: Are all markets efficient?

Post by nisiprius » Wed May 24, 2017 7:49 am

The efficient market hypothesis is an hypothesis.

Academics (presumably) are applying the scientific method. They are saying "how different is what we see from what we would see if markets were efficient?" The usual finding is "not provably different."

You must at all times maintain a critical attitude and realize that in the investment world, people are trying to sell you stuff. If the market is efficient, there's no reason to buy anything but an index fund, so the efficient market hypothesis is a threat to peoples' livelihood. Indexing is now too popular to ignore, and rather than attacking it head-on, a common attac is to acknowledge that indexing makes sense for part of your portfolio but to try to chip away at the edges. Yes, you're smart to be indexed for part of your portfolio but you shouldn't be 100% indexed. And to acknowledge that indexing works but then counter that by saying "in some categories" or "some of the time."

So instead of a head-on attack, "indexing sucks, markets are not efficient, and any savvy expert can beat it" you get:

a) Sure, the U.S. large-cap market is efficient, but not small-caps.
b) Sure, the U.S. market is efficient, but not international markets.
c) Sure, indexing works--in bull markets--but it can't protect you in bear markets, and active strategies can.
d) Sure, the market is efficient for long-only investments, but not short sales. It's hard to pick the good stocks, but any savvy manager can spot the dogs and short them.

Could there be grains of truth in some of these? Maybe. Just be aware that what you're hearing is likely filtered by the need to sell things.
Last edited by nisiprius on Wed May 24, 2017 7:58 am, edited 1 time in total.
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Re: Are all markets efficient?

Post by sschullo » Wed May 24, 2017 7:53 am

I look at it this way:
If the market isn't efficient, then stock prices are either higher or lower than the current trading price. All we can say with certainty is that small cap company stocks probably vary more from the current price than large cap. OK, so what is the price if the market is not efficient? Nobody knows.
If I want to purchase a share of a company or an index, I must pay the current price! Whether the price reflects all that is known or is not known is beside the point. The current price is the current price. Welcome to the investing world.
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Re: Are all markets efficient?

Post by knpstr » Wed May 24, 2017 7:57 am

Runalong wrote:I only check in here once every other month or so so pardon me if this has been covered in depth.

In particular I wonder if VINEX (International small caps, 0.4% expense ratio) is a good investment on the assumption that the non-US small cap market does not get near as much attention as say, the S&P 500, therefore bargains can be found by those who search for them, thus justifying the extra 0.25% per year.

In a simlar vein,could VEMAX (actively managed EM) possibly be better than VWO in spite of charging 0.75% more per year if the managers can find bargains in emerging markets by avoiding the typical stocks favored by EM index funds and applying due diligence to the remaining universe of available equities?

Are there markets today where alpha is still a realistic possibility?
There are individual opportunities in all markets.
The "risk" of identifying say small/micro cap that is undervalued and "overlooked" is that it stays "overlooked". You have to hope that it gets "discovered" by everyone else to bid the price up to a fair valuation if it is undervalued. Ben Graham even cautioned this in his works.

Generally speaking I don't think (my opinion) market indexes are systematically undervalued simply because it is small cap, for example. But any market can certainly get undervalued during crashes. Such as in 08/09.

I would say the search for "alpha" is best found in individual companies. Not indexes. However, it is more than a full time job to play in that arena. If you are going to index, forget about "finding extra return". It's fools gold.
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Re: Are all markets efficient?

Post by whaleknives » Wed May 24, 2017 9:00 am

Runalong wrote:. . . I wonder if VINEX (International small caps, 0.4% expense ratio) is a good investment on the assumption that the non-US small cap market does not get near as much attention as say, the S&P 500, therefore bargains can be found by those who search for them, thus justifying the extra 0.25% per year.
In a similar vein,could VEMAX (actively managed EM) possibly be better than VWO in spite of charging 0.75% more per year if the managers can find bargains in emerging markets by avoiding the typical stocks favored by EM index funds and applying due diligence to the remaining universe of available equities? . . .
I notice the original question of "Are some international markets less efficient" has been generalized to "All markets". Vanguard lists some additional risks for its Emerging Markets Stock Index Fund ((VEIEX and VEMAX):
  • "• Emerging markets risk, which is the chance that the stocks of companies located in emerging markets will be substantially more volatile, and substantially less liquid, than the stocks of companies located in more developed foreign markets because, among other factors, emerging markets can have greater custodial and operational risks; less developed legal, tax, regulatory, and accounting systems; and greater political, social, and economic instability than developed markets.
    • China A-shares risk, which is the chance that the Fund may not be able to access a sufficient amount of China A-shares to track its target index. China A-shares are only available to foreign investors through a quota license or the China Stock Connect program." (emphasis added)
    Vanguard Emerging Markets Stock Index Fund Summary Prospectus
From Wikipedia's Efficient-market hypothesis: "Burton Malkiel has warned that certain emerging markets such as China are not empirically efficient; that the Shanghai and Shenzhen markets, unlike markets in United States, exhibit considerable serial correlation (price trends), non-random walk, and evidence of manipulation."

But recognizing that there are less efficient markets does not guarantee that your fund or manager is in a position to profit from it.
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Re: Are all markets efficient?

Post by asset_chaos » Wed May 24, 2017 9:26 am

Would you want to invest in a truly inefficient market? It's one in which insiders have preferential information, preferential access. You're unlikely to be an insider, I know I am not.
Regards, | | Guy

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Re: Are all markets efficient?

Post by NiceUnparticularMan » Wed May 24, 2017 11:04 am

asset_chaos wrote:Would you want to invest in a truly inefficient market? It's one in which insiders have preferential information, preferential access. You're unlikely to be an insider, I know I am not.
Defined that way, no. Hence I am not really interested in investing in every market everywhere.

The question becomes one of balance, then. Assuming there is a diversification benefit but also some such "insider" inefficiency risk (and there is some such risk for ALL markets, including the U.S.), one should ask if the former outweighs the latter. Only when it does should that market be considered for investment.

However, I have zero interest in trying to figure that out for myself. So I hope my fund managers (and usually more the index providers they are following) are more or less getting this right.

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Re: Are all markets efficient?

Post by willthrill81 » Wed May 24, 2017 11:13 am

JoMoney wrote:
Runalong wrote:...your argument then is that all markets everywhere are always efficient?
I believe saying there is no asymmetric information within most markets can be proven false.
I believe saying there are no traders with positional advantages (like trading faster, front running, acting as a middle man) can be proven false.
I believe if you can look at all the work done in behavioral economics and psychology and the whole profession of marketing, and somehow think these factors don't impact investment markets, you're in denial of reality... I think the psychologists might say "cognitive dissonance".
That being said....
I believe it's a tautology to say aggregate performance of investors in a market (however you want to define the boundaries of 'the market') will always equal that of the market.
I believe markets are extremely competitive, and if you want something extra, you have to be able to bring something extra to the game... But by definition we can't all be above average, and most aren't prepared to play against the pros (i.e. Winning the losers game). Very few teams will finish a season competing for the top ranks. But the market makes it very simple, easy, and low cost to guarantee 'average'.
Very well said. :sharebeer
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Re: Are all markets efficient?

Post by alex_686 » Wed May 24, 2017 11:20 am

Runalong wrote:Are there markets today where alpha is still a realistic possibility?
Yes - all markets have the potential to generate alpha.

EMH comes in 3 flavors, Strong, Semi-Strong, and Weak.

Strong states the market is efficient and there is no way to generate Alpha. Not by research, insider trading, etc.

Weak states that there are market inefficiencies all over the place.

Semi-Strong states that generating Alpha is hard but not impossible. This is what I think. There is a fair amount of academic research here. Inefficiencies are transient, once being discovered are arbitraged away. Funds that have certain types of high expenses (research, trading, etc.) have higher pre-expense returns. Other inefficiencies are subtle and hard to exploit - for example small and value factors are only significant if one's holding period is over 10 years.

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Re: Are all markets efficient?

Post by Runalong » Wed May 24, 2017 11:29 am

I agree with your points alex_686.

Meanwhile, as to my original question, further research shows that VMMSX has trounced VEMAX since inception:

1 year: 28:21
2 year: +2: -6
5 year: 24: 9

past results are no guarantee... but I would expect a gradual levelling over time rather than a sudden reversal. for now the risk/reward profile and the extra expense looks worth it, i haven't decided yet but i'm leaning toward VMMSX.
Last edited by Runalong on Wed May 24, 2017 1:30 pm, edited 2 times in total.

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Re: Are all markets efficient?

Post by asset_chaos » Wed May 24, 2017 11:37 am

Are there markets today where alpha is still a realistic possibility?
The US stock market. As Larry Swedroe used to frequently point out whenever active managers banged on about it being or not being a "stock pickers market", the dispersion of returns even in the S&P500 is huge every year, around 30% from best performing to worst performing large-cap stock. Every year there is a realistic possibility to exploit this dispersion, over (under) weighting the good (bad) performers, and generate alpha. And every year some subset of active managers generates alpha; they just don't consistently make alpha year after year. It appears that market structure and competition generates a nearly efficient market averaged over some relatively short time period.
Regards, | | Guy

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Re: Are all markets efficient?

Post by alex_686 » Wed May 24, 2017 1:24 pm

asset_chaos wrote:...the dispersion of returns even in the S&P500 is huge every year, around 30% from best performing to worst performing large-cap stock. Every year there is a realistic possibility to exploit this dispersion, over (under) weighting the good (bad) performers, and generate alpha.
I think you are missing a step here. The only way to exploit this dispersion is to actively pick the stock with skill, not luck. If the market is efficient then this dispersion is random in a fashion that skill can't circumnavigate. What inefficiencies are there to, in your words, to "exploit". Sure, funds will beat or trail the market, but that is not sufficient to prove that markets are inefficient.

I can think of many inefficiencies in the market that can be exploited. However they tend to fall into specific categories. 10 to 30 bps in the bond market. High skill which tends to have high expenses. Illiqudity. Long holding periods. In short, things which are hard to exploit, not 30% - or even 5% - a year.

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Re: Are all markets efficient?

Post by lazyday » Thu May 25, 2017 4:49 am

Runalong wrote:Meanwhile, as to my original question, further research shows that VMMSX has trounced VEMAX since inception:

1 year: 28:21
2 year: +2: -6
5 year: 24: 9

past results are no guarantee... but I would expect a gradual levelling over time rather than a sudden reversal. for now the risk/reward profile and the extra expense looks worth it, i haven't decided yet but i'm leaning toward VMMSX.
Ideally you would do an analysis that considers factors such as Value, Momentum, Profitability, etc. It's possible that the active EM fund had poor alpha once you consider these factors. Unfortunately I don't believe you can use https://www.portfoliovisualizer.com/ for EM, but it may be possible to do your own analysis if you're ambitious.

Another option is the RAFI Fundamental index. It has Value exposure and might have some quality loading. I like FNDE.

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Re: Are all markets efficient?

Post by JoMoney » Thu May 25, 2017 6:42 am

If you had confidence in the "factor" models, somehow I don't think that's consistent with buying an actively managed fund... I would think you would be looking at different factors based on the manager and your assessment of their judgement and methodology if you were looking for active management. I'm not sure how to pick a winning manager, I think I could pick out some things I do not want in a manger, but that's different than being able to pick one that will provide above average results. Most of them, for better or worse, are able to tell a very good "story". Vanguard managers don't usually even give interesting letters to shareholders in the annual report. But FWIW, you can read over a rough idea of their style(s)/methodology under the "Security Selection" part of the prospectus:
https://personal.vanguard.com/pub/Pdf/p752.pdf
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Re: Are all markets efficient?

Post by rkhusky » Thu May 25, 2017 6:56 am

sschullo wrote:I look at it this way:
If the market isn't efficient, then stock prices are either higher or lower than the current trading price. All we can say with certainty is that small cap company stocks probably vary more from the current price than large cap. OK, so what is the price if the market is not efficient? Nobody knows.
If I want to purchase a share of a company or an index, I must pay the current price! Whether the price reflects all that is known or is not known is beside the point. The current price is the current price. Welcome to the investing world.
+1
People talk about a market (or a stock) being undervalued or overvalued, but this is just a form of anchoring. If a market is efficient, it is correctly priced at any instant of time. The fact that the market goes up and goes down is not an indication that it is not efficient or that it is undervalued or overvalued. Stocks are worth whatever people are willing to pay for them.

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Re: Are all markets efficient?

Post by sschullo » Thu May 25, 2017 7:26 am

rkhusky wrote:
sschullo wrote:I look at it this way:
If the market isn't efficient, then stock prices are either higher or lower than the current trading price. All we can say with certainty is that small cap company stocks probably vary more from the current price than large cap. OK, so what is the price if the market is not efficient? Nobody knows.
If I want to purchase a share of a company or an index, I must pay the current price! Whether the price reflects all that is known or is not known is beside the point. The current price is the current price. Welcome to the investing world.
+1
People talk about a market (or a stock) being undervalued or overvalued, but this is just a form of anchoring. If a market is efficient, it is correctly priced at any instant of time. The fact that the market goes up and goes down is not an indication that it is not efficient or that it is undervalued or overvalued. Stocks are worth whatever people are willing to pay for them.
People like to make things more complicated than they are. After all of the noise is taken out, this stuff is very simple. But taking the noise out takes years because we live in a corporate media world and human beings are attracted to useless noise. It's in our books, movies, and all stories.
Public School K-12 Educators: "Ask NOT what your annuity sales person can do for you, ask what you can do to be a Do-It-Yourselfer (DIY)."

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Re: Are all markets efficient?

Post by NiceUnparticularMan » Thu May 25, 2017 8:50 am

JoMoney wrote:If you had confidence in the "factor" models, somehow I don't think that's consistent with buying an actively managed fund... I would think you would be looking at different factors based on the manager and your assessment of their judgement and methodology if you were looking for active management.
In theory you could do both--look for funds that together create the factor exposure you want, and then also look for managers who you think can add even more value.

In practice--controlling for factors really helps build the case against active management, since even more supposed "alpha" disappears once you do that (meaning the manager claiming to have beat the SP500 over X years may not have beaten an index customized to their actual factor exposure over those years).

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Re: Are all markets efficient?

Post by JoMoney » Thu May 25, 2017 9:27 am

NiceUnparticularMan wrote:... manager claiming to have beat the SP500 over X years may not have beaten an index customized to their actual factor exposure over those years...
I'm not sure "factors" make for a good strategy to try and chase higher returns, but I do think they're useful for analyzing funds in hindsight. Like a backward looking Morningstar style box. Factor regressions can provide more detail (at least in explaining the retrospective style relative to performance).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: Are all markets efficient?

Post by afan » Fri May 26, 2017 6:01 pm

asset_chaos wrote:Would you want to invest in a truly inefficient market? It's one in which insiders have preferential information, preferential access. You're unlikely to be an insider, I know I am not.
I would if I were an insider. There have long been interest and efforts to make public financial markets as efficient as possible. Transaction costs are low. Extensive regulations require public reporting of prices. But there are all sorts of markets that do not have these features. Take the art market. Many sales are never reported to the public. Only those large enough to trigger taxes are even reported to the IRS. Unless you are an expert, likely a dealer, you have no chance of knowing the market price of a piece. That is why dealers remain in business. They charge for.their expertise.

Real estate transactions are public but real.estate development involves a lot more than just buying property. Evaluating the potential profit in a new project, pricing and managing construction, financing the purchase, marketing... All these require highly specialized knowledge. You cannot look up the relevant prices online.

So no. Not all markets are.efficient.
But the.special case of financial markets with public reporting of prices. THOSE markets are very efficient.
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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