GW Leibniz (I’m a fan) was an 18th century polymath, who is most known today for having invented calculus (simultaneously with Newton) and for his thought-provoking assertion that ours is the best of all possible worlds. Actually, he may be better known by being satirized for this view by Voltaire in Candide.
The corresponding position to best-of-all-possible-worlds in 20th/21st-century academic finance is the efficient markets hypothesis. The idea comes in several flavors, but the overall thrust is that the stock market itself–as revealed in stock prices in current trading–contains/embodies/reveals every relevant fact about all publicly-traded companies. Therefore, deviations from the structure of the main market indices can’t make returns higher. Active management can only reduce them. So everyone’s best bet is an S&P 500 ETF. Learning economics and accounting, studying industry structure, using the SEC Edgar site…are all wastes of time.
There’s some evidence to support this thesis, although I think it’s rather flimsy. It’s basically that if we look at the records of the biggest and most famous money management organizations in the US, and even if we add fees back in, there are none that have a, say, 10-year record of consistent outperformance of their target indices.
On the other hand, though, there’s no reason to believe that, as profit-making concerns, this is their main goal–hitting home runs is a better marketing strategy for a fund group that wants to retain clients than playing good defense is. There’s also the cautionary tale of Value Line, which widely publicized its twenty-year record of index outperformance, and the detailed rationale behind it, to find that competitors (some still in business) copied it and outperformance disappeared. So there’s no reason to believe that a successful manager will necessarily publicize his/her success. (By the way, the main academic counter to VL’s success was the phlogiston-like theory that the company was taking on an as-yet unknown type of risk.)
It’s also very convenient for academics, who by and large have no practical investing experience, to maintain that acquiring any is at best useless, at worst harmful.
This is a lead-in to writing about the two main ways that “practitioners,” which is what academics call people like me, approach equities.
Decades ago, a distinguished alumnus of Value Line was interviewed by Barron’s, and the reporter was astounded by his portfolio of out-of-favor stocks. The investor replied, “My wife and baby son can’t fire me.” I have a suspicion that individual investors as a whole outperform the indices over time (which probably means that a few brilliant individuals attain returns that exceed the underperformance of ordinary mortals). After all, if institutional investors as a whole lag the indices, doesn’t that mean that individuals as a whole outperform?