Is it possible to beat the
market? Can ordinary investors produce better returns, with similar or less
risk, than they could get from a fund that tracks a simple stock-market index
such as the S&P 500?
Many
researchers, professional investors and financial advisers believe it isn't.
They argue the market is so good at pricing individual securities—in the jargon
of economics, it is so "efficient"—that attempts to beat it are
largely fruitless. The handful of investors who do succeed are typically just
lucky.
After
accounting for fees, these experts argue, the large majority of actively
managed mutual funds perform worse, over time, than the indexes.
Investors
in this school prefer to buy plain-vanilla index funds, and then just leave
them alone.
But a
growing body of research is calling that point of view into question. It says the
traditional indexes can be beaten—if you know how. A quick rundown:
The
best-known of these market-beating strategies is the "value effect."
Researchers showed more than 20 years ago that investing in stocks that are
priced cheaply in relation to their net assets, per-share earnings and other
fundamentals has produced better returns than the rest of the market over time.
In
research published last year, Nardin Baker, a global strategist at Guggenheim
Partners, and the late Robert Haugen, president of investment adviser Haugen
Custom Financial Systems, studied 33 different equities markets and found that
stocks with lower volatility had produced higher returns than the rest.
In a
study published last year, Cliff Asness and Andrea Frazzini of hedge fund AQR
Capital Management and Lasse Heje Pederson, a finance professor at New York
University, found the same was also true of high-quality companies, meaning
those with above-average rates of profitability and growth and stronger balance
sheets.
Even an
equally weighted portfolio of stocks picked at random produced superior returns
to the traditional indexes over the past half century, according to Rob Arnott,
Jason Hsu and Vitali Kalesnik of Research Affiliates, an investment-advisory
firm, and Phil Tindall of consultants Towers Watson in a paper published in
2012.
Click here
for the full article in the Wall Street Journal.