July 7, 2009
Passive investing has no more outspoken advocate than Burton Malkiel. At age 72, Malkiel remains every bit as committed to the efficient market hypothesis as when he wrote A Random Walk Down Wall Street in 1973.
Malkiel, who has taught finance at Princeton for the last 20 years, was a featured speaker at the Forbes Advisor Conference last week. He insists that investors should buy and hold index funds and defended his position against a series of challenges put to him by John Dobosz, a Forbes editor.
Against institutional investors, who are responsible for 98% of all trading, individuals don’t stand a chance, Malkiel said. “Institutions can’t beat the market because they are the market,” he said, and individuals can’t expect to do any better.
Fundamental analysis does give investors an edge, but Malkiel said that it works so well that any valuable information gets reflected so quickly in stock prices that investors cannot make any money by using it. Malkiel agrees with Steve Forbes, who learned from his grandfather that you make more money selling information than trading on it.
Investors who choose stocks with certain characteristics, such as low P/E ratios, high growth rates, or upward EPS revisions, are likely to fail because these metrics are “too isolated” to work in the long run. There is “some evidence” that value stocks do a little better than growth stocks, Malkiel admitted, and it would be a reasonable strategy to tilt portfolios in that direction. But he cautioned that value stocks don’t beat growth stocks consistently – certainly not in the late 1990s. “And if it does work,” he said, “it doesn’t mean that the market is inefficient but that in some sense those stocks are riskier.” On a risk-adjusted basis their returns are not exceptional, he said.
On a similar note, Malkiel conceded that small companies have historically outperformed larger companies, based on data going back to 1926. “But that doesn’t happen all the time,” he said.“To the extent that you get a higher rate of return it may just be a compensation for higher risk,” he added.
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