Advertisement

The market really is inefficient

A new, in-depth study suggests that it really is possible to beat the market, says John Stepek – you just need to know how.

936-newton-634
Momentum: it works in stocks too

whitetag

A new, in-depth study suggests that it really is possible to beat the market you just need to know how.

In theory, you shouldn't be able to beat the market consistently. That's the basis of the efficient market hypothesis, and it's the main rationale for buying an index fund (one which simply tracks the market), rather than trying to pick one of the few individual active fund managers who does manage to beat the market regularly, whether through sheer luck or unusual levels of skill.

Advertisement - Article continues below

However, as we all know, theory and practice often diverge. While it is by no means easy to beat the market, there are various styles or "factors" that have been shown to deliver market-beating returns over the long run, by taking advantage of apparent anomalies.

Now a fresh piece of research has taken a look at just how durable these strategies have been over time. Global Factor Premiums, a paper from Dutch investment group Robeco, by researchers Guido Baltussen, Laurens Swinkels and Pim Van Vliet, takes data stretching back more than 200 years, and looks at how six of the most popular factors have performed in equities, government bonds, currencies and commodities.

Advertisement
Advertisement - Article continues below

To cut a long story short, the researchers found that in most cases, the investment styles showed compelling evidence of outperformance; that they worked consistently over time (clearly they didn't beat the market all the time, but there was no obvious point at which any of the strategies simply stopped working); and that they were not obviously correlated to any particular investment backdrop in other words, they worked in both good times and bad times.

Advertisement - Article continues below

So what are these styles? The most effective was trend-following, which quite simply involves buying what's going up and selling what's going down. The similar strategy of momentum (buying stocks that perform well relative to others) was not quite as effective but still worked.

The other four styles were: seasonality (whereby different asset classes do well at different times of year); carry (high-yield assets beat low yield); value (cheap assets beat expensive ones); and finally, "bet against beta" whereby investing in the least-risky assets delivers higher returns than buying the most risky ones.

The findings are striking on several levels perhaps we need to rethink our scepticism about the old "Sell in May" adage, for example. But perhaps the most useful for a private investor is that it suggests another useful dimension beyond geography and asset class, across which to diversify your portfolio. In particular, it suggests that, regardless of your views on the efficacy of technical analysis, you shouldn't dismiss trend-following as an investment strategy. And nor, despite its poor showing since the financial crisis, should you give up on value.

Advertisement
Advertisement

Recommended

Visit/investments/investment-strategy/601607/will-inflation-return-or-is-japanification-the-real-threat
Sponsored

Will inflation return – or is “Japanification” the real threat?

SPONSORED CONTENT – Should we actually be concerned about deflation in the wake of Covid-19?
3 Jul 2020
Visit/investments/stockmarkets/uk-stockmarkets/601588/laura-foll-uk-stocks-small-companies-income-yields
UK stockmarkets

Laura Foll: small companies, income, and the power of equity markets

Merryn talks to fund manager Laura Foll about value, income yields and the UK market's underperformance, plus the benefits of smaller companies and th…
1 Jul 2020
Visit/economy/people/601565/nick-leeson-the-man-who-broke-barings-bank
People

Great frauds in history: Nick Leeson – the man who broke Barings Bank

"Rogue trader" Nick Leeson’s losses cost his employer, Barings Bank, an estimated £860m, plunging it into bankruptcy.
1 Jul 2020
Visit/currencies/601571/the-end-of-a-tailwind
Currencies

The end of currency a tailwind for UK investors

A weak pound and strong dollar are unlikely to keep bolstering returns for British investors over the next decade.
29 Jun 2020

Most Popular

Visit/investments/property/601606/house-prices-crash-uk-property-prices-falling-where-next
Property

House price crash: UK property prices are falling – so where next?

With UK property prices falling for the first time in eight years, are we about to see a house price crash? John Stepek looks at what’s behind the sli…
2 Jul 2020
Visit/economy/inflation/601584/the-end-of-the-bond-bull-market-and-the-return-of-inflation
Inflation

The end of the bond bull market and the return of inflation

Central bank stimulus, surging post-lockdown demand and the end of the 40-year bond bull market. It all points to inflation, says John Stepek. Here’s …
30 Jun 2020
Visit/investments/stockmarkets/601611/nasdaq-all-time-high-markets-and-the-real-economy
Stockmarkets

How can markets hit new record highs when the economy is in such a mess?

Despite the world being in the midst of a global pandemic, America's Nasdaq stock index just hit an all-time high. And it's not the only index on a bu…
3 Jul 2020