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

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.

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.

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.

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.

Recommended

Great frauds in history: Carlton Cushnie’s befuddling Ponzi scheme
People

Great frauds in history: Carlton Cushnie’s befuddling Ponzi scheme

Carlton Cushnie set up a finance company which was valued at an estimated £230m, but made only one trade finance loan in its existence, which actually…
28 Oct 2020
Being unpopular can make life easier for companies – just ask BP and HSBC
Investment strategy

Being unpopular can make life easier for companies – just ask BP and HSBC

When you're as hated as banking and the oil sector, it doesn't take much to pull off a nice surprise. John Stepek explains what that means for investo…
27 Oct 2020
Robin Geffen: dividend cuts aren't all down to Covid
Stockmarkets

Robin Geffen: dividend cuts aren't all down to Covid

The seeds of recent dividend cuts and cancellations were sowed many years ago, says veteran investor Robin Geffen.
25 Oct 2020
Dividend payments will take a long time to recover
Income investing

Dividend payments will take a long time to recover

Companies are gradually resuming dividend payouts, but we can expect only a modest rebound in 2021, says Cris Sholto Heaton.
25 Oct 2020

Most Popular

The Bank of England should create a "Bitpound" digital currency and take the world by storm
Bitcoin

The Bank of England should create a "Bitpound" digital currency and take the world by storm

The Bank of England could win the race to create a respectable digital currency if it moves quickly, says Matthew Lynn.
18 Oct 2020
Don’t miss this bus: take a bet on National Express
Trading

Don’t miss this bus: take a bet on National Express

Bus operator National Express is cheap, robust and ideally placed to ride the recovery. Matthew Partridge explains how traders can play it.
19 Oct 2020
Three stocks that can cope with Covid-19
Share tips

Three stocks that can cope with Covid-19

Professional investor Zehrid Osmani of the Martin Currie Global Portfolio Trust, picks three stocks that he thinks should be able to weather the coron…
12 Oct 2020