Tags:
Journalism of Courage
How do you know that the price you8217;re paying for a share is right? How, for instance, can you tell that the Rs 995 you pay for one share of ONGC, India8217;s most valued company, is its true value? If it indeed is the true value and that value encapsulates all the information available to millions of investors at any point in time into that singular price, then its price need not fluctuate so much every trading day. On the other hand, if the price is also a function of things other than available information, analysis of prospects or insider information, for instance, then while the volatility question is addressed the end point of its correctness is left open-ended.
Questions like these have been bothering economists since the birth of stock exchanges. And have divided academics and theoreticians into two distinct camps 8212; efficient market hypothesis and behavioural finance. The first one suggests that prices are efficient, that all the information is captured in the moment8217;s stock price and that even a monkey throwing darts on stock listings could do as well as a professional stock picker. The second one accepts human behaviour with all its imperfections and idiosyncrasies as an active participant and suggests that not all transactions, and hence all stock prices, will be rational.
If the market is right 90 per cent of the time, the difference between the performance of index funds and managed funds should be small, statistically insignificant. But when I tested this hypothesis with real numbers, I found that during the past 10 years half the equity funds have outperformed the Sensex. On a smaller time scale of five years, a little over 28 per cent of the funds outperformed the Sensex. But how much outperformance? If we take a random outperformance of 3 percentage points, we find just two out of five funds managed to deliver these returns over 10 years, while just one out of five funds delivered them on a five-year timeframe.
So, while a significant number of funds do manage to outperform the index, the extent of the outperformance is nothing to write home about 8212; but nothing to lament either. Which leaves us unclear about which method works. All it proves is that the truth, predictably, lies somewhere in the middle. Practically speaking, since the choice is between an index fund and a managed fund, it helps to know the chances of success. But how to choose the fund that will outperform remains a risk. It8217;s like looking for a needle in the haystack, says Malkiel in the latest issue of the Journal of Applied Corporate Finance: 8220;I am more convinced than ever that if you just buy the haystack, namely an index fund, you will be much better off.8221;
The one grouse I have against the proponents of efficient market theory is that they are unable to recognise, accept or explain talent. The consistent outperformance of Warren Buffett8217;s Berkshire Hathaway over the market8217;s, for instance. They call him an 8216;aberration8217;. Something like Issac Asimov8217;s 8216;mule8217;. But his basic principle of buying value when Mr Market is selling at a discount, compounded by a formidable performance over decades, can8217;t be ignored by any theory.
Tailpiece: All this noise about equity linked saving schemes ELSS of mutual funds having to turn closed-end, which brought panic to industry and investors, it seems, was in vain. Unlike as suspected by the industry, there was no intent to 8220;send a signal to the industry8221;, 8220;tell AMCs that they can8217;t take the government for granted8221; and so on. It was, as a finance ministry official put it, 8220;a mistake that8217;s being rectified8221;. Pretty expensive mistake, given the time spent in undoing it. Just because of an invisible, unaccountable official8217;s laziness?
