Merton Miller's illustrious academic career started at Harvard,
from which he graduated in 1943. He spent the next few years in
Washington, D.C., working at the US Treasury and the Federal Reserve.
He earned his Ph.D. from Johns Hopkins in 1952. The following
year, he joined Carnegie Tech, in Pittsburgh, where he taught
economic history. At Carnegie Tech, Merton Miller first encountered
another, somewhat older, economist, Franco Modigliani. Their subsequent
collaboration was destined to become part of economic history.
Modigliani won the Nobel Prize in Economic Sciences in 1985. In
turn, Merton Miller won his in 1990. The product of their collaboration,
which was quickly dubbed the "M&M theorem," is still widely
discussed and argued among economists and corporate finance types.
If you thought economists were dull, Merton Miller will change
your mind. He has a well-known sense of humor, and we'll put it
to the test. While the M&M theorem is not directly about investing
in stocks, it does have some very real application to valuing
a company. By the time we're finished, I think you'll agree that
everyone interested in the field should know something about it.
We ask about his views on market efficiency and investing generally,
and we get into areas few people have ever explored with Professor
Miller. Here we go.
Peter J. Tanous: How did you first get interested in stocks?
Merton Miller: Well, I don't know, because it was so long ago!
They are part of the atmosphere. I was in economics even as
an undergraduate. Stocks were part of the environment. How did
you get interested in stocks?
I was an economics major at Georgetown. In my first economics
class as a freshman, our professor, Dr. Gunther Ruff, asked
the students why they were taking the course. I said, because
I thought I might learn how to make money. He said, "My dear
fellow, I have a Ph.D. in economics, and if I knew how to make
money, I wouldn't be here."
When I started worrying about stocks, it was the late 1930s
and early 1940s and it didn't seem like a good way to make money
then, either. Stocks were in bad repute after 1929. A variety
of questions were being raised everywhere about the role of
the stock market crash in bringing on the depression. There
were also congressional hearings and investigations, not only
into the crash, but on the role of the corporation in American
economic life. The subject of stocks was very much in the news.
As an economics undergraduate, I also worked on a part-time
basis in Cambridge, Massachusetts, for a company that was advising
customers about portfolio decisions, writing reports. So I was
constantly exposed to stocks, if only by reading through Moody's
and transcribing numbers for the customer reports.
As far as personal investing was concerned, I was more concerned
with my savings account than with stocks.
I guess that was appropriate to the '30s.
Yes, it was. You could get an interest-paying savings account
in Harvard Square, providing there wasn't too much activity
in your account. I would get my monthly allowance and put it
in one of the local banks, making small withdrawals every day
to pay expenses. After awhile, I would get a notice from the
bank saying that there was too much activity in my account and
they were closing it out. So, I would walk my money across the
street to one of the other banks. There were four of them, one
on each corner. I just put the money in the next bank. That
way, I managed to have a checking account without paying transaction
fees. I didn't feel guilty, because I knew that the banks had
gotten the government to ban interest on checking accounts.
I was just doing to them what they were doing to me.
I see the beginning of an economic theory here. As you know,
Professor, our book focuses on interviews with great investment
managers, but I also wanted to get some top academic points-of-view
on markets. I thought it might be interesting to begin our conversation
by talking about your celebrated work with Franco Modigliani
in the area of corporate capital structure. I am referring,
of course, to your combined work, amusingly known at "the M&M
theorem." As I recall, instead of asking investors how they
might determine which of a corporation's securities they might
want to buy, you looked at it from the opposite perspective.
You asked, how should corporations decide what securities to
sell.
Yes. That was certainly part of it. Early on, I had to teach
a course on corporate finance. I had never had a course in finance,
or at least a business school variety course. My expertise was
in public finance, particularly corporate taxation, since I
had worked at the US Treasury. At first, I worked in the corporate
tax unit of the Division of Tax Research at Treasury, later
in the government finance unit at the Federal Reserve. So, I
knew the tax side of corporate finance, and the economics of
public finance, but not the standard finance stuff.
In 1954 or so, before they let me teach a business school finance
course, at Carnegie Tech [now Carnegie Mellon], they
said, you must sit in on the class of someone who is teaching
it the proper Harvard Business School way. So, I sat in the
class. When we took up case number one in the case book, I remember
being struck that the solution was not obvious to me. After
the instructor explained it, however, I said, Yeah. That's right;
that makes sense. Then we came to case two, and I said, Okay,
I remember how we solved case one, so the answer must be this.
And, of course, it was different. I couldn't sense any connection
from one case to the next. Everything was, as they say on railway
tickets, good for this train and this day only. For me, as an
economist, it was frustrating to have no sense of a theory of
corporate finance to tie all this material together.
Do I sense the origins of M&M theory here? I think you
are saying that there wasn't just one right solution to the
cases you studied. Likewise in M&M, you were seeking the
optimal capital structure for a corporation; in other words,
how much debt, and how much equity a company should have. Then
you found out it didn't matter. There wasn't just one right
answer.
That's down the road a bit. First, the problem was to figure
out what determines these choices. There are various analogous
models in economics that could have been applied in this area,
but none of them seemed to work very well. Franco and I were
both working on the problem, but from somewhat different perspectives-he
from macroeconomics and me from corporate finance. I had some
of the students in my finance class actually do some empirical
work on capital structures, to see if we could find any obvious
patterns in the data, but we couldn't see any. We couldn't find
any consistent patterns and certainly no evidence of an optimal
structure. We said, you know something, maybe there isn't any
optimum! [For example, in the proportions of debt and equity.]
Franco and I then tried to prove our suspicion that there is
no optimal capital structure.
People often ask: Can you summarize your theory quickly? Well,
I say, you understand the M&M theorem, if you know why this
is a joke: The pizza delivery man comes to Yogi Berra after
the game and says, Yogi, how do you want this pizza cut, into
quarters or eighths? And Yogi says, cut it in eight pieces.
I'm feeling hungry tonight.
Everyone recognizes that's a joke because obviously the number
and shape of the pieces doesn't affect the size of the pizza.
And similarly, the stocks, bonds, warrants, etc., issued don't
affect the aggregate value of the firm. They just slice up the
underlying earnings in different ways.
I recall a story that, after word got out that you had won
the Nobel Prize in Economics, the media tracked you down and
asked you to explain your theorem in a way their audience might
understand. Like in ten seconds.
The pizza story is one I often use. Another is, if you take
money out of your left pocket and put it in your right pocket,
you're no richer. Reporters would say, you mean they gave you
guys a Nobel Prize for something as obvious as that? [Lots
of laughter.] And I'd add, Yes, but remember, we proved
it rigorously. [More laughter.] Actually, we did use
a new form of rigorous proof known as "arbitrage" proof. Arbitrage
proof has since been widely used throughout finance and economics.
If I'm summarizing the M&M theorem correctly, the market
value of any firm is independent of its capital structure, so
the proportions of stock [equity] and bonds [debt]
doesn't affect the value of the corporation. Now if that's the
case, are all these highly paid corporate chief financial officers
wasting their time tying to figure out how much preferred stock
to issue, or how many bonds, or how much common stock?
To some extent. But remember, the M&M proposition is the
beginning of wisdom; it's not the end of it. To really utilize
it best, you have to tip the proposition on its head. You say,
look, in order to make this proposition true, you must make
the following 15 or so assumptions. So if people out there say,
aha, the M&M theorem doesn't hold true in the real world,
then we say, it must be because one or more of the 15 assumptions
must be failing. And that has provided the research agenda for
the profession.
What happened after publication of our paper was that, for
the next 40 years, people said, all right, we now know the answer
to the capital structure question under ideal conditions. Let's
now drop, or relax, some of these assumptions and see how it
affects some of the conclusions. That's not the kind of undisciplined
Harvard Business School, each case on its own, approach. It's
systematic. You can say, for example, as we did even in our
first paper, suppose there's a big corporate income tax with
a 50% rate? That's going to affect the optimal choice between
debt and equity. In fact, it's going to make issuing debt, rather
than equity, extremely desirable [since interest is deductible
for tax purposes]. Next, you go on from there and say, yeah,
but firms don't have 100% debt. Then you have to start to explain
why and think up additional reasons, such as agency costs or
offsetting taxes, that will keep them from going to extremes.
That's what the profession has been doing for 40 years.
It occurs to me that the great junk bond revolution might
have had the effect of confirming or disproving the M&M
theorem since so many companies opted to go heavily in debt.
Did the popularity of junk bonds affect corporate values?
The junk bond revolution fits right in with M&M. Junk bonds
prove there's nothing magical in a Aaa bond rating. Don't pass
up big profit opportunities, or tax savings, just because of
your credit rating. What counts is what you do with your money,
not where it came from.
I also want to mention the one example where the original M&M
theorem can actually be seen holding in the real world. It comes
from the field of options, where it is known as the put-call
parity. It holds to three decimal places. Options, of course,
bring Myron Scholes, one of my former students, to mind as well
as my good friend Fischer Black.
Their reputations are well established. These fellows developed
the famous Black-Scholes model. Could you explain it briefly?
I don't have a pizza story, but I do want to go on the record
saying that I regard their Black-Scholes formula as one of the
major intellectual breakthroughs of the latter part of the 20th
century in this field. It was not only an intellectual achievement,
but it spawned a whole new industry. Their model was an amazing
development because it is one of the few cases in finance where
you can actually compute what a security is worth, not just
in abstract terms, but in actual dollars.
Black and Scholes developed a formula which priced options
as a function of observables. By observables, I mean that the
warranted option price is a function of the strike price, the
price of the underlying security, the interest rate, the time
to maturity, and the volatility of the underlying security.
The only thing that isn't directly observable is the volatility,
but that can be very closely approximated. Much better to approximate
the volatility of something than the mean expected return, which
is what stock pickers have to do. You can always get a pretty
good fix on the volatility, even though it's not perfect. It's
still a lot easier than estimating the expected rate of return
on shares. Incidentally, if you read the original Black-Scholes
paper ["The Pricing of Options and Corporate Liabilities,"
Journal of Political Economy, vol.81, May-June, pages
637-659], you would note that they generously acknowledge
the influence of the arbitrage proof from the M&M capital
structure paper, which was earlier.
Since Fischer Black and Myron Scholes were able to determine
option pricing by using all of the surrounding variables, might
it be possible to do the same thing for stocks?
No, you can't really, except, perhaps, in some extreme cases.
If a share is super highly leveraged, so that you just got this
little thin sliver of equity over the debt, then Fischer and
Myron pointed out that it's basically a call option, not a share.
And you can, to some extent, price it that way. You can also
do that with some kinds of bonds. But, by and large, options
are the only case in finance where you can successfully price
something as a function of observables.
That's very interesting. Now let's turn to the subject that
is a focal point of this book: active versus passive management.
Let me ask you right off the bat, do you believe in active management
in any form?
Not really. That's based on my study of finance and my belief
that markets know much more as markets than an individual does
as an individual. This is, of course, the subject we talked
about a couple of weeks ago. I should mention that I am a member
of the board of directors of Dimensional Fund Advisors.
I had a long talk with Rex Sinquefield.
Rex is one of my students, too. Almost everybody is because
I've been around so long!
I spoke to another one of your students, Gene Fama.
Of course. I favor passive investing for most investors, because
markets are amazingly successful devices for incorporating information
into stock prices. I believe, along with Friedrich Hayek [also
a Nobel laureate, and a contemporary of John Maynard Keynes]
and others, that information is not some big thing that's locked
in a safe somewhere. It exists in bits and pieces scattered
all over the world.
Everybody has a little piece of the total information. Even
the dentist from Peoria, I always say, at least he knows whether
or not his patients are paying on time. So everybody has some
information. The function of the markets is to aggregate that
information, evaluate it, and get it incorporated into prices.
But if information, as I insist, is widely scattered and diffuse,
most individuals are not going to have much information relative
to the total. Most people might just as well buy a share of
the whole market, which pools all the information, than delude
themselves into thinking they know something the market doesn't.
They can't be hurt by doing that, because the price they pay
will indeed reflect society's best current information.
I've tried to approach this as open-mindedly as possible
and I've talked to top-tier academics, you among them. I've
also talked to people in the business, like Rex Sinquefield,
who is dogmatic on this subject. Yet, when I talk to the active
managers, especially those who have a fairly long performance
history-what the academics call "persistence"-I keep running
into anecdotes.
That's all they are . . .
But you keep running into these stories about information,
seemingly previously unknown, that gets uncovered, with a certain
amount of research. Isn't it true that, until somebody does
that research, it really wasn't widely known?
Here's an example: Michael Price, who runs Mutual Shares,
had a wonderful story about a metal, tantalum, that was going
up in price. He did some research to find out which companies
were involved in tantalum, and, in fact, managed to discover
them before the effect of the price rise was generally reflected
in the prices of those stocks. I expect there are many other
stories like this.
Let me back up and say one thing more clearly, I hope. There
are really two different groups of investors. One group, the
overwhelming majority, and the group I've been talking about,
has no significant private information not already in prices,
and they should invest passively. They aren't going to make
above-normal returns, except by accident. But there's another
group that can hope to make money by careful research in the
market. How much money can they expect to make? Taking the group
as a whole, they make just enough, on average, to cover the
cost of their research.
This distinction I've been making, between traders with significant
non-public information and those without it-which includes most
investors, including pension fund and mutual fund managers-is
known as the Grossman/Stiglitz theorem. Sandy Grossman is a
brilliant young economist at Wharton (and a former student of
mine, needless to say). He was here at Chicago, and then went
on to Stanford, Princeton, and now Wharton. Joe Stiglitz went
from Yale to Stanford, and is now the President's chairman of
the Council of Economic Advisors. They wrote a famous paper
on rational expectations and prices ["On the Impossibility
of Informationally Efficient Markets," American Economic
Review, Vol. 70, 1980, pp 393-408]. Their proof that
both the informed, and the uninformed, investors can expect
to make the same return, on average, is neat.
The essence of the efficient market thing is, after all, as
we in economics have always held: There's no free lunch. You
can't just sit back in your office scanning the newspapers,
reading research reports, and listening to "Wall Street Week,"
and hope to earn above-normal rates of return. To beat the market
you'll have to invest serious bucks to dig up information no
one else has yet. Because it looks easy, many people may be
tempted to try it. But there's no automatic reward from investing
in trying to dig up important non-public information. It's like
gold mining. A few lucky ones may strike it rich, but most "active"
investors are just wasting their time and money. Once they realize
that average returns on investment in information are zero or
less, if the industry becomes overcrowded, the smart ones will
stop trying and will leave the search industry. They become
indexers.
Isn't the research and the hard work you do the price you
pay for the reward you achieve?
Yes, but it just compensates you for the expenses. Of course,
I don't mean you, personally. I mean you, on the average. Remember,
as economists, not psychologists, we deal with behavior on the
average. This is just my view, of course. It's not the opinion
of everybody in the finance or economics profession, needless
to say.
I sensed that even Gene Fama and Bill Sharpe believe that
a very few managers, like Peter Lynch at Fidelity Magellan,
have persistently outperformed the market, and that is borne
out by the data.
Well, we've heard many of these tales. We used to hear, for
example, that Value Line had some kind of an edge. These tales
come and go. They don't usually stand up forever, although sometimes
they seem to last for many years. You can make a huge living
in the investment field, moreover, if you can once get the reputation
of being a winner. It's going to take a long time to reverse
it.
I always use an example that dates back to the '30s. The big
name then was Bernard Baruch. A genius. He was everybody's favorite
pundit. There wasn't any economic issue where the press didn't
go to see Barney. When you study his fabulous record, however,
I think he was right once. But, he was right in a big way. If
you make a big score way out on the right hand tail of the distribution,
then the probabilities you face from then on are mostly the
little moves to the left and to the right in the center of the
distribution. You're not going to get that first big gain removed.
You only need to make one big score in finance to be a hero
forever.
I see your point. That one score will keep your average
gain high for years. But take the whole outlier theory-the right
tail of the distribution curve where you find the Peter Lynches
and Warren Buffetts. What separates the men from the boys, so
to speak, is persistence, isn't it?
Perhaps it would be, if we could measure persistence accurately.
But in practice, if often comes down to not suffering a loss
as big as the huge gain you made a while ago. Thus a fellow
like George Soros may be skating on thin ice. You see, he made
a big killing and if he would now just do modest investments,
he would never lose it. He'd be a winner on balance over any
time horizon. But if he insists on plunging again, he's just
as likely to take a bigger loss. He may wind up giving it all
back.
It's funny. One of the managers I'm interviewing, Richard
Driehaus, said about Soros, "He had a hunch and bet a bunch!"
Right. And he'll have another hunch, and he'll bet another
bunch, and this time he'll lose. But if he doesn't do it that
way, if he has a hunch and bets a bunch and wins, and thereafter
plays the conservative game, he'll go down in history as the
genius of all time. The gains and losses average out, but only
in the very, very long run.
To me, the name of the game is finding the people who show
persistence at beating the market.
Well, let me tell you one of my favorite stories. I once asked
a pension fund manager, why don't you just index your funds
instead of doing all this churning you're doing there? And he
said, I can't index the fund because then I wouldn't be worth
$400,000 a year! If you ask people in the trade, how come you
make so much money? What do you want them to say? Oh, it was
just dumb luck, Professor. I don't think you'll get that response
very often.
The more typical answer is that it was our brilliant deductive
analysis that got you that great performance.
Yeah. There are people like Bill Sharpe and Gene Fama who are
working all the time to test various hypotheses about it, but
to me the sample is way too small to judge "persistence," that
is, to be able to tell luck from skill. There's another story
I love to tell: The bursar of a British college, at Oxford,
had members who were pounding on him that they weren't earning
enough. He answered by saying, I admit our returns have been
down recently but you must remember that the last two hundred
years have been very unusual!
Big consolation!
I don't know how long is long enough to get rid of the influence
of sample flukes.
I have no doubt that Bill Sharpe and Gene Fama's work all
supports the efficient market theory.
I can't speak for them, of course, but I believe that most
economists would accept the view that, while you sometimes can
make a score by sheer luck, you can't do it constantly, unless
you're willing to put the resources in. One way or another,
you have to get significant non-public information, which most
fund managers don't have.
In fact, I thought the most convincing of Gene Fama's points
was that he took ten years of mutual fund data from The Top
20 Mongingstar funds and looked at their performance for the
following ten years.
And there was no correlation. It has all the earmarks of a
random process. One amusing thing that the SEC once did was,
they said you can't bring out a new commodity fund unless you've
got five years of experience. So what do you do? You run your
fund on the small until you manage to hit five good years. Then
you've got a track record, and you say we've done it five years
in a row! And then you go public, of course. All the studies
have found that there is no correlation between the results
of the previous five years and the subsequent five years. Virtually
no correlation. But that's a mass statistical test. There may
be one fund that was high in both periods. But remember, in
economics, we work with statistical aggregates, not individuals,
so that is bound to happen sometimes. Individuals, quite naturally,
resent our pointing that out. They say, don't treat me as a
statistical aggregate. I'm an individual!
I've got to tell you, I spoke to Peter Lynch, who was absolutely
wonderful. I said, Peter, you've got to realize that to the
great academicians, and we're talking Nobel Prize winners, you
are the millionth monkey, the lucky orangutan at the typewriter
who wrote Romeo and Juliet. And Peter is not the only one with
a great record.
That's why they're where they are and I'm where I am. It's
a tough argument to counter. He did have success. Anything we
say sounds like sour grapes. If we're so smart, why aren't we
rich?
No. They don't talk like that. That would be very inelegant.
They wouldn't do that. The point they do make is, wait a minute,
let me tell you how I did it! I mean, this is the process that
I use, and continue to use, and guess what? It's not magic.
It's just common sense, and it works.
Here's the way to look at it. There's a famous trader in the
bond market at the board of trade-I'm getting so old, I can't
remember his name-but he made huge amounts of money trading
bonds and bond futures. He said, I've got a foolproof trading
system here. But here's the acid test of whether I really have
a winning system. I will accept a few hand-picked students and
teach it to them. The test is whether they make money. Can you
explain it to a third person, and if that third person trades,
does he make money? He set up a little school and he trained
these people. You know what happened? He's now out of the business
and so are the students. Maybe Peter Lynch can do it, but can
he teach another person to do it? If he could, we'd have some
evidence that it's more than just luck.
Well, he says he can in his books. The way I put it to Peter
Lynch was, if I read both of your books, which I have several
times, I'd find the answer to getting rich is to hang out at
the mall and see what's selling.
I don't read the books. But that's the thing that makes us
academics so skeptical. If it's a teachable skill, then perhaps
you can teach it to many others. That may generate enough data
to tell skill from luck. After all, when a 15 handicap golfer
breaks par, which can happen, you know it's just dumb luck.
But to be considered a real champ, you have to break par in
hundreds of matches. My point is that you can't tell skill from
luck unless you have large samples. We just don't have them
for testing skill in stock picking.
I have to ask you a favor.
Okay.
You know that you're noted for having a wonderful sense
of humor. There's a story, and I don't know if its true or not,
but if it is I'd love you to tell it. It's about a speech you
were supposed to give in Hamburg.
Whether it's true or not, here is the story. I was traveling
in Germany many years ago and a friend of mine, a German professor,
arranged for me to give a talk to the finance faculty at the
university in each city. I wanted to see all of the big cities
in Germany, including Hamburg, but my friend said, I can't send
you to the University of Hamburg because they're all communists
there. There is, however, one school in Hamburg where the communists
haven't taken over, and that's the high command staff school
of the German army, the Hochschule der Bundeswehr. I'll set
it up for you, he said.
So I went from Cologne to Hamburg on a military pass. I get
into the Hochschule der Bundeswehr and, like he said, it's a
military school. The students, all in uniform, went everywhere
running at a trot, not only in the corridors, but up the stairs.
Now the only talk I had for this trip was on a fairly technical
subject of interest only to finance professors. So I looked
down from the lectern at the rows of young uniformed faces sitting
politely at attention in the high-tech auditorium, and the only
thing I could think of to say was: "Gentlemen: Tomorrow we invade
Poland!" [Gales of laughter.]
We're nearing the end of our talk, professor. I wonder if
I might ask you, based on your experience, how do you think
people should invest for the future, be it their retirement,
or college education, or what have you? Should they buy index
funds?
Absolutely. I have often said, and I know this will get some
of your readers mad, that any pension fund manager who doesn't
have the vast majority-and I mean 70% or 80% of his or her portfolio-in
passive investments is guilty of malfeasance, nonfeasance or
some other kind of bad feasance! There's just no sense for most
of them to have anything but a passive investment policy. And
I know people will say, yeah, but if everybody invested passively,
who would discipline the corporations? Well, as I explained
earlier, the few people who are willing to spend the money to
do it. And they will get enough extra returns to compensate
for their costs. But that's about it. Most pension fund managers
cannot even reasonably hope to do any better than a passive
fund. And, on a risk adjusted basis, they don't! I believe that
data are quite strong on this.
In fact, Bill Sharpe thinks only "mad money" should be actively
managed.
That's based on the principle that, as long as you keep the
amounts of active money reasonably small, the active managers
won't do too much damage.
I'll tell you another story that will irritate your audience.
The first time I made this point was in the '50s, when there
was a guy at a pension fund who was explaining to me that he
had five separate managers. At the end of each year, he'd see
which manager did the best and which did the worst. He fired
the worst and he brought in another one.
A fairly common tactic and theory.
A common theory. Well, I always say that's like having a passive
fund, all right. Only it's the most expensive way to do it.
Because if you have five separate managers, you're going to
wind up pretty much with the market average. So why not just
go there in the beginning and stop all this style analysis nonsense.
Some people, I'm sure, make a handsome living tracking styles
and so forth. I'm very skeptical. If I were in charge of a pension
fund, I would put it in passive management.
But the style thing does have relevance. The academics have
demonstrated that styles of stock vary together. In other words,
the growth stocks tend to perform similarly but, for example,
the growth and the value style don't perform the same way.
Well, you know, I suppose if you take 50/50 growth and value,
you get back to the market. How are you going to tell which
one is due to take off?
You can't. The idea is that you allocate assets by style.
One thing I find interesting is that the data show that value
stocks outperform growth stocks.
They show that they have over some period of time. As I said,
I'm always worried that the last two hundred years, or whatever
your sample period is, have been somewhat unusual. I take a
very long view and I'm not convinced, yet, that simple passive
investing isn't the best way to go for the vast bulk of all
investors. Unless you can explain to me why some strategy that
everybody could follow is superior.
Oh, they explain it all right. They explain it by risk.
They say you get rewarded for the risk you take. Value stocks
are riskier. Ergo, you get more reward with value stocks. Now,
that's controversial.
Yeah. But if it is risk that accounts for the differential,
and it has to be if the differential is not just some random
sampling fluke, then some day the risk will happen. And when
it does, you give it all back. After all, our Dimensional Fund
Advisors small-cap portfolio under performed the S&P 500
for 6 or 7 years in a row. It's back up again now, but who knows
when it will tank again? All you can say is that small stocks
are part of total wealth. I should hold my share of them, not
just the S&P.
Do you practice what you preach in your own investments,
or do you secretly have an active manager on the side?
No. I do read the papers. Sometimes I get intrigued by the
idea of a drug company that has a drug for obesity, or something
like that. I may take a flyer on some of those things.
Boy, am I glad to hear that!
Yeah. But that's strictly recreational. It's not serious investing.
But for serious investing, I presume you invest in the market.
For the equity portion of my portfolio, yes. But I made a mistake,
probably along with many others in my generation who lived through
the '70s. I had too balanced a portfolio-too much bonds, relative
to stocks. Had I put more in stocks, I'd be wealthier today!
Many thanks, professor. That is no doubt worthy advice.
Indeed it is! Stockbrokers rejoice! Here is the noted economist,
Merton Miller, telling us he wished he had put more of his own
money in stocks. And once again, we are exposed to the prevailing
view among academics that those of us who try to beat the market
are just wasting our time. Sure, some of us will succeed, just
like a few of us will win the lottery or hit a slot machine jackpot.
I found it interesting that Miller's view of the efficient market
hypothesis is not extreme. He allows that some people may be able
to get information before others, a la Michael Price, and profit
from that information. However, he believes that in the aggregate,
the extra profits will only amount to the money spent doing the
research. But, among those making those extra profits, there will
be some who do very, very well. Our challenge is to identify these
winners and observe how they do it.
As I reread Miller's comments, I was impressed by the elegance
of his points, and the compelling explanations of his views on
market efficiency. Miller is an historic figure in the field of
economics. We asked him to stray from his normal field, the classic
Miller and Modigliani theorem. But the journey was worth it. This
wise man-I dare not call him old-not only shared insights and
wisdom with us, he did so with humor.
