"At first glance, the professional money managers seem to be
providing real value to their followers. On closer examination,
it seems that buying their favorites is no better than throwing
darts," writes Woolley. If the pros can't beat the market, then
index funds that provide the market return become a prudent proposition
for investors.
Woolley evaluates the "Investment
Dartboard" column of the Wall Street Journal that derived
its name from Burton Malkiel's (Professor of Economics at Princeton
University) famous words, "Even a dart-throwing chimpanzee can
select a portfolio that performs as well as one carefully selected
by the experts." The column pits investment pros against a random
portfolio selected by throwing darts at the securities pages of
the journal.
Prof. Malkiel's assertion seems to be challenged by the fact
that the expert stock pickers featured in the column have consistently
beaten the market for the last 10 years. They have notched up
a 11.1% average six-month gain since 1990 compared with 7% for
the Dow Industrials and 4.5% for the randomly selected portfolios.
But Woolley says that a recent study by Bing Liang of Case Western
Reserve University in the University of Chicago's Journal of Business
(click here
to subscribe) reveals that "you can't take this outperformance
to the bank." It shows that readers buying on the pros' picks
would have made just 8.2% on average for a six-month holding period.
Brokerage fees further reduce this return. The study also claims
that the pros' higher returns are gained largely by picking riskier
stocks.
The study found that there was abnormally high trading volume
in the recommended stocks even before the column came out. This
meant that investors were buying in anticipation of the boost
the stocks get after the column is published. Most of the post-announcement
gains though were wiped out within a month. " . . . the little
guy, who tends to buy during the middle of the day of publication,
winds up on the short end of the stick," writes Woolley.
Since the pros were competing against one another to return for
the next column, they had plenty of incentive to pick riskier
stocks (higher standard deviation). Liang's study shows that,
adjusted for risk, the pros' picks underperform the market by
almost 4%.
Even Prof. Malkiel said that the Investment Dartboard isn't a
fair test of the efficient-market theory because of the small
number of stocks involved and because a "publicity effect" might
make the stocks selected for the contest perform better than others,
at least temporarily. He also noted that the pros tend to pick
stocks that are riskier than the market as a whole, which may
boost their return in the short term.
If the pros can't beat the market average then investors are
wasting their valuable dollars by investing in mutual funds that
charge high asset management fees. A better alternative would
be to invest in low-cost, tax-efficient index funds that provide
the market return.
Review By Rahul Seksaria, Assistant Editor
