After five decades, the Institute for Financial Analysis has polled its members, who now no longer believe in efficient markets – or, more specifically, that share prices do not reflect all available information. Does this mean an end to the random use of Greek letters in financial jargon? What should a rational investor do without his trusty Capital Asset Pricing Model? Is the DCF dead? How can one function in these volatile times without a simplistic framework?
We view this apparent mass epiphany as arrant nonsense, verging on sacrilege. The world is awash with financial information, dispensed with formidable rapidity to a very wide audience by Bloomberg , Reuters, CNBC, email and even Twitter for those of a trendier persuasion. CEOs can’t scratch their nose without it being made public, and any informational advantage that an investor can claim is likely to be either fallacious or illegal. Where the academic fraternity has gone wrong is in assuming that all participants interpret new news in the same way. This has NEVER been the case, and it most certainly isn’t now. Investor psychology will always influence how news is reflected in market pricing, and at times of panic and extreme bullishness will twist data to extraordinary degrees to suit current positioning. Just look at the changing response of markets to capital raisings over the last six months. These episodes are always the most fertile for active investors who can adopt some degree of objectivity in their process. The ‘art’ of fund management is simply discerning the balance between what type of economic outcome is reflected in stock prices and what is likely to eventuate based on history or other guides – and one must always be cognisant of the old adage that history may not repeat itself, but it does tend to rhyme. The panic of last year was an unpleasant episode to go through but sowed the seeds of huge pricing anomalies. The aftershocks of the financial crisis are likely to continue to provide a lot of opportunity to add alpha over the next six months – or indeed to outperform (as we would put it in the vernacular).
