The biggest waste of time for me in college was learning about efficient markets. No such thing. I want my money back. Markets aren’t efficient, though they are often taught to be in finance classes. Not even close. Professors tell you that if there is some inefficiency, opportunistic investors will buy the undervalued securities and sell the overvalued securities and the markets will become efficient. Sounds reasonable but not true.
One of the most famous and widely practiced investment philosophies is value investing. About 25 years ago academics discovered what Warren Buffett discovered decades ago: investing in value stocks outperforms passive investing, on the average. At first, prominent finance professors denied it. Then they claimed that it will disappear soon, as more and more investors take on value investing. Finally, as they saw the outperformance persist despite their predictions, the prominent finance profs claimed it must be a risk factor.
Value stocks managed to beat growth stocks by 39 basis points per month between 1926 and 2000. How do you think value stocks performed during the past decade? Between 2001 and April 2011, value stocks managed to beat growth stocks by 37 basis points per month. Finally, between March 2009 and April 2011, value stocks beat growth stocks by 51 basis points per month. How did value stocks perform in 2011?
Not that well. Growth stocks beat value stocks by 33 basis points per month during the first four months of the year. Value stocks didn’t perform well the last time there was an internet bubble. During the 18 months between September 1998 and February 2000, value stocks underperformed the growth stocks by a mind numbing 320 basis points per month. During those 18 months Julian Robertson lost so much money that he had to close his hedge fund in 2000. Markets aren’t efficiently priced, and sometimes those inefficiencies persist for a very long time. However, in the long run, value stocks will probably keep beating growth stocks.