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A recent blog post [0] from the Economist stated that buying random stocks on the stock market actually performs better than valuation-weighted investment and c

by tormeh 12y ago

A recent blog post [0] from the Economist stated that buying random stocks on the stock market actually performs better than valuation-weighted investment and conscious investment. I wonder if the optimal strategy is to just invest randomly? [0]: http://www.economist.com/blogs/freeexchange/2014/06/financial-knowledge-and-investment-performance http://www.economist.com/blogs/freeexchange/2014/06/financia...

chimeracoder 12y ago
That's really an argument for buying index funds, since the costs and fees of buying and selling random stocks would eat away any profits very quickly. (Even just buying and holding truly random stocks is still less likely to be a better investment strategy than index funds after taxes and fees are taken into account, let alone the volatility).
- tormeh 12y ago
  Sorry, I think I wrote hedge fund when I meant index fund. To clarify I've just replaced it with "valuation-weighed investment".
- josu 12y ago
  What about a random fund? Is there such a thing out there?
applecore 12y ago
That strategy only makes sense for markets that are close to "informationally efficient", e.g., the public stock market.
- tormeh 12y ago
  I don't get it. The strategy involves throwing darts at randomly sorted stock listings. It uses absolutely no information other than the fact that the company is public. It actually implies that information is harmful. It's vulnerable to people setting up lot's of companies to win the investment lottery, so everyone can't do it, but otherwise I don't get what you mean.
  - nostrademons 12y ago
    Valuation-weighted information is harmful. Remember the rule is to "buy low, sell high". When you weight by valuation, you're explicitly overweighting stocks that are valued highly by the market; in other words, you're buying high and selling low. In theory you can do better with fundamental-weighting (i.e. weighting by revenues, earnings, P/E, PEG, etc.), but there are a lot of subtleties to a stock's future performance that are not captured in the financials and are exploitable against an investor that only naively looks at them. You end up with an investor that's picking up companies that are looting their future prospects for cash because their market is disappearing.
    - tormeh 12y ago
      How about inverted valuation-weighing, then?
      - nostrademons 12y ago
        That's actually an interesting idea, except that you have no idea of knowing whether a company is worth very little because the market undervalues it, because it's intrinsically a small company, or because it's about to go bankrupt. An inverted valuation-weighted fund would put that vast majority of assets into stocks that are worth just above nothing. I suspect that a good portion of these are companies that are about to go bankrupt - probably a much bigger proportion than the ones that are small and about to take off, or the ones that are small and overlooked. Investing in companies that are about to go bankrupt isn't really a sound strategy. The ultimate problem is that stock market returns are a future-prediction problem. When a stock does better than expected, it goes up. When it does worse than expected, it goes down. Doing this reliably includes both having a complete understanding of the rest of the market's expectations and knowledge of the future, which is pretty challenging. I think that behavioral-finance approaches, which gauge the emotions of your fellow investors, have actually been shown to work pretty well. "Be fearful when others are greedy, and greedy when others are fearful." Hard to put that in an index, though.
        12y ago
MaysonL 12y ago
Here's an interview with a guy who runs indices that are not valuation-based and seem to do better: http://www.ritholtz.com/blog/2014/07/masters-in-business-rob-arnott-of-research-affiliates/ http://www.ritholtz.com/blog/2014/07/masters-in-business-rob...
prostoalex 12y ago
A random buy is likely to be smallcap-biased, as there's simply more of them. Smallcaps performed quite well over the past decade. Same strategy would not backtest with the same levels of success during any period.

by tormeh 12y ago

chimeracoder 12y ago

That's really an argument for buying index funds, since the costs and fees of buying and selling random stocks would eat away any profits very quickly. (Even just buying and holding truly random stocks is still less likely to be a better investment strategy than index funds after taxes and fees are taken into account, let alone the volatility).

tormeh 12y ago
Sorry, I think I wrote hedge fund when I meant index fund. To clarify I've just replaced it with "valuation-weighed investment".
josu 12y ago
What about a random fund? Is there such a thing out there?

applecore 12y ago

That strategy only makes sense for markets that are close to "informationally efficient", e.g., the public stock market.

tormeh 12y ago
I don't get it. The strategy involves throwing darts at randomly sorted stock listings. It uses absolutely no information other than the fact that the company is public. It actually implies that information is harmful. It's vulnerable to people setting up lot's of companies to win the investment lottery, so everyone can't do it, but otherwise I don't get what you mean.
- nostrademons 12y ago
  Valuation-weighted information is harmful. Remember the rule is to "buy low, sell high". When you weight by valuation, you're explicitly overweighting stocks that are valued highly by the market; in other words, you're buying high and selling low. In theory you can do better with fundamental-weighting (i.e. weighting by revenues, earnings, P/E, PEG, etc.), but there are a lot of subtleties to a stock's future performance that are not captured in the financials and are exploitable against an investor that only naively looks at them. You end up with an investor that's picking up companies that are looting their future prospects for cash because their market is disappearing.
  - tormeh 12y ago
    How about inverted valuation-weighing, then?
    - nostrademons 12y ago
      That's actually an interesting idea, except that you have no idea of knowing whether a company is worth very little because the market undervalues it, because it's intrinsically a small company, or because it's about to go bankrupt. An inverted valuation-weighted fund would put that vast majority of assets into stocks that are worth just above nothing. I suspect that a good portion of these are companies that are about to go bankrupt - probably a much bigger proportion than the ones that are small and about to take off, or the ones that are small and overlooked. Investing in companies that are about to go bankrupt isn't really a sound strategy. The ultimate problem is that stock market returns are a future-prediction problem. When a stock does better than expected, it goes up. When it does worse than expected, it goes down. Doing this reliably includes both having a complete understanding of the rest of the market's expectations and knowledge of the future, which is pretty challenging. I think that behavioral-finance approaches, which gauge the emotions of your fellow investors, have actually been shown to work pretty well. "Be fearful when others are greedy, and greedy when others are fearful." Hard to put that in an index, though.
      - 12y ago

MaysonL 12y ago

Here's an interview with a guy who runs indices that are not valuation-based and seem to do better: http://www.ritholtz.com/blog/2014/07/masters-in-business-rob-arnott-of-research-affiliates/ http://www.ritholtz.com/blog/2014/07/masters-in-business-rob...

prostoalex 12y ago

A random buy is likely to be smallcap-biased, as there's simply more of them. Smallcaps performed quite well over the past decade. Same strategy would not backtest with the same levels of success during any period.