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Financial Happenings Blog
Thursday, April 17 2008

The New York Times in March reported the researched being conducted by Professor Ken French - "Can You Beat the Market? It's a $100 Billion Question".  There is no hiding that we are a big fan of past work by Ken French in combination with Eugene Fama in developing the Three Factor Model, a major part of how we build investment portfolios.  He is an astute researcher who is highly regarded academic.


In one of his latest research projects Professor French has been looking into how much is being spent by Americans to identify market beating investments.  His finding is that investors collectively are spending US$100 billion a year trying to beat the stock market.  Mark Hulbert of the New York Times concludes that this is a huge price tag and helps explain why beating a buy-and-hold strategy is so difficult.


In the study, French has taken into account the fees and expenses of US mutual funds (including ETFs), investment management costs paid by institutions, fees paid to hedge funds and the transaction costs paid by all traders (including commissions and bid-ask spreads).


From this amount he deducted what investors would have paid if they instead had simply bought and held an index fund the difference being what investors as a group pay to try to beat the market.  The total difference was $99.2 billion for the 2006 year.  This equates to 0.67% as a percentage of market capitalisation.


The research highlights one of the problems with active management - the cost involved with research.  The flip side is that buy-and-hold strategies are benefitting from all of these costs as they are assisting the efficiency of markets.  In a sense, index or whole of market funds are sitting back while the active managers are out their busily researching.  Through their trading based on their research, asset prices reflect this research thus ensuring that they efficiently reflect all of the information available at a particular point in time.


In conclusion, it must be highlighted that this is an American study but has some general application in the Australian context.  As the article concludes:


"The bottom line is this: The best course for the average investor is to buy and hold an index fund for the long term. Even if you think you have compelling reasons to believe a particular trade could beat the market, the odds are still probably against you."

Posted by: Scott Keefer AT 05:50 pm   |  Permalink   |  Email
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