Wednesday, July 05, 2006

Efficient Buffett Hypothesis

As Warren Buffett is in the news in a big way again, the old debate on Efficient Market Hypothesis has resurfaced. Greg Mankiw weighs in on it. As much as I respect and admire Prof. Mankiw, I don't think his word on this should be given the weight you would afford his views on macroeconomics. Academic economists add an important component to this debate, but a practicioner's perspective is a critical element that cannot be ignored. Actual investors, managing real money, who have serious fiduciary obligations by necessity know more about this question than the academics. In this category, the grand master is probably this guy. Here's an excerpt from his excellent book, Pioneering Portfolio Management:

"Investors evaluating management alternatives for marketable equity portfolios face a spectrum ranging from generally efficiently priced large-capitalization domestic equities to the frequently mispriced emerging market stocks." Also, "Because Wall Street finds following smaller companies far less profitable...investors face the prospect of uncovering some interesting, mispriced investment opportunities...small capitalization equity managers with an edge have a reasonable shot at generating attractive relative returns."

There you have it. Parts (most) of the market are efficient, and other parts are less so. Like many theories EMH is broadly applicable but breaks down significantly under certain circumstances and and within certain areas of activity. The savviest investors know where it holds and where it breaks down and marshall their resources appropriately.

N.B. Swensen's book referenced above is indespensable for serious, professional investors, and his other book is highly valuable for anyone who takes an active role in the planning and execution of their individual investments.


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