Can individual investors “beat the market”?

"I'd compare stock pickers to astrologers but I don't want to bad mouth astrologers."

• Eugene Fama, "Father of modern finance", 2013 Nobel Laureate, University of Chicago Professor, Dimensional Fund Advisors Director

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Carousell and the financial markets

Have you ever tried to sell something on Carousell or eBay? It could have been a pair of pants, a piece of furniture, a bicycle, or something completely random. 

The item itself is not important: if you try to sell it for too high a price, it does not move. If you set the price too low, you will get a ton of inquiries and be kicking yourself for underpricing. Naturally, we are always trying to get the highest price possible that the market (a buyer) will accept.

Let's now shift this concept from selling used items to the greatest market on the planet: the financial markets. According to the World Bank, the total global value of stock traded annually stands at US$104 trillion as of 2022. This means, on average there was close to US$300 billion traded on average per day on the global stock markets. All of that money, irrelevant of who was behind it — it can be a sovereign wealth fund, a college student, a high-frequency trader, a billionaire, all trying to find a deal and set new prices, constantly.

We are all participating in a market where the value of goods and services is relative and constantly on the move.

The Efficient Market Hypothesis

The efficient market hypothesis is annoying — we can seldom get a great deal.

But it is also comforting to know that you will seldom get terribly ripped off. You will likely walk away with a 'fair' deal, most of the time.

Eugene Fama, 2013 Nobel Laureate, is credited with developing the Efficient Market Hypothesis, on which intelligent investment decisions can be made.

The efficient market hypothesis simply states that:

• Current prices incorporate all available information and expectation
• Current prices are the best approximation of intrinsic value
• Price changes are due to unforeseen circumstances
• "Mispricings" can certainly occur, but not in predictable patterns

It absolutely does not state that:

• All investors are rational
• Prices are always right
• Prices should be stable

Let’s not ignore market pricing

The markets are living, breathing, and reflecting data constantly. Prices move around as people and institutions act on their convictions. At any point in time, a price is an amalgamation of the aggregate human view. Prices can absolutely be wrong — you can spot this and act on it, and feel pretty good when the markets move in your direction.

Unfortunately, it is almost impossible to beat prices persistently and consistently.

Professionals who look at the market all day and night cannot beat the market. Morningstar, one of the most well-known fund rating companies, rates on a one to five-star system. The number of five star rated funds that will remain five stars just three years later is a meagre 14%. The persistence of returns over the market is non-existent, and playing that game is a low confidence endeavour.

In fact, the number of people who do beat the market is less than that due to random chance — a depressing statistic on the human condition.

You might hear people say "Asia is different," or "Only the US markets are efficient." Even if it is true that some markets are more 'efficient' than others, unless you are getting a steady stream of insider information and acting on it (which is absolutely illegal) why would you operate and make decisions in any other way?

Can we beat the market systematically?

Forget about short-term price beating, trading or should we call speculation. 

A rich universe of academic research, dating back to the ground-breaking three-factor model developed by Dr. Eugene Fama and his colleague Dr. Kenneth French has shown that over the long-run, there are pervasive, persistent, and proven factors that drive the future returns of specific asset classes.  

Watch: In pursuit of the perfect portfolio: Eugene Fama (38 mins by MIT Labs)

In equities, these factors include: 

• Value: Cheaper companies as measured by valuation metrics such as price-to-book ratios tend to outperform more expensive companies.
• Size: Companies with smaller market caps tend to outperform those with larger market caps.
• Quality: Companies of higher quality, measured by metrics such as profitability margin, tend to outperform lower-quality companies.

Based on historical empirical analysis, systematically building a portfolio that buys more small-cap, cheap (value), and profitable companies can lead to outperformance over the long-run. This phenomenon is persistent across longer time frames and markets. 

It is important to note that the outperformance of such systematic factor investing does not happen consistently every year, but rewards investors patient enough to sit out the volatility, and maintain their course.

Dimensional Fund Advisors, an asset management firm founded in 1981, systematically pursues such factor investing. Their long-term benchmark-beating track record demonstrated that these systematic factors can be captured through broad diversification in a cost-efficient manner.

Let the prices work for you. There is no need to bet against the market to beat the market.

Systematic factor investing with Endowus

At Endowus, we are committed to helping our clients maximise their chance of investment success based on a scientific, evidence-based approach, such as that put forward by Nobel Laureate Dr. Eugene Fama and put into practice by Dimensional Fund Advisors.

Through Endowus Hong Kong, Professional Investors in Hong Kong can now directly get access to a suite of institutional share class funds from Dimensional Fund Advisors — with total expense ratios of as low as 0.26%. Another way for investors to get access to Dimensional’s strategies is through the Endowus Flagship Portfolios, launching in June 2024. Join the waitlist now.

If you are new to Endowus in Hong Kong, you can get started by opening an account with us. 

Read more: 

• Are you investing or speculating?
• Webinar: Navigating today's markets: How to enhance the odds of investing success with Dimensional’s Apollo Lupescu
• Why invest through Endowus

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