Have equity markets become less efficient over the past 30 years?
Lightning-fast access to data and the ease with which many market participants can now trade should have, in theory, made markets more efficient. But are they? And more importantly, does it matter?
Our answer might surprise you (and not for the reasons you think).
Cliff Asness, co-founder of AQR Capital Management, with over $120 billion in assets under management, has authored a new paper that will be forthcoming in the 50th anniversary issue of the Journal of Portfolio Management.1 In the paper, Asness argues that markets have become less efficient over time since he started his career. “I believe markets have gotten less efficient over the 34 years since the data in my dissertation ended,” he writes. “I think the ups and downs will be bigger and last longer, making more money for those who can stick with it long term, but making it harder to do so.”
In my experience, Cliff Asness is a tenacious investor and a purist in terms of how he invests. His preferred way of investing is using factors such as size and value. This paper may be taken as a justification for the fact that AQR’s way of investing hadn’t worked well for a long time (although some strategies have recently been performing better), but who knows? Nevertheless, there are some nuggets that all investors can glean from what Asness is saying.
In summary, he believes these are the factors that have caused the markets to be less efficient:
- Index investing
- 10+ years of ultra-low interest rates
- Social media’s impact on irrational day traders
Asness thinks that stock trading has become a form of gambling or gaming, and these irrational actors have made markets less efficient. Some other data points support this view; a recent Axios study found a decrease in investment inflows when sports betting was legalized in a state. Asness is unsure if this phenomenon will be a permanent change, since markets and technologies are evolving, but he does not see rational investing being challenged in terms of providing an advantage to outperform.
At the highest level, I believe that what Asness is saying is important, but is also a fundamental investing idea: investors must be long-term focused and patient.
In our view, investing in indexes is a good idea in highly efficient markets and can sometimes make sense even in less efficient markets. And in all markets, there is volatility – and when volatility takes place, investors tend to want to change their investment strategy. A fund manager’s job is to exploit inefficiencies, so the nature of that work has changed. For clients who are allocating funds, knowing that managers have a tough time exploiting these evolving inefficiencies, index investing can be an excellent option.
This is behavioral investing 101 – set your long-term allocation and stick to it. It will perform over time. Yes, markets may be less efficient – but investment principles have not changed.
Please let us know if you have any comments or thoughts on this topic.
