After reading an article by Roger Lowenstein defending the efficient market hypothesis, Seth Klarman (Trades, Portfolio) wrote an article in which he provided arguments in favor of value investing and the obvious market inefficiencies ("A Response to Lowenstein’s Searching for Rational Investors in a Perfect Storm," Journal of Corporation Law, 2005).
In the article, Klarman provided a strong argument about two things: the importance of practice against theories and the relevance of observing and reaching common-sense conclusions.
"There are two ways of learning how to ride a fractious horse: One is to get on him and learn by actual practice how each motion and trick may be best met; the other is to sit on a fence and watch the beast awhile, and then retire to the house and at leisure figure out the best way of overcoming his jumps and kicks.
"The latter system is the safest, but the former, on the whole, turns out the larger proportion of good riders. It is very much the same in learning to ride a flying machine. If you are looking for perfect safety, you will do well to sit on a fence and watch the birds, but if you really wish to learn, you must mount a machine and become acquainted with its tricks by actual trial.
"So, too, for the stock market. It is easy to study stock tables in solitude from the comfort of your office and declare the market efficient. Or you can be a full-time investor for a number of years and, if your eyes are open, learn that it is not. As with the Wrights, the burden of proof is somehow made to fall on the practitioner to demonstrate that he or she has accomplished something the so-called experts said could not be done (and even he may find himself explained away as aberrational). Almost none of the burden seems to fall on the armchair academics who cling to their theories even in the face of strong evidence they are wrong."
The main ideas we can get from Klarman's comments are the following:
Practice is the best teacher. What Klarman discussed is of great value for us as investors. We certainly benefit from reading, watching videos, attending lectures, but there is no actual substitute for applying that knowledge and investing money ourselves. Why? The main reason is our emotions. It is one thing to look at results with hindsight and say that allocating capital at a low price was obvious, while a completely different thing is actually putting the money to work with an uncertain outcome. To achieve success at investing, we must have control over our emotions, which generally proves harder said than done. For the intellectual part, that is easier to overcome via learning.
The market is efficient in the long run. While we all agree that the market certainly provides opportunities via mispricings, it is only by a natural correction –Â that is, with the existence of market efficiency –Â that value investors (and any other investor) can expect to reap profits out of the stock market. Value investors are generally more patient and transact less; however, it is generally swing traders who provide the liquidity in the market. As Ben Graham, the father of value investing, pointed out: "In the short run, the market is a voting machine, but in the long run, it is a weighing machine."
What do you think?
