Rob Arnott on Clairvoyant Investment Analysis by Research Affiliates

Research based on “clairvoyant values” and “clairvoyant discount rates” reveals, after the fact, that investors price growth and small-cap stocks to give stunningly low returns. The upshot: Growth and small cap portfolios provide value-added returns only if they contain outliers.

Research Affiliates’ Rob Arnott on Clairvoyant Investment Analysis

A deeper look at clairvoyant investment

Whether read singly or together, the “clairvoyant” papers offer cogent insights into market efficiency, the pricing of growth and value stocks, and the value and size effects. Research Affiliates is pleased to present these three papers anew.

Clairvoyant Value and the Value Effect

Robert D. Arnott, Feifei Li, and Katrina F. Sherrerd

Journal of Portfolio Management, vol 35 no. 3 (Spring 2009), 12-26.

In the first paper, the authors defined a stock’s ex post realized value as its “clairvoyant value,” that is, the value that an investor with perfect foresight would have placed on the company. Their findings provide intriguing historical evidence on the value effect as well as the efficiency of the stock market.

Clairvoyant Value II: The Growth/Value Cycle

Robert D. Arnott, Feifei Li, and Katrina F. Sherrerd

Journal of Portfolio Management, vol. 35 no. 4 (Summer 2009), 142-157.

In the second paper, the authors found significant concurrent and predictive links between changes in the valuation gap between growth and value stocks and the market’s growth/value cycle.

Clairvoyant Discount Rates

Robert D. Arnott, Feifei Li, and Geoffrey J. Warren

Journal of Portfolio Management, vol. 40 no. 1 (Fall 2013), 109-123.

And, in a third paper, the authors used “clairvoyant discount rates”—the discount rates a clairvoyant investor would have to accept to justify the current price—to explore the relationship between expected returns and prices, and to probe the value and size effects. The results are startling.

Research Affiliates' Rob Arnott On Clairvoyant Investment Analysis