One of our favorite finance writers at The Acquirer’s Multiple is Jason Zweig. Zweig is a personal finance columnist for The Wall Street Journal. He’s also the editor of the revised edition of Benjamin Graham’s The Intelligent Investor (HarperCollins, 2003), the classic text that Warren Buffett has described as “by far the best book about investing ever written.”
He recently wrote a great article on the number of studies that claim to have found patterns that can predict outperformance in the stock market saying, “The incentives to find a pattern are huge, and the costs are minimal. Supply a smart young analyst with a decent computer and plenty of pizza, and in a matter of days or weeks you will have a set of data full of patterns – many of them probably spurious — that you can market to investors.” He adds, “You should approach all claims of market-beating patterns with extreme skepticism.”
Here’s an excerpt from that article:
Carlson Capital's Double Black Diamond Fund returned 85 basis points net in August, bringing its year-to-date net return to 4.51%. According to a copy of the fund's September update, which ValueWalk has been able to review, its equity relative value and event-driven strategies outperformed during the month, contributing 131 basis points to overall P&L. Double Read More
The same problem persists in medicine, where researcher John Ioannidis’ paper “Why Most Published Research Findings Are False” has been viewed more than 2 million times but has barely stemmed the tide of studies on small groups of subjects with weak results.
The problem of “p-hacking,” or dredging through an ocean of data until you find a pattern you can present as statistically significant, is endemic to research in finance. You should approach all claims of market-beating patterns with extreme skepticism.
In January, Campbell Harvey, a finance professor at Duke University, gave the presidential address at the American Finance Association on that topic. He estimates that at least half of all “discoveries” in investment research (and, thus, the expectations of investors in funds based on them) are false. The video of Prof. Harvey’s talk is well worth watching, or you can read his text here.
As Prof. Harvey has shown, so much data is available in finance that someone searching for a pattern “predicting” outperformance is all but certain to find one — even by statistical fluke alone.
Source: WSJ.com, MoneyBeat blog, http://on.wsj.com/2qdGi6E
This article was originally posted by Johnny Hopkins at The Acquirer’s Multiple.