Investing: What Finance Professors Really Do

Finance professors have written papers documenting the value and momentum anomalies, some of which I have cited in this group, and they appear to be exploiting those anomalies in their own investments. I don't know why you sneer at them, other than that being your general disposition.

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wrote

Wouldn't you like to know why they overwhelmingly do not themselves apply the "traditional valuation techniques (specifically, the dividend-based valuation models) and the traditional asset-pricing models (namely the CAPM, APT, and Fama and French and Carhart models)"? Isn't this worthy of further academic study? Or are you not serious about the truths that academic research reveals?

I posted for the general reader here, not you. No one should be duped into thinking that investing successfully is so terribly complicated. People as extensively educated as Warren Buffett, Ben Graham, and Robert Shiller, tend to agree, from my reading.

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Do note that the 2/3 of finance professors who are passive investors may well be using the results of e.g. the Fama-French three-factor model: they just choose index funds for the small and value asset classes to complement a total market or other large growth dominated index fund. That's what I do, though I'm a statistics professor rather than a finance professor. So academic research such as that of Fama and French should not be sneered at.

David

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"David Moore" wrote

It seems to me you just repeated what my original post already stated. See the part that says two-thirds of finance professors "took their own teachings to heart" and bought index funds.

The focus (in the Motley Fool article and the paper) seems to be on the one-third who blew off indexing and instead chose to pick stocks, but not using any of the complicated traditional models they teach.

Aside: From my reading, small cap index funds are not proven the way larger cap ones are.

The question is still begged as to whether the one-third of finance professors in this study who consider themselves mavens of stock picking are beating the market. Or are they vulnerable to the same temptations that many hum-drum day traders are? It's worth seeking other papers that study this.

I do agree we should trumpet the likes of certain finance (or specialized econ) professors. E.g. Professor Jeremy Siegel, now an advisor to WisdomTree investments, and owner of 2% of the company. Also Professor Robert Shiller, whom I mentioned earlier. Fortunately this newsgroup regularly refers to the teachings of some of the greats, even if it is only by implication when, say, index funds are recommended.

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Good point. It would also be interesting to see statistics on how the people who write books on financial planning, the splashy ones that sell to the public in bookstores, actually invest their own money. I would hazard a guess the some of the authors who write about the latest plan or strategy for getting rich stay far away from it with their own money. Also, I would like to see the portfolios of securities analystys and others who recommend particular stocks in newsletters. I would guess they do not always follow their own "buy," and "hold," recommendations, and I would also guess they "sell" a lot more often than thety recommend in their newsletters. How many commissioned sales people buy the mutual funds they recommend? Data about all these things, if it were possible to get it, would be an excellent source of information for ordinary investors. Many investors who do not uderstand all the intricate details of finance might well understand the meaning of "Do as I say, not as I do," and profit by applying that information to their own decisions.

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Buffett, Graham, and Shiller are all much smarter than the average person, although Buffett often tries to present himself as an ordinary guy. In his latest Berkshire Hathaway letter

atttributes part of his success to superior innate ability 'a"business" gene', and I don't think he is boasting: "At 84 and 77, Charlie and I remain lucky beyond our dreams. We were born in America; had terrific parents who saw that we got good educations; have enjoyed wonderful families and great health; and came equipped with a "business" gene that allows us to prosper in a manner hugely disproportionate to that experienced by many people who contribute as much or more to our society's well-being."

Of course, you have a habit of vigorously denying things that have not been asserted. One can invest successfully without a PhD in finance by using a diversified group of mutual funds, and the professors themselves (such as Malkiel) have written books about this. What is doubtful is that many amateurs are capable through individual stock picks of assembling portfolios of stocks that will outperform the stock market on a risk-adjusted basis.

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wrote snip; I do not see how your point answers my own. In fact, we agree that it does not take a PhD in finance to invest successfully. Perhaps we also agree with the statements quoted in my original post: Two-thirds of the profs take their own advice.

Please know again that I am speaking to a larger audience, not merely you, when I point out that my general reading indicates that the "pros" are just about as incapable as the amateurs. Most pros are as incapable as amateurs, I'd say, unless one wants to split hairs over what a "pro" is.

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Fool/CNN didn't appear to read the actual paper. Give it just a few minutes, the research is sloppy but even what they came up with says something different. There are problems in the imprecise way they asked questions, the inconsistencies in responses, and the lack of analysis of the data they collected. It certainly doesn't show that the stock-pickers weren't using the models they teach...the survey forgot to ask about what they taught so how could we know? And it didn't even cross reference "what I believe" responses with "how I invest" responses, which would be required to make the claim that they don't eat what they cook.

And somehow the charts all have size, value, beta and momentum coming up as important factors in stock selection, but the researchers concluded they weren't using finance models. Except of course the models that talk about size, value, beta and momentum as the important factors.

And really, Fool/CNN buried the lead, which was "Survey says overwhelming majority of PhDs in Finance choose indexing." That's a good take-away for an individual investor, and is of course consistent with academic research. Note however that the sample group probably invested primarily through their 403b plans, given the median salary mentioned in the paper and their careers/employers. So that may explain the high percentage of index mutual fund ownership. But we can only speculate because they didn't ask about that either.

There is some irony to citing an academic paper - especially a weak one

- as part of a general assault on financial academicians.

-Tad

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The traditional valuation techniques don't look at what is being produced by the corporations. An investor can't get enthusiastic about an investment if there isn't going to be strong demand for the products being produced.

For instance, with energy costs increasing any device that will lower energy consumption or produce an alternative will find new investors.

-- Ron

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