Conclusions and implicationswinner emerges. We know that a winner must emerge, but would we really believe
that skill was involved? We should more likely judge the winner to have had
remarkably good fortune in the face of a very small probability of success.A strategy for an investor in marketable securities
The evidence that we reviewed in this chapter, and what we found about diversifica-
tion and risk reduction in Chapter 7, leads to the following strategy as being preferable:l Divide the total to be invested by between 15 and 20, and invest the resultant
amounts in different securities. Try to invest over a range of different industries. By
doing this the investor will eliminate almost all of the specific risk attaching to the
individual securities.
l Do not trade in securities. Only alter the securities in the portfolio to ‘rebalance’
should the values of the holdings of individual securities become significantly dif-
ferent from one another as the result of relative security price movements within
the portfolio. This is to maintain the broad equality of value of the 15 to 20 differ-
ent holdings. Do not be tempted to take profits on securities that are performing
well or to get rid of badly performing ones. Efficient market evidence is clear that
the current price is the best available estimate of the value of a security, given the
projected future. The evidence is also clear that, unless the investor is an insider, the
current market value is a better estimate of the security’s worth than the investor’s
estimate. The evidence is clear that active trading is costly in terms of dealing costs
and does not yield security price value (see, for example, Barber and Odean 2000).
A buy-and-hold policy has been shown to be the best.Small investors may find it uneconomic, in terms of dealing costs (brokers’ fees),
which tend to have economies of scale, to follow the first of the above recommenda-
tions. Here, the use of an investment fund may be the best approach. Investment fund
managers charge an annual fee, usually based on the size of each investor’s holding,
but they can achieve dealing economies of scale. If this approach is taken, the investor
should select a fund that has a buy-and-hold strategy.Implications for financial managers
These are vitally important and the main reason why we are discussing capital mar-
ket efficiency in this book. Broadly the implications are:
l It is difficult to fool the investors. Investors rationally interpret what the business’s
management does, and ‘window dressing’ matters will not cause security prices to rise.
l The market rationally values the business. If the management wants to issue new
equity shares, then the existing equity price is the appropriate issue price. If the
general level of prices were low on a historical basis, it would be illogical to wait for
a recovery before issuing new equity. If security prices follow a random walk, there
is no reason to believe that just because prices have been higher in the past they will
return to previous levels.
l Management should act in a way that maximises shareholder wealth. As this is the gen-
erally accepted criterion for making investment decisions within the business,
if managers make decisions that logically should promote it, then provided that
they release information on what they have done, security prices will reflect the