An Interview With Burton Malkiel

the odds that all those investors who were mentored by Graham posted market-beating returns over long time frames by chance seems vanishingly slim to me. No, Buffett didn't pick "all those investors." He picked only those who were winners out of tens of thousands of people employing Graham's techniques. There are no odds because they were a deterministic, not a random draw. Buffett didn't talk about those mentored by Graham who lost everything they owned. BTW, Buffett's crystal ball seems a bit hazy lately. Companies can have a negative enterprise value when they are flush with cash. Stock prices reflect the expected profits of the firm in perpetuity. The two are not at all related and are therefore not contradictory under the assumption of EMH. I'm well aware of the theory of secular bear markets, but that doesn't mean we're in one. We're in the aftermath of a particularly nasty bursted bubble which was fueled by government policy which is continuing. I am rather pessimistic about...(Read more of this comment) the next couple of years, though, and I think the market will reflect that growing pessimism in the coming months. But here's where we differ. I don't claim to have a crystal ball. You are stuck in "market timer" mode. You think there's an intelligent way to not only predict the future but the timing of it - I don't. Being pessimistic about the next couple of years, I am considering moving to riskless assets for a while. But where to put the assets and how long to keep them there is a pure gamble. If I had changed my position only two weeks ago I would have been a big winner. Hindsight is 20/20. @David: Yes, you are correct that Index investing should generally be balanced across world markets. But not all markets have as much liquidity as others and therefore face much greater volatility in their indices. So the weight wouldn't necessarily be based on market cap alone. There are also issues of transparency, regulation, sophistication, and policy reversals to consider as risks. Many foreign stocks are cross-listed on US exchanges or have ADR's. That gives more than ample opportunities to invest in those other geographies without departing from a domestic index.(Show less of this comment)

Yet at the same time, Malkiel (in a Barrons article) argues for investing China. Shouldn't a proponent of index investing believe that allocation of one's portfolio to geographical regions should be based only on the market capitalization of each of those regions? Why would it be easier to beat the market on geographies than on individual equities?

I disagree with you that Buffett was "full of manure" in his Columbia speech: the odds that all those investors who were mentored by Graham posted market-beating returns over long time frames by chance seems vanishingly slim to me. But set that aside for a moment. Let me address another problem I have with the efficient market theory: how does it explain stocks trading at negative enterprise values? At the beginning of this year, I spotted a number of these, and this makes no sense intuitively from a market efficiency perspective. Reasonable people can disagree on what a particular profitable business is worth -- you might think it's worth some multiple of its average earnings over the last few years; I might think it's worth $1. But how is it reasonable for such a business to be worth, say, -$2,000,000? That's the implication of valuing a profitable company for (often, several million dollars) less than its net cash, and the market did that for a number of stocks earlier this year. ...(Read more of this comment) Let me also ask you a couple of different questions re your investment allocation. Why do you use the S&P as an index? Are you aware of who compiles it? Also, are you familiar with Vitaliy Katsenelson's thesis about secular bull and bear (or range-bound, as he calls them) markets? Briefly, according to his research going back over a hundred years, secular (i.e., longer than five years) bull markets tend to be followed by bear or range-bound markets of similar length, which are characterized by gradually compressing valuation multiples. Given that history, why be long an equity index now, considering that we might be only half way through the current secular bear market?(Show less of this comment)

Dave: Buffett's tale is full of manure. When he began talking about cancer I was reminded of real-world cases of "cancer clusters" which have been falsely attributed to chemicals, nuclear reactors, electric wires, cell phone towers, etc. The existence of "clusters" of winning callers sharing some familial, geographic, academic, military, philosophical or other qualities is a statistical certainty given a large enough number of coin flips. The fallacy is called fundamental attribution error. Observers see a cluster of winners and seek a common attribute. The search is not methodical or comprehensive. They seek attributes consistent with some theory which explains the outcome and when they think they've found it, they stop looking. In this case the outcome is successful stock picks and the attribute is a particular book, school, mentor, author, or technique. There are few observations of the LOSERS with similar or identical attributes. If losers are observed, the gullible observer wh...(Read more of this comment)o wants to believe his hypothesis seeks an attribute which is absent/present in the loser but is present/absent among the winners. These attributes are seldom hard to find and are often plausible. The winners seem to pick great companies. But great companies often have similar qualities in management, innovation, efficiency, and filling niches. These similarities are obvious ex post. What the gullible observer doesn't find, because he does not seek, are failed companies which possess the same attributes. The observer also doesn't see the people who picked these failures using the winners' techniques. In Buffett's model, losers drop out. In the real world, losers can get back on board. Some lose again and some become winners, like this kid. Like most other winners, someone had his back. They didn't face the risk of ruin. The real world also have new entrants and the game goes on forever. More coins are called and there are more opportunities to see people calling correctly 6 standard deviations above the mean. Buffett's winners aren't finished calling coins yet. But even losers are winners in this game. You don't have to be a continuously successful fund manager. You only have to have a plausible excuse or scapegoat for your wrong calls. Gullible people won't update their expectations of the whiz kids when the Law of Large Numbers begins to drag them back down toward below-average returns. Some of these winners don't live long enough to be dragged back down. Buffett will likely be one of those. Some say poker is a game of skill. They observe "the same people always seem to make the final table." Maybe it is a game of skill. Maybe they have an advantage. Or maybe they got lucky once, wrote some books, built a legend around themselves, found some sponsors, and then entered a lot more tournaments than everyone else. So let me replace my former statement with a more precise one. There might be more than luck in the stock picking game. There might be exploitable market inefficiencies which the wealthy can afford to implement and avoid the risk of ruin. But the mere observation of continually successful people isn't evidence of this hypothesis beyond a reasonable doubt. We need more statistical proof than that. Unfortunately that leaves us with the P=NP problem. If we could verify that some people actually could "beat the market", it would be by finding the secret of their success, thereby rendering it useless. The strong-form EMH would thereafter prevail and no one could ever again beat the market! Winning is a necessary but not a sufficient condition of market genius. I remain unconvinced and all my money is in S&P Index Funds.(Show less of this comment)

Buffett refuted Robert Miller's coin-flip analogy twenty five years ago in his Columbia speech, "The Superinvestors of Graham-and-Doddsville": I want to present to you a group of investors who have, year in and year out, beaten the Standard & Poor's 500 stock index. The hypothesis that they do this by pure chance is at least worth examining. Crucial to this examination is the fact that these winners were all well known to me and pre-identified as superior investors, the most recent identification occurring over fifteen years ago. Absent this condition - that is, if I had just recently searched among thousands of records to select a few names for you this morning -- I would advise you to stop reading right here. I should add that all of these records have been audited. And I should further add that I have known many of those who have invested with these managers, and the checks received by those participants over the years have matched the stated records. Before we begin this exam...(Read more of this comment)ination, I would like you to imagine a national coin-flipping contest..." Click on the link to read the rest. Now, it's true that value investors have largely screwed the pooch over the last few years, but then again, so have index investors.(Show less of this comment)