Quantitative Strategy, Trading, and Algo Development Industry News

An Index-Fund Evangelist Is Straying From His Gospel

In his classic 1973 book “A Random Walk Down Wall Street,” Burton Malkiel, a Princeton economics professor, made an assertion that was startling at the time: that “a blindfolded monkey throwing darts at the stock listings could select a portfolio that would do just as well as one selected by the experts.”

Three years later, Vanguard, the asset manager where Mr. Malkiel served on the board for 27 years, started the first passive index fund, an innovation that has swept the financial world.

Now, at age 84, Mr. Malkiel has had a remarkable change of heart: Maybe the experts can beat the monkeys after all. That is, if the experts are software engineers writing sophisticated algorithms for computer-generated trading.

A large and growing body of academic research suggests there are market anomalies that can be exploited to beat a strict index approach. Some of that research has been recognized with Nobels in economic science — William F. Sharpe in 1990 and Eugene F. Fama in 2013. One of these findings is that value outperforms growth, rewarding those who identify stocks with lower price-earnings ratios and other metrics that suggest they’re undervalued. Another factor is momentum, in which stocks that are already outperforming market averages continue to do so.

There’s a lot of statistical and, perhaps more important, behavioral support for these strategies,” Mr. Hougan said. “You’ll find plenty of two- or three-year stretches where this will underperform, but if you buy and hold, it’s going to add value. We’ve seen value outperform for over 80 years. And Wealthfront is blending five factors that should smooth out and reduce those periods of underperformance.”

Read the full article on the New York Times

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