Value Investing: Tools and Techniques for Intelligent Investment

Chapter 1. Six Impossible Things before Breakfast, or, How EMH has Damaged our Industry^[1]

The efficient markets hypothesis (EMH) is the financial equivalent of Monty Python's Dead Parrot. No matter how much you point out that it is dead, the believers just respond that it is simply resting! I wouldn't really care if EMH was just some academic artefact, but as Keynes noted, 'practical men are usually the slaves of some defunct economist'. The EMH has left us with a litany of bad ideas, from CAPM to benchmarking, and risk management to shareholder value. The worst of its legacy is the terrible advice it offers on how to outperform – essentially be a better forecaster than everyone else. It is surely time to consign both the EMH and its offshoots to the dustbin of history.

• Academic theories have a very high degree of path dependence. Once a theory has been accepted it seems to take forever to dislodge it. As Max Planck said, 'Science advances one funeral at a time'. The EMH debate takes on almost religious tones on occasions. At one conference, Gene Fama yelled 'God knows markets are efficient!' This sounds like a prime example of belief bias to me (a tendency to judge by faith rather than by evidence).

• The EMH bothers me less as an academic concept (albeit an irrelevant one) than it does as a source of hindrance to sensible investing. EMH has left us with a long list of bad ideas that have influenced our industry. For instance, the capital asset pricing model (CAPM) leads to the separation ...