Equity Markets (in)efficiency

Value investors generally look for something that is worth more than the market price. If your analysis is proven correct the market price will converge to your estimate in time – you just don’t know when. It may take 6 months to 3 years generally. But let’s look at the average holding period in the U.S.:
What we see is that market participants are turning the portfolio way faster than they used to. But why is that? Clients generally have a shorter timeframe than portfolio managers thus yearly we see money flowing from last year’s losers to winners. Due to that managers try to perform well in a shorter timeframe. So it is a cycle – not a virtuous one though. Now it is clear the reason a client base aligned with the investment strategy is a competitive advantage – think of the Baupost Group.
So in a market with that kind of irrationality that comes from short term/momentum investing many opportunities arise for those who are able to have a longer investment horizon. The conclusion is that the managers with well defined investment processes, disciplined, with a longer timeframe and with the client base aligned with the strategy will be the last man standing or in another expression, time arbitrage will be the last strategy standing.

Quoting Jeremy Gratham from GMO:

“For the best instituional investors, their time horizon is 3.0000000 years.” (Source: Graham & Doddsville, Fall 2012)

Quoting Joel Greenblatt on why he thinks investment time horizons will not lenghten:

“I think the reason for this is that your investors – your clients – generally just don’t know what the investment manager’s logic was for each investment. What they can view is performance.(…) Clients tend to make decisions over much shorter time horizons than are necessary to judge skill and judgment and other things of that nature. So I think time horizons are getting shorter, not longer.” (Source: Graham & Doddsville, Fall 2012)


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