Who beats the stock market and why? In his October 2019 paper entitled “The Five Investor Camps That Try to Beat the Stock Market”, William Ziemba discusses how different categories of investors succeed. For investors pursuing active strategies, he addresses broadly the means of getting an edge and betting well. Based on his academic work and practical experience, he concludes that:
- The five categories of successful investors are (with perhaps some overlap):
- Efficient market believers – beat 75% of active managers by buying and holding a broad fund and thereby avoiding the drag of trading frictions.
- Risk premium pursuers – capture extra return by bearing extra risk expressed as a handful of stock factors and firm characteristics.
- Geniuses – make brilliant investments, perhaps intuitively, with some persistence over time.
- Efficient market rejectors – rigorously evaluate companies and identify those with value substantially greater than price. They pick a few of these undervalued firms that they understand well, get involved in their management and hold them for a long time. They understand and sometimes exploit tail risk with modest bets when they see huge edges.
- Superior researchers – automatically and repetitively exploit behavioral biases and market anomalies with strict rule-based betting (risk control).
- The most successful investors (achieving $100 million or more in wealth) fall into categories 3, 4 and 5.
- Many great investors, including most of category 5, use Kelly betting.
- Errors in estimating expected return are as much as 100 times more important to investment outcome than errors in estimating volatility and diversification. Investors should focus resources on estimating mean returns for investments and just use historical variances and covariances.
In summary, the most promising paths to great wealth through investment are categories 4 and 5, involving discipline, Kelly betting and focus on expected investment returns.
The discussion is mostly notional rather than demonstrative.
Browse the “Investing Expertise” category of posts for other perspectives.
