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<v Host>Welcome once again as MIT professor Paul Samuelson</v>

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discusses the current economic scene.

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This series is produced by Instructional Dynamics

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Incorporated.

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This program was recorded August 27.

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<v Paul Samuelson>I'd like today to talk about a problem</v>

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of long run importance.

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I'm constantly being asked, what is this notion that the

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stock market accomplishes something?

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Isn't it manifestly a case of hysteria and enthusiasm

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at the moment that I'm speaking in August of 1974?

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The Dow Jones Industrial averages of 30 stocks, stocks

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that people look at, have at least momentarily broken down

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through 700, below 700.

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They were 1,050.

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Adjusted two or three years back, the American economy

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hasn't changed very much, but the quotations on those stocks

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have certainly changed.

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Indeed, they're right now as low as they were back at

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the depths of the 1970 recession.

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And you could go back to the middle 1960s to find

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the Dow Jones as low as this.

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They're broad categories of stocks, public utility stocks,

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for example, which are right now where they were 13 or 15

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years ago.

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Now, that being the case how can a economist seriously argue

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that the something like the random walk hypothesis holds

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for the stock market?

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How can he argue that all of the best information is

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constantly being processed by the best intelligence

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and is constantly being turned into some of kind of correct

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pricing?

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That's the question that I'm asked repeatedly, and I'd like

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therefore to discuss this fundamental problem to you.

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It's not only a fundamental problem in personal finance,

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but it's a problem of great moment for how we run

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the economic system.

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Because if the stock market is just a casino, that doesn't

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accomplish very much, then if we wiped it out under some

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puritanical laws, there wouldn't be much harm done.

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On the other hand, if it really is accomplishing a lot,

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it would be a tragedy to let temporary populist bouts

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of opposition to such an institution lead to the euthanasia

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of it.

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For this purpose, I was asked to prepare an article for

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a new journal.

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This is the new journal called the Journal of Portfolio

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Decision Making.

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It's to bridge the gap between the academic world

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of finance, the sort of thing that assistant and associate

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professors of finance in the graduate business schools

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of this country write about and study.

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And, the actual practical world where institutional money

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managers are putting their reputations on the line each day

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in trying to perform a little bit better than a random dog

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could do, and a little bit better than the best of their

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colleagues could do.

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Let me say in the beginning, that this particular magazine

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or journal is, as I understand it, being published by

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the same publishers who published the Institutional

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Investor, which has been a very successful magazine

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for people in the money market.

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The Institutional Investor group have sponsored innumerable

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conferences in New York, and those conferences, I imagine

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don't come cheap, and they're attended by really thousands

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of people.

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No doubt there's an ebb and flow.

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It's no secret that there are a lot of holes in people's

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shoes in Wall Street today, so instead of each company

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taking 20 tickets to a conference like this they might

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economize and send just three people there, so the

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attendances are down, but perhaps the loss to the commercial

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world is a gain to scholarship and so this may help

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to explain why this new journal is being started.

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It's new editor, I think they're lucky in their choice

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of him, it's Peter Bernstein, Peter Bernstein is a

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well-known economist who happens also to be a well-known

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investment counselor.

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He was a graduate of Harvard College and taught at Williams

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College and then was an economist for New York Bank,

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I think the amalgam made it Workers' Bank, and then

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he went into his father's firm, rather famous firm

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of Bernstein McColley.

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Fred McColley was a very emminent researcher at the National

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Bureau, did some of the first work on the relationship

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between term structures of interest rate.

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And that prospered and finally became part of Hayden Stone

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and more recently, I believe that organization continues

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with Hayden Stone but Peter Bernstein has gone back

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on his own and I think he's doing some consulting for

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a large foundations.

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So, you have a man who has a foot in both worlds.

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The new issue will be available to subscribers, I don't

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think you can see it on your friendly news stand unless

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you have an unusually academic news stand.

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Sometime I suppose this fall because I know that the first

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edition is now in the press.

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Well, when invited to contribute to the first issue,

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I thought I would and I thought I'd really throw

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the gauntlet down to the practical man.

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So, let me share with you the rather brief views that I

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stated in this original article.

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No mathematical equations in the article.

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I suppose that's uncharacteristic of an academic economist

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and it's written in a casual style, but it's meant

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seriously.

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The title that I gave is Challenge To Judgment.

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That is a challenge to the notion that discretionary

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security analysis and portfolio decision making does

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accomplish something.

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I begin by pointing out that there, there are now two

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worlds.

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Once upon a time, there was one world of investments.

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It was the world of practical operators in the stock

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markets and the bond markets.

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But now there are two worlds.

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There's the same old practical world, of course, a little

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bit the worse for wear, and the new world of the academics

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with their mathematical stochastic processes.

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Stochastic process means they probabilistic analysis.

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These worlds it's fair to say are still light years apart.

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They're as far apart as the distance from New York

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to Cambridge or New York to Berkeley, or perhaps

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exaggerating a bit, they're as far apart as the vast width

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of the Charles River between the Harvard Business School

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and the Harvard Yard where the academic statisticians tend

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to reside.

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Now perhaps there has been in recent years some discernible

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rate of convergence between this disparate worlds but

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in any case I guess I would expect the future to show

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some further approach between them.

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But let me reveal my own bias.

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I think the ball is in the court of the practical men.

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It is the turn of the mountain to take the first step

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towards the theoretical Mohammed.

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In other words, the convergence I think is going to have

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to take place between the practical men, coming closer

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to the academics than to have the academics get closer

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to the practical men.

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Now that shows how academic I am.

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Well let me explain.

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If you oversimplify the debate, it can be put in the form

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of the following simple question

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Resolved that the best of money managers cannot

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be demonstrated to be able to deliver the goods of superior

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portfolio selection performance.

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Any jury that reviews the evidence, and I think there is

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a great deal of relevant evidence, must at least come out

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with the Scottish verdict, superior investment performance

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is unproved.

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In our system of jurisprudence, the jury finds you guilty

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or unguilty, or not guilty, innocent.

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But in the Scottish system it used to be the case at least

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that there was an intermediate category called unproved.

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Well I think that superior investment performance is to

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say the least unproved.

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Now let me clarify.

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I don't want to be misunderstood.

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It's true, the Morgan Guarantee Bank trust department

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did do better in certain years than the average mutual fund.

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That's demonstrable fact.

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It's not in doubt.

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It isn't denied either that, say, the T. Rowe Price

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organization achieved greater increments of wealth in many

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years than did many other organizations.

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And both of these may well turn out to perform better than

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the market as a whole in the future.

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Yet, remember this.

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There were years when the Dreyfus Fund or the Enterprise

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Fund or the Fidelity Funds or, dare I say it, Chang,

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Chang's portfolios, they seem greatly to outperform

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the mob.

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And then again, there were other years when they didn't.

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And the same thing is true about the Morgan Guarantee Trust

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portfolio.

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It's no secret that the last year or so has not been great

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for the first tier of the market where the Morgan people

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have primarily been.

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They can tell you how they've done on Avon and Polaroid

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and perhaps Xerox and IBM and the story is not the great

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triumphant story that it used to be.

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Similarly, with respect to T. Rowe Price, they still,

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it still is an estimable organization, but the confidence

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in which an observer can say that that organization has

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recently been outperforming the rest or the averages must

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very much be diminished.

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What at issue, what's at issue, is not whether as a matter

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of logic or root fact, that could exist at subset of

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decision makers in the markets who are capable of doing

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better than the averages on a repeatable sustainable basis.

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There's no reason and logic why there shouldn't be a small

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group of, I won't even call them insiders because that

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sounds as if they get their extra edge by means of inside

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information, but there could be a small group of people

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who are capable of doing better than the averages, then

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the totals on a repeatable sustainable basis.

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There's nothing in the mathematics of random walks

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or Brownian movements, which academic economists apply

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to the stock market, that A, proves this to be impossible,

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or B, postulates that it is in fact impossible.

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In other words, as a matter of logic or a matter of fact.

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The crucial point though is this.

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When investigators, and there are a lot of them, a lot

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of good ones, like Irwin Friend of the Wharton School

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at the University of Pennsylvania or Jack Trainor, now

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the editor of the Securities Analyst Journal, or James

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Laurie at the graduate business school, or Fisher Black

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and Myron Scholes of the graduate Chicago Business School.

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Or, it doesn't have to be an academic, any foundation

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treasurer of fair-minded and serious intent.

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If they look to identify those minority groups or methods,

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and endowed with sustainable superior prowess, they seem

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quite unable to find them.

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The only honest conclusion then, I think, is to agree,

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that a loose version of the "efficient market" or random

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walk unquote hypothesis does accord with the facts

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of life.

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Now, this truth, let me emphasize, is a truth about New

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York.

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It's also a truth about Chicago and it's a truth about

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Omaha.

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And it's as true in New York as it is in Cambridge.

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If it's true, it's true about the real world, it's not

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something which is true in the learned papers in the

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assistant professors of finance or in the PhD theses

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of graduate students of the business schools.

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It's either true or it's not true.

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This doesn't say that many people, even most people, aren't

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capable of frittering away the funds given them.

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Most people can be capable of doing worse than the averages

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or worse than at random.

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To lose money all you have to do is flip a coin.

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Buy General Motors on heads and sell it on tails and just

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keep doing that.

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That way you'll do worse than the averages.

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And you'll do worse even in holding General Motors

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or avoiding it.

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The money you lose and on that system the odds are

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overwhelmingly against you.

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That money will go to lower the losses of your hard-pressed

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broker.

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It's not true that it's a zero sum game.

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That what you lose some other speculator wins because

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there's a lot of dead weight loss due to just the dead

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weight of commissions.

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Similarly, the transaction volume generated by the

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non-random decisions of the vast majority of the big

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and small investors who all think they have a flair,

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but don't demonstrably have it.

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Most of those transactions serve only to suck economic

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resources out of useful GNP activities, you name it,

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(mumbles) and you, whatever you think is useful in the GNP.

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And puts those resources into brokers, telephone

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solicitations and into a lot of bookkeeping.

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Now, this is not a condemnation of market activity.

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Even if 8 out of ten transactions are wasteful, who's

257
00:16:27.800 --> 00:16:29.923
to say which are the two that are not.

258
00:16:30.850 --> 00:16:35.850
I went to a retirement dinner for Professor Larry Seltzer

259
00:16:37.600 --> 00:16:39.705
of Wayne State University, a very eminent economist who

260
00:16:39.705 --> 00:16:44.705
had been there 50 years if you can believe it, and in his

261
00:16:47.390 --> 00:16:51.521
nice little speech he quoted one of his professors and said,

262
00:16:51.521 --> 00:16:54.310
"All my life what I've been teaching has been half wrong

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00:16:54.310 --> 00:16:56.690
and unfortunately I don't know which half it is."

264
00:16:56.690 --> 00:17:00.943
Well, so it can be argued that some transactions are

265
00:17:02.650 --> 00:17:04.143
desirable and necessary.

266
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But, this is a useful hint to most pension and trust

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00:17:10.070 --> 00:17:13.460
managers that their clients would in all likelihood

268
00:17:13.460 --> 00:17:17.660
be ahead if their turnover rates were halved.

269
00:17:17.660 --> 00:17:20.863
And their portfolios were more broadly diversified.

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00:17:22.180 --> 00:17:24.913
You might say they also serve who only sit and hold.

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00:17:26.000 --> 00:17:31.000
But, no doubt, the fees that I might earn as a consultant

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00:17:31.240 --> 00:17:36.240
by giving such sensible advice and which portfolio managers

273
00:17:38.120 --> 00:17:43.120
might earn by following such prosaic behavior, are less

274
00:17:43.550 --> 00:17:47.543
than from trying to give it that old post-college try.

275
00:17:48.980 --> 00:17:51.813
What is it that logic can demonstrate?

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00:17:53.120 --> 00:17:56.730
What it can demonstrate is that not everybody, nor even

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00:17:56.730 --> 00:18:00.290
the average person can do better than the comprehensive

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00:18:00.290 --> 00:18:01.623
market averages.

279
00:18:03.370 --> 00:18:06.290
That would contradict the tautology that the whole is

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00:18:06.290 --> 00:18:07.663
the sum of its parts.

281
00:18:09.100 --> 00:18:12.590
Moreover what statistical probabilistic theory can suggest,

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00:18:12.590 --> 00:18:16.820
this is not a logical theorem, is this.

283
00:18:16.820 --> 00:18:20.540
If you select at random a list, of say, a hundred stocks,

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and if you buy them with weights that are proportional

285
00:18:22.980 --> 00:18:26.173
to their respective total outstanding market values,

286
00:18:27.510 --> 00:18:31.730
although your sample's performance won't exactly duplicate

287
00:18:31.730 --> 00:18:35.730
that of a comprehensive market average, it will by the law

288
00:18:35.730 --> 00:18:38.383
of large numbers, come close to doing so.

289
00:18:39.220 --> 00:18:44.200
Closer than if you throw a dart at only one stock.

290
00:18:44.200 --> 00:18:48.360
But of course, you won't do as well with a sample, even

291
00:18:48.360 --> 00:18:52.378
a random sample, of a hundred stocks as you would with 200,

292
00:18:52.378 --> 00:18:57.378
300, or using all the stocks that are available in

293
00:18:57.890 --> 00:18:59.653
the marketplace.

294
00:19:01.070 --> 00:19:04.620
Now, do I really believe what I've been saying?

295
00:19:04.620 --> 00:19:08.340
That judgment doesn't help.

296
00:19:08.340 --> 00:19:11.300
I'd like to believe otherwise.

297
00:19:11.300 --> 00:19:15.740
But a respect for evidence compels me to incline towards

298
00:19:15.740 --> 00:19:17.690
the hypothesis.

299
00:19:17.690 --> 00:19:21.240
Now it's only a hypothesis, that most portfolio decision

300
00:19:21.240 --> 00:19:23.203
makers should go out of business.

301
00:19:24.290 --> 00:19:29.290
They should take up plumbing, teach Greek, or just be

302
00:19:30.651 --> 00:19:32.151
ordinary corporate executives.

303
00:19:33.760 --> 00:19:37.400
Now, even if this advice to drop dead is good advice,

304
00:19:37.400 --> 00:19:40.440
it obviously isn't counsel that's going to be eagerly

305
00:19:40.440 --> 00:19:41.960
followed.

306
00:19:41.960 --> 00:19:44.823
Few people will commit suicide without a push.

307
00:19:45.710 --> 00:19:49.900
And fewer still will pay good money to be told to what

308
00:19:49.900 --> 00:19:52.823
it is against human nature and self interest to do.

309
00:19:53.990 --> 00:19:57.425
It was Ralph Waldo Emerson who said, "The will world beat a

310
00:19:57.425 --> 00:20:01.750
path to the door of the man who invents a better mousetrap."

311
00:20:01.750 --> 00:20:04.320
Let's amend that, the person that invents a better

312
00:20:04.320 --> 00:20:05.940
mousetrap.

313
00:20:05.940 --> 00:20:09.190
Well that shows what Emerson knew about economics.

314
00:20:09.190 --> 00:20:12.820
The Wells Fargo Bank out on the west coast sent out a trial

315
00:20:12.820 --> 00:20:17.820
balloon in the way of a sensible, non-managed fund that

316
00:20:18.500 --> 00:20:21.780
embodied essentially the whole market.

317
00:20:21.780 --> 00:20:25.770
The Standard and Poor 500 stock.

318
00:20:25.770 --> 00:20:30.770
It was even better than that because they enabled you to

319
00:20:32.670 --> 00:20:36.800
mix your own leverage at very low interest rates relative

320
00:20:36.800 --> 00:20:41.800
to the market so that sticking with the evidence you could

321
00:20:42.270 --> 00:20:47.270
do as well as the market with the sureness, and you could

322
00:20:47.760 --> 00:20:50.090
take advantage of the little bit of daylight that seems

323
00:20:50.090 --> 00:20:55.020
to be there in the way of the not perfectly equilibrated

324
00:20:55.020 --> 00:20:56.560
prices.

325
00:20:56.560 --> 00:20:59.430
What I have in mind here, but I don't want to digress

326
00:20:59.430 --> 00:21:02.333
too far, is that there is a little bit of evidence,

327
00:21:03.450 --> 00:21:07.880
that if you put your money into non-volatile stocks,

328
00:21:07.880 --> 00:21:10.790
you think that's the prudent way of investing, but it's

329
00:21:10.790 --> 00:21:12.930
the only imprudent way of investing.

330
00:21:12.930 --> 00:21:17.890
They do a little bit worse on the average than more volatile

331
00:21:17.890 --> 00:21:19.070
stocks.

332
00:21:19.070 --> 00:21:20.950
Now you would say, "How is that possible?"

333
00:21:20.950 --> 00:21:24.410
The volatile stocks, we're comparing cheese and chalk.

334
00:21:24.410 --> 00:21:29.410
They're very volatile, and how can you compare them?

335
00:21:29.870 --> 00:21:32.570
Well, the way you compare them is the following.

336
00:21:32.570 --> 00:21:37.153
You buy the non-volatile stocks on leverage, so by

337
00:21:38.390 --> 00:21:42.870
leveraging up your position you make them just as volatile,

338
00:21:42.870 --> 00:21:47.870
as the volatile stocks are without that much leveraging.

339
00:21:47.920 --> 00:21:51.290
Then you look at the average rate of return which has

340
00:21:51.290 --> 00:21:56.080
actually been earned over the years by a comprehensive

341
00:21:56.080 --> 00:21:58.220
portfolio of one as compared to the other, and lo

342
00:21:58.220 --> 00:22:01.283
and behold, and this is the only deviation practically

343
00:22:01.283 --> 00:22:06.283
from the random walk hypothesis that has ever been observed,

344
00:22:06.610 --> 00:22:11.130
and that has lasted as a valid observation, you could do

345
00:22:11.130 --> 00:22:12.560
a little bit better in the volatile stocks.

346
00:22:12.560 --> 00:22:15.440
Well, I think the Wells Fargo was in a position to take

347
00:22:15.440 --> 00:22:17.390
advantage of that.

348
00:22:17.390 --> 00:22:22.390
But, alas and alack, I don't believe that the world beat

349
00:22:22.760 --> 00:22:26.900
a path to the San Francisco door or Los Angeles door

350
00:22:26.900 --> 00:22:29.010
of the Wells Fargo Bank system.

351
00:22:29.010 --> 00:22:33.424
There's an organization in Boston, Battery Marts, that has

352
00:22:33.424 --> 00:22:38.424
likewise a scheme for matching the averages.

353
00:22:38.670 --> 00:22:41.760
All you need is perhaps a few hundred thousand dollars

354
00:22:41.760 --> 00:22:46.760
to get into it, and I may be wrong, but I don't have

355
00:22:47.180 --> 00:22:51.760
the impression that they're overflowing with inquiries

356
00:22:51.760 --> 00:22:52.933
and telephone calls.

357
00:22:53.790 --> 00:22:58.790
One of the American Express mutual funds has experimented

358
00:22:59.310 --> 00:23:02.100
with establishing an outlet for pension fund money.

359
00:23:02.100 --> 00:23:06.540
All you need is a million dollars I believe to get into it.

360
00:23:06.540 --> 00:23:11.490
But it's surprising how many, how few are the millions

361
00:23:11.490 --> 00:23:16.490
of dollars ready to go into these sensible mousetraps,

362
00:23:17.960 --> 00:23:19.130
these sensible instruments.

363
00:23:19.130 --> 00:23:21.890
In fact, one's left with the impression and an awful lot

364
00:23:21.890 --> 00:23:25.670
of underbrush has been growing up before the doors

365
00:23:25.670 --> 00:23:28.670
of these deviance into good sense.

366
00:23:28.670 --> 00:23:31.563
Ralph Waldo Emerson, not withstanding.

367
00:23:32.790 --> 00:23:35.960
At the very least then, I suggest, some large foundation

368
00:23:35.960 --> 00:23:40.160
should set up and in-house portfolio that seeks to track

369
00:23:40.160 --> 00:23:44.014
and duplicate the S and P 500 Index.

370
00:23:44.014 --> 00:23:47.100
To do this, if only for the purpose, of setting up a naive

371
00:23:47.100 --> 00:23:50.730
model against which their own in-house gunslingers

372
00:23:50.730 --> 00:23:52.884
can measure their prowess.

373
00:23:52.884 --> 00:23:56.590
Instead, as you know, most portfolio committees bolster

374
00:23:56.590 --> 00:23:59.540
their self-esteem by showing they have done better than

375
00:23:59.540 --> 00:24:02.970
the Valuline 1500 Stock Index.

376
00:24:02.970 --> 00:24:07.400
And no wonder, that index being a geometric median index,

377
00:24:07.400 --> 00:24:10.670
I can outperform it merely by buying its stocks and

378
00:24:10.670 --> 00:24:11.913
its proportions.

379
00:24:13.290 --> 00:24:17.200
And I can do so both in down markets and up markets.

380
00:24:17.200 --> 00:24:20.620
Since money is only sophisticated enough to grow

381
00:24:20.620 --> 00:24:23.740
arithmetically, dollar on top of algebraic dollar.

382
00:24:23.740 --> 00:24:26.770
Algebraic dollar because it's loss as well as gains.

383
00:24:26.770 --> 00:24:31.240
I've seen the same thing in a recent report, some mutual

384
00:24:31.240 --> 00:24:34.030
fund, it shall be nameless, didn't do as well as the

385
00:24:35.390 --> 00:24:40.390
Standard and Poor's average, so they pointed out the index,

386
00:24:40.890 --> 00:24:42.630
they pointed out they did better than the average stock

387
00:24:42.630 --> 00:24:44.600
in the index.

388
00:24:44.600 --> 00:24:47.770
Well, they don't realize it, but they've shifted the ground

389
00:24:47.770 --> 00:24:52.460
to very close to the geometric mean because, I won't go

390
00:24:52.460 --> 00:24:55.100
into the details, it's the law of normal distribution,

391
00:24:55.100 --> 00:24:58.640
and anybody who buys all the stocks in the index will

392
00:24:58.640 --> 00:25:00.927
do better than the average stock in the index because

393
00:25:00.927 --> 00:25:05.840
the stocks that make a gain, make a much larger gain than

394
00:25:05.840 --> 00:25:10.840
those which lose on the average because the tail of

395
00:25:11.190 --> 00:25:14.560
the distribution is always skewed off to the right.

396
00:25:14.560 --> 00:25:16.930
That's true, by the way, in down markets and up markets,

397
00:25:16.930 --> 00:25:19.030
but I'd have to state the proposition a little more

398
00:25:19.030 --> 00:25:19.863
carefully.

399
00:25:20.740 --> 00:25:25.740
Perhaps CREF, which pioneered the variable annuity

400
00:25:26.240 --> 00:25:29.460
and the variable pension plan, it's the non-profit

401
00:25:29.460 --> 00:25:34.460
organization set up by teachers annuity, perhaps it can

402
00:25:35.270 --> 00:25:39.040
be induced to set up an in-house pilot plant operation

403
00:25:39.040 --> 00:25:41.990
of an unmanaged diversified fund, but I wouldn't like

404
00:25:41.990 --> 00:25:43.640
to bet on it.

405
00:25:43.640 --> 00:25:46.660
I've actually suggested to my colleague, Professor Franco

406
00:25:46.660 --> 00:25:49.490
Modigliani, who's going to be the president of the American

407
00:25:49.490 --> 00:25:53.732
Economic Association, in 1976, that economists might

408
00:25:53.732 --> 00:25:56.940
want to put their money where their darts are.

409
00:25:56.940 --> 00:26:00.410
That the AEA might, as a service, contemplate setting up for

410
00:26:00.410 --> 00:26:04.480
its members, a no load, no management fee, virtually no

411
00:26:04.480 --> 00:26:09.210
transaction turnover fund along the Sharpe Mossin Lintner

412
00:26:09.210 --> 00:26:13.090
lines of the academic theories.

413
00:26:13.090 --> 00:26:17.610
But I daresay there's so little supernumerary wealth

414
00:26:17.610 --> 00:26:22.105
to be found among 20,000 economists that you could do better

415
00:26:22.105 --> 00:26:27.105
if you tried such a fund among 20,000 chiropractors.

416
00:26:27.730 --> 00:26:31.140
For as George Bernard Shaw should have said, those who

417
00:26:31.140 --> 00:26:35.470
have don't know, those who know don't have.

418
00:26:35.470 --> 00:26:39.533
That's my twist on if you're so smart why ain't you rich.

419
00:26:40.630 --> 00:26:43.890
Well now how does one judge the validity of all this

420
00:26:43.890 --> 00:26:45.480
I've been asserting?

421
00:26:45.480 --> 00:26:48.720
We certainly don't want to replace old, tired dogmas

422
00:26:48.720 --> 00:26:52.670
such as be selective in the search for quality with

423
00:26:52.670 --> 00:26:54.000
new dogmas.

424
00:26:54.000 --> 00:26:58.000
However scientific is their nomenclature.

425
00:26:58.000 --> 00:27:01.040
But the sad truth is, that it is precisely those who

426
00:27:01.040 --> 00:27:04.510
disagree most with a hypothesis of efficient marketing

427
00:27:04.510 --> 00:27:09.370
pricing of stocks, who poo poo beta analysis, and all that.

428
00:27:09.370 --> 00:27:11.710
They're the one who are least able to understand the

429
00:27:11.710 --> 00:27:15.360
analysis needed to test that hypothesis.

430
00:27:15.360 --> 00:27:16.193
What do they do?

431
00:27:16.193 --> 00:27:19.100
Well, first they simply assert that it stands to common

432
00:27:19.100 --> 00:27:23.482
sense, a great effort to get facts and greater intelligence

433
00:27:23.482 --> 00:27:26.970
in analyzing those facts, will pay off in better performance

434
00:27:26.970 --> 00:27:28.700
somehow measured.

435
00:27:28.700 --> 00:27:31.490
But of course by this logic, the cure for cancer ought

436
00:27:31.490 --> 00:27:34.123
to have been found way before 1955.

437
00:27:35.020 --> 00:27:40.000
Second, those people always know a man, a bank, or a fund

438
00:27:40.000 --> 00:27:41.143
that does do better.

439
00:27:42.200 --> 00:27:44.853
But alas, anecdotes don't make science.

440
00:27:46.250 --> 00:27:49.810
And once the Wharton School dissertation writers seek

441
00:27:49.810 --> 00:27:52.135
to quantify these performers.

442
00:27:52.135 --> 00:27:55.660
They have a tendency to evaporate in air, or at least

443
00:27:55.660 --> 00:27:59.193
into statistically insignificant T-statistics.

444
00:28:00.050 --> 00:28:03.200
Well, let me sum up, I have to do it very briefly.

445
00:28:03.200 --> 00:28:05.970
It isn't ordained in heaven, or by any second law

446
00:28:05.970 --> 00:28:08.660
of thermodynamics, that a small group of intelligent

447
00:28:08.660 --> 00:28:12.080
and informed investors, can't systematically achieve

448
00:28:12.080 --> 00:28:15.370
higher mean portfolio gains with lower average

449
00:28:15.370 --> 00:28:16.580
variabilities.

450
00:28:16.580 --> 00:28:19.340
People who different heights, in their pulchritude and their

451
00:28:19.340 --> 00:28:20.173
acidity.

452
00:28:21.194 --> 00:28:24.050
Why not in their PQ or performance quotient?

453
00:28:24.050 --> 00:28:27.190
Any sheep with a billion dollars has every incentive

454
00:28:27.190 --> 00:28:30.463
to track down organizations with such high PQs.

455
00:28:31.470 --> 00:28:34.460
But as Frank Knight used to point out, paradoxically,

456
00:28:34.460 --> 00:28:37.010
it takes PQ to identify PQ.

457
00:28:37.010 --> 00:28:40.170
So, it's not easy to get off the ground.

458
00:28:40.170 --> 00:28:45.040
But anyone with special abilities, like those could earn

459
00:28:45.040 --> 00:28:48.290
a differential rent on that flair, which we economists

460
00:28:48.290 --> 00:28:49.453
call a rent.

461
00:28:50.880 --> 00:28:55.160
Those few with extraordinary PQ won't give away such rent

462
00:28:55.160 --> 00:28:59.360
to the Ford Foundation or their local bank trust department.

463
00:28:59.360 --> 00:29:02.020
They have too high an IQ for that.

464
00:29:02.020 --> 00:29:05.730
Like any racetrack tout, they will share it with those

465
00:29:05.730 --> 00:29:08.803
well-heeled people who can most benefit from it.

466
00:29:10.260 --> 00:29:14.030
It's a mistake though to think that so much money will

467
00:29:14.030 --> 00:29:16.160
follow the advice of those best talents.

468
00:29:16.160 --> 00:29:19.210
Inevitably as a matter of the logic of competitive arbitrage

469
00:29:19.210 --> 00:29:24.210
alone, that the rest of us will be left with white noise,

470
00:29:25.680 --> 00:29:28.840
random darts situations, in which every security of

471
00:29:28.840 --> 00:29:31.780
the same expected variability has the same expected mean

472
00:29:31.780 --> 00:29:33.114
return.

473
00:29:33.114 --> 00:29:36.030
Because for the nature of the case, there must always

474
00:29:36.030 --> 00:29:39.019
be an important measure of uncertainty and of doubt

475
00:29:39.019 --> 00:29:43.320
concerning how much of one's money one can entrust wisely

476
00:29:43.320 --> 00:29:46.800
to an advisor whom you only suspect of having exceptional

477
00:29:46.800 --> 00:29:47.633
PQ.

478
00:29:48.520 --> 00:29:51.980
Many of my academic colleagues fall implicitly in the

479
00:29:51.980 --> 00:29:53.820
confusion on this point.

480
00:29:53.820 --> 00:29:56.850
They think that the truth efficient market or random walk

481
00:29:56.850 --> 00:30:00.590
or more precisely Fair Martingale hypothesis, is established

482
00:30:00.590 --> 00:30:04.179
either by logical tautology or with the same empirical

483
00:30:04.179 --> 00:30:08.310
uncertainty, the same empirical certainty as the proposition

484
00:30:08.310 --> 00:30:10.893
that nickels sell for less than dimes.

485
00:30:12.200 --> 00:30:17.200
Well, we're left though, with the fact that if there do

486
00:30:19.220 --> 00:30:21.850
exists such talents, they are very rare and they are

487
00:30:21.850 --> 00:30:24.650
very hard to identify.

488
00:30:24.650 --> 00:30:28.760
This fact, although not an inevitable law, is a brute fact.

489
00:30:28.760 --> 00:30:31.620
The ball, as I've said, is in the court of those who doubt

490
00:30:31.620 --> 00:30:33.740
the random walk hypothesis.

491
00:30:33.740 --> 00:30:36.620
They can dispose of the uncomfortable brute fact, and

492
00:30:36.620 --> 00:30:40.120
the only way that any fact is disposed of, by producing

493
00:30:40.120 --> 00:30:41.743
brute evidence to the contrary.

494
00:30:43.440 --> 00:30:45.962
<v Host>If you have any comments or questions</v>

495
00:30:45.962 --> 00:30:46.795
for Professor Samuelson,

496
00:30:46.795 --> 00:30:50.478
address them to Instructional Dynamics Incorporated, 450

497
00:30:50.478 --> 00:30:52.628
East Ohio Street, Chicago, Illinois, 60611.