My recent theme has been this thing called asset allocation and its importance to being a successful investor. My suggestion has been that the choice of mix between cash, fixed interest, property and shares is all important to the likelihood of achieving the desired result. Far more important than picking a particular share or managed fund.
On this theme I was interested to read an interview, published by Ibbotson Associates, Chicago with Gene Fama, an acknowledged expert in the area of investment. Gene Fama was Professor of Finance at the Graduate School of Business at the University of Chicago.
Fama argues that on average, it is nearly impossible for an individual to consistently beat the share market as a whole because of the broad availability of public information. This is known as the efficiency of markets. The majority of professional managers will have the same problem in beating the market.
In most cases an investor will do as well to invest in an index such as the NZX50 and earn the market return. The question then arises as to how those indexes should be combined – the asset allocation.
Fama was asked whether the single most important decision to make would be the asset allocation decision? His answer was that it is the only decision in his view and that individual investors should focus more on the choice of shares versus fixed interest and within the share mix to what extent they go to small shares versus big shares, whether they go value versus growth, and then the international perspective.
When he was asked how he himself invests he said that he was a passive investor – on the basis that he believes in efficient markets. He went further in saying that he knows nothing about share picking and that he doesn't believe that the opportunities are there to beat the market.
That is an interesting answer when you consider that this man has spent a lifetime researching investments and markets.
There are of course some very successful and well-known investors such as Warren Buffet and Peter Lynch who pick particular shares to invest in and have done very well doing so.
These are individuals on the whole rather than fund managers noted Fama. They are successful, but also a very rare species.
What does all this mean?
Firstly, that chasing the latest fad or hot share is not a fail-safe way to investment success.
A more effective method should be to firstly determine what the asset mix should be (risk v return), employ good managers to implement the mix, get the right time horizon in mind and then let the markets do the rest.
