Saturday, 8 June 2013

Why would you read an investment newsletter?

The latest issue of the Hargreaves Lansdown Investment Times arrived in the post last week. As always it was full of advice on which investment funds are good bets for your money. Adherents to the efficient market hypothesis would suggest that such investment newsletters are basically a waste of time. But, I always enjoying reading through my copy of the Investment Times. So, why can investment newsletters be useful?
       To answer that question let's start by explaining why investment newsletters are supposed to be useless. The efficient market hypothesis says that stock, commodity, bond, fund prices etc. should always reflect all the information available at that time. If, therefore, a freely available, published newsletter claims 'here's a great opportunity to invest' it shouldn't remain a great opportunity by the time you get the newsletter! The person writing the newsletter, for one, has an incentive to act on the advice. By the time you get the newsletter, prices should have adjusted, and the great opportunity will have disappeared.
      There's no denying that this argument has some truth in it. It is, for instance, unlikely a fund manager can outperform high profile indices, like the FTSE100, by 'good stock picking'. In such highly traded markets, prices will adjust immediately to new information and so 'good stock picking' equates to a heavy dose of  'good luck'. You would be better to invest in a tracker fund than pay extra for the services of a manager. An investment newsletter's claim to have found the best stock picker is likely to reflect past performance rather than future potential. They can tell you who was lucky, but are not so good at telling you who will be lucky!
     But, investment newsletters are not a complete waste of time. The 'textbook' benefit of a newsletter is that it can advise on the risk, return trade-off. Some investments are more risky than others and an investor would be well advised to take this into account. Someone close to retirement, for example, should have their money in relatively safe assets while someone far from retirement can play a more risky strategy. A good investment newsletter can explain this, and advise which investments are relatively safer or riskier.
      . To appreciate further benefits of a newsletter, we need to look at the limitations of the efficient market hypothesis. We know that in practice asset prices can be well above or below fundamental value. The issue then becomes one of time and patience. Suppose, for example, that shares in the FTSE100 companies are under-priced. Prices need not adjust immediately because speculators fear a further drop in prices. Indeed, for speculators eager to make money here and now, it is not particularly useful to know that companies are under-valued. For someone willing to take a longer term view, however, under-priced shares area a good opportunity to make money. Prices might go lower in the short run, but over time the price should readjust. Investment newsletters can advise on such opportunities. But, note, that you don't need a good stock picker to realize such gains. It is enough to invest in a tracker fund.
      The efficient market hypothesis also becomes less relevant when we come to markets with a smaller volume of information and investors. This puts attention on small companies and markets in developing countries. The lack of information creates the possibility for asymmetric information, and this can be exploited. Consider, for example, a small start-up company. Who knows whether this company will be a success or not? A good fund manager might be better than others at answering this question. Asymmetric information comes from the manager's efforts to study the firm, meet the CEO, ask the right questions etc. An investment newsletter can advise on who the good managers are. Such investments are likely to be quite risky, and so we can think if this as advice on the best risky investments.
     So, investment newsletters are not a complete waste of time. But, the advice needs to be treated with care. Claims on how to outperform highly traded markets are almost certainly overblown. Advice on which markets to invest in and who to trust with your money to in less traded markets is potentially more valuable.

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