Q: Are markets efficient, and does it matter?

A: Finding inefficiencies is difficult, and exploiting them even more so.

A friendly debate about whether markets are efficient can easily turn into a heated argument. There are strong feelings on both sides.

What it all boils down to is whether an investor or money manager can use available information — including earnings reports, economic indicators, financial ratios, technology claims, analyst ratings, political news, and more — to find securities that are priced "too high" or "too low." An investor who could systematically find these inefficiencies would easily outperform the markets by buying the underpriced securities and selling them before they become overpriced.

Inefficiencies are elusive
Systematically is the key word here. Surely there are cases when information and price do not match up. These inefficiencies are very easy to identify after the fact but difficult or impossible to systematically recognize and exploit in real time.

The challenge of exploiting inefficiencies is solidly supported by empirical evidence, including the chart above. The graphic shows the relative performance of actively managed mutual funds — whose managers, armed with the latest research and analysis tools, seek to earn their management fee by buying underpriced stocks and riding them upward — versus passively managed benchmarks.

Morningstar sorts funds into nine segments based on size and style. In only the two segments marked in purple did the active managers outperform the passively managed indexes over the last five years. In the other seven categories, less than a third of actively managed funds beat the benchmarks — worse performance than one would expect picking stocks at random.

At Osbon Capital we don't believe in chasing elusive or imaginary inefficiencies. We focus on the real factors that most affect return and risk: diversification, asset allocation, rebalancing, expense control, and tax efficiency. It is our belief that goal-driven asset management tailored to your needs is ultimately the best use of our time.

Next time: Are "frontier markets" ready for investment?

Contact: John Osbon 617.217.2772 josbon@osboncapital.com

Osbon Capital Management, LLC ("Osbon") is an SEC registered investment adviser with its principal place of business in the Commonwealth of Massachusetts. Osbon and its representatives are in compliance with the current notice filing requirements imposed upon registered investment advisers by those states in which Osbon maintains clients.

The index returns are based on the following: iShares Morningstar Small Value Index Fund JKL; iShares Morningstar Small Growth Index JKK; iShares Morningstar Small Core Index Fund JKJ; iShares Morningstar Mid Value Index Fund JKI; iShares Morningstar Mid Growth Index Fund JKH; iShares Morningstar Mid Core Index Fund JKG; and iShares Morningstar Large Value Index Fund JKF. The mutual fund returns include the oldest share class for all U.S. diversified mutual funds with at least a one-year history. The performance is a representative snapshot of a select group of funds and indices and may not be reflective of all funds and indices.

This Q&A contains general information that is not suitable for everyone and should not be construed as personalized investment advice. The historical data presented herein are for informational purposes only and do not reflect actual client accounts.

Any historical returns are not net of advisory and/or other fees and expenses. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this Q&A will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

For additional information about Osbon, including fees and services, send for our disclosure statement as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money. For information pertaining to the registration status of Osbon, please contact Osbon or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).