Investors’ rollercoaster ride

Short View:
By John Authers, Investment editor
Published: April 29 2009 19:45 Financial Tiems

Florida’s Disney World this week hosted the annual gathering of the CFA Institute, which controls the education of investment managers and analysts globally.

Investors ended days of grim talk by going to a theme park, where they could choose between a rollercoaster ride or being dropped from a building. The symbolism was obvious.

A year ago, the meeting was dominated by talk of “black swans” – extreme events that were unpredictable from existing data. The credit crisis was such, chartered financial analysts said.

This year, it is accepted that it was all too predictable. Investors should have heeded precedents for crises following a credit binge.

Furthermore, the industry did a bad job last year, even taking into account losses on the markets. Pension funds did not understand their own liabilities, and so the gap between their assets and liabilities widened sharply. Asset allocators using hedge funds to spread risk away from equity markets made minimal investments in managed futures and dedicated short-selling funds (which did well), and allocated money to funds that did badly.

There is also growing acceptance that basic assumptions must be jettisoned. CFAs no longer believe that markets are efficient – meaning that prices incorporate all known information – or that investment returns follow a normal “bell curve” distribution. The search is on to apply biology and psychology to better understand markets.

Duke University’s Douglas Breeden spoke for many when he said the industry had been guilty of hubris. He also pointed out that Paul Samuelson, the great economist who laid the foundations of efficient markets theory, always warned that his theory was “subject to refutation by observable facts”. That refutation seems now to have happened.