Monday, May 31, 2010

Contrarian Investment Strategies - The Next Generation: Chapter 1

The founder and Chairman of Dreman Value Management (est. 1977) shares his views on how investors can beat the market with this book (written in 1998). In reference to the efficient market hypothesis (EMH), Dreman writes "Nobody beats the market, they say. Except for those of us who do." More on this book is available here. One of his earlier books (from 1982) has already been summarized here.

There are probabilities of success and failure in the market as surely as there are in gambling. But Dreman argues that the odds in the market can be put in your favour. This book is about how to do just that.

The professional money manager is often described as someone who should manage your money. Armed with the best team of analysts money can buy, he is expected to be able to buy low and sell high. Unfortunately, in practice this is not how it turns out. Dreman offers a slew of statistics demonstrating that the vast majority of managers under-perform their benchmarks.

As it became known several decades ago that managers could not beat the market, Efficient Market Hypothesis (EMH) emerged as a convenient explanation. Using computational power that was not previously possible, academics were able to "prove" that market prices were "correct" and that market-beating returns were not possible.

Dreman argues that this theory is built on a foundation of hot air, and likens it to the generations of scientists that believed the earth was at the centre of the universe. When situations occurred that seriously questioned the integrity of the theory (for EMH, the 1987 one-day point drop; for astronomers, the observation of planet locations inconsistent with their revolution around the earth), new parameters were added and the theory was made more complex to try to explain these phenomena.

Dreman sees the main problem with EMH is its built-in assumption that market participants behave 100% rationally. Psychology, however, affects all of our investment decisions. By understanding the behavioural traits that affect our decisions, however, investors put themselves in a position to put the odds in their favour.


rayhaan said...

yo saj,must say u clearly arent getting d kind of readers u deserve.I mean y does everybody have a problem if u occasionally post ads even though u explicitly mention it! i conducted my rather limited review of v.i. Blogs but i still like urs the best. I mean rohit chaudhary of indianvalueinvestor where ur link is featured never bothers to tell bout net nets like u, and at times diverts from stocks into delisting arbitrage or ends up looking a bit over influenced by nnt,(apologies rohit), jae jun is fine but his blog is definitely not for beginners ditto for old school value also they dont stand a chance against ur book reviews. so did u like fb valueinvestors app ? Also wot kinda music does a value investa listen to?(lol i no dis is a stupid q still try n reply) .tc

Saj Karsan said...

Haha, thanks for the kind words Rayhaan. I haven't tried the fb app. I have no idea what kind of music value investors listen to...if I had to guess though, I would imagine they listen to classical music, but that's probably a little "stereo"typing on my part based on my age/race expectation of the typical value investor. I myself prefer hip hop!