Question

In: Finance

Assume that owing to the explosion of computers and the expert training of security analysts, the...

Assume that owing to the explosion of computers and the expert training of security analysts, the market, as confirmed by numerous studies, has been shown to be 95% efficient. Investment firms have, thus, decided to retire all their portfolio managers and let random choice govern the security selection process. What mistake is implicit in this action?

Solutions

Expert Solution

In the wake of rising use of Artificial Intelligence and Robotics, efficiency has improved many folds in various sectors, specially the service sector. Long before this, faster algorithms have been developed in the security markets to reap the benefits of arbitrage and make profits on transactions.

Most of the theories on Capital market- be it the Capital market Theory or the Modern Portfolio Theory , make an assumption that markets are efficient and Investors are rationale. However this assumption is not a realistic one. If markets were 100% efficient then volatility and “human Psychology “ wouldn’t have played any part in market.

The statement in the question that Portfolio managers would be retired since security analysts have attained 95% efficiency is not a correct thing to do since both , Portfolio managers and security analysts , have different roles to play in the market. A security analyst analyses a stock – technical or fundamental analysis. He would analyze the financial data of companies and make recommendations on the company’s future financial story.He may use various valuation techniques to calculate the intrinsic value of the stock.

On the other hand , a portfoliio manager’s primary job is to manage the portfolio of various asset class which he has build with the investor’s funds. His objective is to maximize wealth for the investors. He would have a more long term vision and wouldnot resort to panic on short term volatility in the market and sell the shares unless there’s some fundamental problem in the company. His job is also to churn the portfolio and pick the value share according to the risk appetite of the investors.He also ensures that no Asset-liability mismatch happens and if required hedges the portfolio too.

Hence to say that since security analysts have become efficient and they would take the role of portfolio manger is wrong because their roles are different and they fall in different places in the value chain.The output of security analysts are the input for a portfolio managers.


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