STREET DOGS

From Losing My Religion by Samuel Lee at Morningstar:

It’s May 17 1984 and Columbia University is hosting a debate in celebration of the 50th anniversary of the publication of Benjamin Graham and David Dodd’s classic Security Analysis.

On the offensive is Michael Jensen, a University of Rochester professor, who’s there to stump for efficient markets, a nearunanimous academic consensus. On the defensive is Warren Buffett, Graham’s most famous disciple and already recognised as one of the greatest investors alive.

Jensen recites a litany of studies showing no statistically significant evidence of skill. He describes the fund industry as a coin-flipping game — enough coin-flippers and someone’s bound to enjoy a long streak that in isolation looks impossible.

Buffett asks you to imagine a national coin-flipping contest with all 225-million Americans. Daily the participants call out heads or tails. If they’re wrong, they drop out. After 20 days 215 coin flippers will have called 20 flips in a row — literally a one-in-amillion phenomenon for each flipper, but an expected outcome given the number of participants. Then he asks, what if 40 of those coin flippers came from one place, say, Omaha? That’s no chance. Something’s going on there.

Buffett presents nine different funds that have beaten the market averages over long periods, all sharing only two qualities: a value strategy and a personal connection to Buffett. In closing, he boldly predicts “those who read their Graham and Dodd will continue to prosper”.

The idea of value stocks outperforming would a decade later be accepted by academics and integrated into their models as the “value premium”, a compensatory return boost for bearing more “risk”. Decades later, they’re still debating what this mysterious risk is!