[lalaland1125]

Correct. I should have been explicit. By "profit", I meant profit relative to the market.

I do agree that the EMH doesn't exactly hold. Empirical proof of that is the existence of profitable trading firms. However, the reasoning behind EMH does imply something about the difficulty of earning profit relative to the market. And I do think it is a theory that people should be aware of when they start trying to understand finance.

[xorfish]

Isn't the whole point of these forms arbitrage?

There is lots of data that shows that active managers don't do better than the market.

[throwawaymath]

No, there is a lot of evidence showing that most active managers, investors and analysts can't outperform the market. There are counterexamples which demonstrate consistent outperformance, they're just the minority. Likewise most basketball players aren't good enough to join the NBA, and most players in the NBA aren't good enough to secure $10 - 100 million contracts.

The EMH doesn't even preclude the possibility of consistently beating the market (consistently mining alpha); it simply states that the cost of providing those investments as a service rationally rises to cannibalize the outsized returns, so it becomes a wash.

We see this in practice: the well known hedge funds which demonstrate consistent alpha eventually close their doors to outside investors. Why pool risk with external capital when you're printing money? Investors are a hassle and no strategy can scale infinitely. When you can consistently mine alpha it's strictly better to just become a prop shop and run on your own money.

[xorfish]

How do you differetiate a manager that outperforms by luck from one that outperforms by skill. Data shows that managers that outperformed in the past are not more likely to outperform in the future.

[throwawaymath]

You keep talking about this data, but you're not citing any of it. Therefore I'm not sure how to specifically counter what you've read.

But in the abstract, you differentiate them the same way you implement any hypothetical distinguisher in probability theory. Consider an n-sigma event observed to occur consistently. As n increases the likelihood of the event occurring by chance (rather than agency) decreases.

[xorfish]

https://www.aei.org/carpe-diem/more-evidence-that-its-really...

There are so few managers that beat the market and then it might still be luck. Until you can be sure that a manager really is concistently better than the market he will be in his sixties.

We know factors that concistently outperform the market. So why not passively follow them?

[throwawaymath]

There are so few managers that beat the market and then it might still be luck.

This is a naive way of doing the analysis, because we have examples of funds whose performance is so many standard deviations beyond the mean that we wouldn't expect them to arise by chance even if every single business in the United States was a professional trading firm. To get you started, I invite you to consider Renaissance Technologies, as one example. [1]

We'll assume that trading returns have a binary distribution. Traders win or lose with equal probability. This is not a great model, but it's good for making ballpark estimates, because it overestimates the odds of a track record like Renaissances.

RenTec's Medallion fund has not had a down year in the past 25. The odds of this are at most 1 in 33 million, using our binary model. Survivorship bias does not begin to explain this; there have not been anything resembling 33 million hedge funds over the course of history. I think 30000 hedge funds is a fairly generous estimate. [2]

In order to account for Renaissance's 30 year record of 70% returns before fees (and 40% after fees) under your hypothesis, we need to advance the claim that Renaissance has been successfully conducting massive fraud and financial conspiracy with a resulting profit north of over one hundred billion dollars over three decades. Even the common citation of the IRS case with the Deutsche basket options doesn't even begin to control for those kinds of returns; there would have to be something fundamentally novel criminal conspiracy occurring in Long Island.

Of course, you can still try to defend that position. But it makes the claim significantly more complex than simply saying, "most managers don't beat the market."

_______________

1. There are others. TGS, Baupost, etc.

2. This is copied from one of my favorite rebuttals of this point: https://news.ycombinator.com/item?id=9860254

[thedudeabides5]

What's a factor?

Sounds like just another manager.