Rewards for Incremental Performance
Consider an investment management fund currently managing a $5 billion portfolio. Suppose that the fund manager can devise a research program that could increase the portfolio rate of return by one tenth of 1% per year, a seemingly modest amount. This program would increase the dollar return to the portfolio by $5 billion X.001, or $5 million. Therefore, the fund would be willing to spend up to $5 million per year on research to increase stock returns by a mere tenth of 1% per year. With such large rewards for such small increases in investment performance, it should not be surprising that professional portfolio managers are willing to spend large sums on industry analysts, computer support, and research effort, and therefore that price changes are, generally speaking, difficult to predict.
With so many well backed analysts willing to spend considerable resources on research, easy pickings in the market are rare. Moreover, the incremental rates of return on research activity may be so small that only managers of the largest portfolios will find them worth pursuing.
Although it may not literally be true that “all” relevant information will be uncovered, it is virtually certain that there are many investigators hot on the trail of most leads that seem likely to improve investment performance. Competition among these many well backed, highly paid, aggressive analysts ensures that, as a general rule, stock prices ought to reflect available information regarding their proper levels.