Balanced strategies - frequently asked questions
If academic research demonstrates that value stocks have higher returns than growth stocks or market portfolios over time, why not put 100% of the equity allocation in value stocks?
For investors who define risk solely as the variability of returns, such a strategy might be appropriate. Whether such investors actually exist is debatable. Most investors are probably sensitive to the risk of being different from the market, even if overall variability is no higher. Value stocks do not outperform market portfolios regularly or predictably - if they did, they would not be riskier. To the extent an investor is likely to be disappointed with performance that differs from a market portfolio, a tilt toward value stocks should be undertaken cautiously. Source: DFA.
This question has come up repeatedly ever since indexed strategies first appeared in the mid 1970s. Critics of indexing assert that markets would be less efficient if all investors adopted a market-fund investment approach. One can accept this theoretical viewpoint and still embrace indexing with enthusiasm.
If the adoption of indexed strategies became so pervasive that market efficiency was impaired, it would be a self-correcting process. Mispriced securities would create opportunities for investors to earn profits in excess of their research costs, and their activity would drive prices back to equilibrium levels. We will never know how much information and liquidity are required for an efficient market. Markets for consumer durables such as homes or autos appear to be at least reasonably efficient, despite very poor liquidity, high search costs, and the absence of perfectly fungible assets. This behavior suggests a shift to passive investing would have to be very pronounced to have any effect on market efficiency.
Even if all professional investment managers adopted a passive approach, other market participants would continue to provide price-setting information. Sources of such information could include corporate stock buybacks, acquisitions, and the investment activities of officers, employees, competitors, and suppliers.
Despite the impressive commercial success of indexed investing strategies over the last twenty-five years, they still represent only a fraction of total stock market wealth.