Stock market inefficiency:
Capitalizing on an imperfect world


Investors often assume that stock markets run perfectly. However, inefficiencies exist in all markets, and they can actually present savvy investors with additional opportunities. But discovery and timing are key. Some inefficiencies are easier to spot than others. And some present narrow windows in which to act—minutes or even seconds.

 


Emerging markets: knowledge
is power

In many emerging markets, reliable data can be scarce and hard to access. Sometimes only local investors are privy to early-stage trends and market happenings. Discerning investors who can incorporate this data into their analysis can act on an event that isn't apparent to others for days or even weeks, giving them an edge.

Developed markets:
information overload

Each day, developed markets analysts publish hundreds of reports; from sector overviews to individual company profiles. It could take an investor weeks to read all of the reports released in a day and so many go unread. However, by using a computer program to digest the reports in a matter of seconds, an astute investor can gain an advantage over market participants relying on more traditional research methods.

Long/short investing: a dual approach

Traditional long investing, or buying stocks and holding them for a period of time, is obviously a way to profit when stocks increase in value. But what if you believe a stock is poised to fall? Short selling, or selling a borrowed stock with the intention of buying it back at a lower price later, gives a long/short investor the ability to profit from this insight, too. Uniting both of these techniques allows an investor to generate returns from market inefficiencies in both directions.

Dampening volatility with a
long/short strategy

By adjusting the proportion of long and short positions in a portfolio, an investor can control exposure to the broad market. This approach makes the portfolio less dependent on market trends and more dependent on investor skill in picking the right stocks to long and short.

The illustration below shows this capability in action. For instance, if a manager invests all of his money in the stock market (i.e. is 100% long) and then shorts stocks equal to 80% of the portfolio’s value, the resulting portfolio has 20% net market exposure. The portfolio can then be expected to have roughly 20% of the volatility of the market due to the exposure.

Long/short strategies can limit the effects of a volatile market
Illustrative example of net market exposure in a long/short strategy

Long/Short strategies can limit the effects of a volatile market

For illustrative purposes only.