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Monkey business: How small caps helped dart-throwing chimps beat the market

June 1, 2021

Monkey business: How small caps helped dart-throwing chimps beat the market

More than 400,000 new trading accounts were opened in 2020 as Australians used their newly-found spare time (courtesy of nation-wide lockdowns) to try their hand in markets.

More than 400,000 new trading accounts were opened in 2020 as Australians used their newly-found spare time (courtesy of nation-wide lockdowns) to try their hand in markets.

The sudden influx of new investors was big enough to prompt warnings from regulator ASIC, that “even market professionals find it hard to ‘time’ the market” in periods of volatility”.

Amateur day traders, ASIC reasoned, must be even more careful than their professional peers, lest they burn themselves (and the piles of cash they invested) in the market too.

ASIC’s warning, while prudent, prompts the question: How do I pick stocks that will do well enough to beat the market?

One surprising answer to that question comes from a bizarre economic experiment from 2013.

Their answer? Monkeys

More specifically, an army of 100 monkeys, armed with darts, throwing them thoughtlessly at a wall of Wall Street Journal stock pages.

If you think this all sounds very tongue in cheek, you’re not entirely wrong. The experiment, run by Research Affiliates, set out to test a somewhat snide claim by Princeton University professor Burton Malkiel, that a blindfolded monkey throwing darts at newspapers would select a portfolio that performs just as well as one compiled by a professional.

Sadly (although perhaps for the best), Research Affiliates didn’t use actual monkeys or darts, but rather replicated the simian stock selection process by creating 100 portfolios of 30 stocks selected randomly from a group of 1000 companies.

They replicated this for every year beginning in 1964, and ending in 2010, and found 98 of the 100 portfolios actually outperformed the market by an average 1.7%.

An artist’s impression of the Research Affiliates’ office after analysing the results. Source: 20th Century Fox

 

There’s more to this absolutely bananas result than just the monkeys’ ‘gorilla trading’ strategy, however.

Within the 1000 stocks used by Research Affiliates in their experiment, the 30 largest companies (representing 40% of the total capitalisation weight) delivered an annualised return of 8.6% for the 1964 – 2010 period.

The remaining 970 companies, however, delivered 10.5% for the same period – a 1.9% premium over the larger stocks, and an 0.8% premium on the 9.7% annualised return achieved by the full 1000 stocks.

Effectively, the monkeys put their money into small stocks purely by virtue of their greater numbers on the pages of the paper, and in the long run it paid off.

Despite this performance, the common thinking within the industry remains that blindfolded monkeys shouldn’t be relied on to select stocks (nor should they be trusted with darts at the best of times).

 

Investing is not suitable for everyone. There is a risk that you can lose more than the value of a trade or its underlying assets. Past returns do not always indicate future returns, and it is also possible to make significant losses. There is always a risk of loss when trading and investing.

Any advice provided by Reach Markets including on its website and by its representatives is general advice only and does not consider your objectives, financial situation or needs, and you should consider whether it is appropriate for you. This might mean that you need to seek personal advice from a representative authorised to provide personal advice. If you are thinking about acquiring a financial product, you should consider our Financial Services Guide (FSG) including the Privacy Statement and any relevant Product Disclosure Statement or Prospectus (if one is available) to understand the features, risks and returns associated with the investment.

Please click here to read our full warning.


General Advice Warning

Any advice provided by Reach Markets including on its website and by its representatives is general advice only and does not consider your objectives, financial situation or needs, and you should consider whether it is appropriate for you. This might mean that you need to seek personal advice from a representative authorised to provide personal advice. If you are thinking about acquiring a financial product, you should consider our Financial Services Guide (FSG) including the Privacy Statement and any relevant Product Disclosure Statement or Prospectus (if one is available) to understand the features, risks and returns associated with the investment.

Please click here to read our full warning.

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