"We, the people at Toilet Duck, recommend Toilet Duck"

And how this led to a crisis
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We at Hoofbosch are not supporters of the efficient market theory

This theory, developed by Professor Eugene Fama in 1970, states that the price of securities such as shares, includes all public information and future expectations. In other words: as an investor, you can by definition not do better than the market average. Although there is an abundance of evidence that the 'efficient market hypothesis' can not be accepted as the truth, many academics, institutional investors, banks and all kinds of advisors continue to embrace the theory as the truth. Any proof that the market is not efficient is simply referred to as an 'anomaly' (phenomenon that can not be explained within a certain model). In other words, as an investor you can not by definition outperform the market average and therefore passive management is preferable to active management.

Warren Buffett and George Soros (both born in 1930) are living proof that the market is not simply efficient. They have beaten the market for decades, as you know, by painstakingly doing their homework. Now you would think that the strategies of both men are the subject of intense study by universities and investment professionals.

Warren Buffett and George Soros (both born in 1930) are living proof that the market is not efficient

The opposite is true. We do not know a single university anywhere in the world that has made the teachings of these gentlemen the subject of study. Because Buffett and Soros can not exist according to the efficient market hypothesis, they are ignored by the academic world. Meanwhile, both gentlemen have earned billions over the last decades by capitalizing on the difference between what people assume is the value of an investment object, and what they think is the fundamental value of the same investment object. To say it like Buffett: "we are so rich because others are so stupid."

"We are so rich because others are so stupid"

We recently received a lecture that George Soros gave on 26 April 1994: "The Theory of Reflexivity." Soros argues that scientists can analyze and name natural phenomena. But those phenomena cannot be influenced. According to Soros, in the social sciences and in particular the economics things are very different. For example, in certain situations, stock markets can influence not only prices but also the fundamentals that - according to efficient market theory - they are supposed to reflect (Reflexivity).

For example, this phenomenon occurred in our opinion during the banking crisis in 2008. The 'spectacular' growth of the earnings per share of banks was considered not to be related to the development of the same banks' equity. Investors, hypnotized by the profit development, bought on the recommendation of often the same banks, large shares of .... banks (We at Toilet Duck ....).

When that happened, the markets came into a situation of total imbalance. It was contrary to what the efficient market theory - all information is processed in the prices - would suggest. Such boom / bust situations, sometimes with years of lead-in time, do not occur very often, but when they occur they can be highly disruptive. We saw that in 2008.

Even now such a phenomenon can be found in financial institutions. In addition to all sorts of financial startups that threaten the survival of traditional banks and insurers, the financial system is not built to withstand extremely low or even negative interest rates. Insurers also have a difficult time. These collect premiums for all kinds of insurance and invest the incoming funds as sensibly as possible in order to withstand a range of calamities. But with an interest rate that moves just above 0% and with customers who operate cost-consciously, the insurance industry is also in turmoil. In fact, in a quarterly report, De Nederlandsche Bank (Dutch National Bank) even talked about a dark-red future for insurers.

Now you would think that, certainly after 2008 when many financial institutions fell, most investors would ignore financial values. But that is not the case. Because even now the markets are behaving differently from what the efficient market theory suggests: investors, on the advice of banks and insurers, are buying shares of .... those same banks and insurers on a large scale.

Investors, on the advice of banks and insurers, are buying shares of .... those same banks and insurers

Soros calls this phenomenon the 'participant's bias'. Furthermore, under the influence of the efficient market theory and again on the advice of banks and insurers, increasingly more funds are passively invested. But again, a large part of that capital is invested in banks and insurers. Not because after careful consideration these seem to be very solid investments, but for the simple reason that banks and insurers represent an important part of the index. That, in turn, is a consequence of the same 'participant's bias' etc. etc. That this all will again lead to new imbalances needs no explanation.

Finally, as is well known, we have not invested in banks and insurers since 2007.

Finally, as is well known, we have not invested in banks and insurers since 2007. All in all, we doubt whether we will ever include this kind of 'values' in the portfolio. Our long-term focus is on avoiding risks, not on spreading risks. In other words, the distribution of risk does not necessarily lead to a reduction of risk.

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