EMH Observations in Emerging Markets

This blog has already explored the fact that many potential investors in emerging economies are impeded by a lack of resources and investment vehicles that can help them realize their speculative pursuits. However, upon further reading and discussing with investors and traders another issue has emerged; the lack of trust in efficient markets.

While efficient market hypothesis theory suggests that a market is efficient when market prices reflect all available information, we can determine the strength of the informative efficiency in three forms; weak, semi-strong, and strong. Weak form, available information includes past price; Semi-strong, available information includes public information; and Strong form, where all insider information is also reflected in pricing. 

Emerging economies are sometimes hindered in capital market development by bureaucracy, inefficient governments, and corruption – however this does not affect the demand for mutual funds and portfolio management. What it does effect is the tools with which portfolios are weighted. In Eastern Europe many investment bankers, despite having years of experience trading and managing client portfolios, believe that capital markets are – generally – informatively inefficient. Peter Lynch and Warren Buffet can write as many books they want about discount cashflow evaluations and value investing, however at the end of the day the corroborated movement of several whales is going to tilt the market against any individual asset selections. Benjamin Graham, author of the staple investment guide “A Random Walk Down Wall Street”, would be happy to know that most portfolio managers in the CEE region prefer to diversify amongst ETFs and run away from any individual company stock selections. However, the observation of these financial professionals are seldom empirical in nature. Many Eastern European funds opened prior to the 2007 financial crash which drove many investments into the ground, and scared a generation of economists. Albeit there is a hint of truth in supporting the weak form of EMH in that it is difficult to find arbitrage opportunities while out of the Wall Street loop of influencers – same goes for domestic CEE markets.

The lack of investor confidence in CEE public markets, coupled with government inefficiencies creates large volume deficits that brings markets to a point where a $500 position might move the price of a stock (as seen on BELEX). Given the market ramifications investment banking schemes switch away from conventional portfolio management and becomes more focused on private equity initiatives and mutual funds focused on holding foreign currency, bonds, and CDs. Mature individual investors turn to the real-estate market for investment, often driving prices up in a speculative buying frenzy – after all if the bubble pops they still have a roof (or more than one) over their heads. Younger investors; believers in Semi-Strong EMH with lower risk aversion – but insufficient capital for a mutual fund or real-estate investment – usually find themselves pursuing trending investment fads that leave them disappointed.

Until local market inefficiencies in the CEE region decrease in impact investor sentiment in capital markets will remain poor.

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