Stock picking versus Indexation-Good News for Us!

An interesting study on stock picking has emerged from academe. Two profs at Indiana University, Utpal Bhattacharya and Neal Galpin did an investigation into the prevalence of indexing versus actual stock picking in global narkets. Notwithstanding Buffett’s comments on indexing, I have found another fabulous quote which precedes Buffett’s view:

“A small gamble in a large number of different companies where I have no information to reach a good judgment, as compared with a substantial stake in a company where one's information is adequate, strikes me as a travesty of investment policy”

This quote is from John Maynard Keynes. The authors conclude that indexing is prevalent worldwide. No surprise here. I believe that this is GREAT news for stock-pickers!

Other conclusions:

Our first big result is that, on an average, there is more stock picking in emerging markets than in developed markets...about 63% for emerging markets versus 45% in developed markets.

Our second big result is that, on an average, stock picking is declining around the world. Of the 43 countries under investigation, we record that for 38 countries, the maximum fraction of volume explained by stock picking is lower in the last five years (2000-2004) than in the previous five years (1995-1999).

In the United States, the maximum fraction of volume explained by stock picking has secularly declined from a high of 60% in the 1960s to a low of 24% in the 2000s.

We find that though stock picking is less in S&P 500 stocks than in non S&P stocks, the difference seems to have disappeared in recent times.

My conclusion...ultimately, even indexing depends on stock-picking. Efficient markets theory suggests that because there are so many equally informed investors, that no one can have an edge and therefore index. Should stock-pickers become less prevalent, the inherent assumptions of efficient markets no longer apply. The irony is that indexes which endorse capital markets efficiency cannot achieve it without the stock-pickers!

I strongly believe that disciplined investing will provide incremental returns over any benchmark index.