Few people today would still insist that financial markets are efficient. Financial markets are driven by ideas and ideas do not flow instantaneously across markets. Social scientists have studied the adoption of new ideas by many different groups ranging from the use of a new treatment technique by doctors to the spread of new technology amongst knowledge workers or the general population. Most of these studies show a common pattern. Ideas are first accepted by a small group of innovators who seldom make up more than a very small fraction of the population; ideas are then more widely disseminated by the early adopters before gaining widespread recognition by the majority of the population, followed subsequently by the late adopters and finally by the remaining laggards. Empirical findings suggest that the diffusion of ideas within financial markets follows the same path.
The Spread of Ideas
The majority of institutional investors are comfortable with not being early adopters, but they would certainly not like to be the laggards who would lose out on any benefits to be gained by shifting asset allocations in response to changing perceptions of the macro-economic environment. The problem they face however is that the timeframe for making major asset allocation decisions necessarily has to be long – many months if not years. But financial markets have experienced major changes within the course of just a few months. Changing allocations in response to key developments such as the introduction of “Abenomics” in Japan, which has proved to be a game changer, can too often be just too late to gain meaningful benefits for institutional investors. Economists and market strategists are sometimes well positioned to identify trends early. But they are hardly ever in a position to change asset allocations quickly in a dispassionate way.
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