Searching for Rational Investors in a Perfect Storm

29 Pages Posted: 24 Nov 2004

Date Written: October 4, 2004


In October, 1991, there occurred off the coast of Massachusetts a perfect storm, a tempest created by a rare coincidence of events. In the late 90s, there was another perfect storm, an also rare coincidence of forces which caused huge waves in our financial markets, as the NASDAQ index soared, collapsed, and bounced part way back.

What had happened to the so-called rational investors, the smart money, whom economists have for decades said would keep market prices in close touch with the underlying values? Despite the hundreds of papers on markets and their efficiency, no scholar, not one, has looked to see who are these rational, i.e., value investors, how they operate, and with what results.

I decided to see how a group of ten value funds, selected by a knowledgeable manager, performed in the disorderly boom-crash-rebound years of 1999-2003. Did they suffer the permanent loss of capital of so many who invested in the telecom, media and tech stocks? How did their overall performance for the five years compare with the returns on the S&P 500?

For most managers, mimicking the index, it was difficult not to own Enron, Oracle and the like, but the ten value funds had stayed far away. Instead, they owned highly selective portfolios, mostly 34 stocks or less, vs. the 160 in the average equity fund. They turned their portfolios at one-sixth the rate of the average fund. Bottom line: every one of the ten outperformed the index over the five year period, and as a group they did so by an average of 11% per year, the financial equivalent of back-to-back no-hitters.

The article closes with a discussion of the clearly large implications for investors, market watchers and public policy. As for those economic models, let the chips fall where they will.

Suggested Citation

Lowenstein, Louis, Searching for Rational Investors in a Perfect Storm (October 4, 2004). Available at SSRN: or

Louis Lowenstein (Contact Author)

Columbia Law School ( email )

435 West 116th Street
New York, NY 10025
United States
212-854-2036 (Phone)
212-854-7941 (Fax)

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