How to diversify your portfolio to avoid market risks (19/20)

It is the theory of efficient markets that propelled ETFs. Paradoxically, this theory risks creating one of the biggest anomalies in the market. Indeed, since professional and private investors have decided to be satisfied with the "average", they artificially inflate the index, regardless of what is in it. We will thus see securities of companies with failing fundamentals being artificially drip-fed with index management. At the same time, small-caps in great shape will be shunned by the market because they are not included in the most followed indices.

We have the same problem with countries and regions, and between economic sectors. ETFs over-represent entire sections of the economy to the detriment of others. It will be argued that they respect the real distribution (the most followed stocks are those of large American companies and other developed countries), although I think that there is still a significant bias in favor of the latter. But in any case, even if in the best case the balance were really respected, that would not change the problem of the drip-feeding of stocks in full collapse and the lack of interest in those that are not followed by the largest ETFs.

As said Warren Buffet, value investors have every interest in the efficient markets theory gaining a large number of followers because this creates even more market anomalies. This is reminiscent of another hypothesis of the efficient markets theory that has been swept away by the facts. Access to information was indeed supposed to allow investors to set the price of shares in the most rational way possible. However, we realize that on the contrary the mass of information available thanks to the Internet makes the market overreact, both upwards and downwards. Typically, the Internet bubble was self-sustaining thanks to a quantity of rumors and false information spread on stock market forums. We know how that ended…