Exploiting market inefficiencies enhances portfolio returns

The great investor Warren Buffet once said, “I'd be a bum on the street with a tin cup if the markets were always efficient." At Karpus Investment Management, exploiting market inefficiencies is a key strategy for generating strong client portfolio returns.

What is market inefficiency? Market inefficiency is a condition in which a security such as a stock or bond is not accurately priced. Human psychology often causes the current price of a security to decouple from the fundamentals of the investment. The security could be under-valued or over-valued. An investor would seek to buy securities when they are under-valued and sell when price changes enable profit.

The idea that markets can be inefficient is in contrast with the efficient-market hypothesis developed by economist Eugene Fama in the 1960s. The efficient-market hypothesis holds that security prices in an active market fully reflect all available information, and therefore the market cannot be outperformed except by chance. Karpus Investment Management believes there are significant exceptions to this tendency.

How does KIM exploit market inefficiencies? KIM is one of the United States’s largest investors in closed-end funds, a significant area of market inefficiency. The company brings a long track record of enhancing client portfolios with underpriced vehicles not understood by most investment managers. Historically, these have included insured CDs offered at great rates by banks; out-of-favor term trusts selling at deep discounts to their net asset value; and stocks sold for tax reasons. Or, the inefficiency might derive from “lag and lead time” disparities in the trading hours of international markets. KIM constantly monitors markets—and an uncommonly broad range of investment vehicles within each market—to uncover pockets of inefficiency. The results are reflected in the firm’s outstanding performance for our clients.

A note: The dotcom bubble of the late 1990s and the market crash of 2008 have led many economists and investment professionals to reconsider the long-accepted efficient-market hypothesis. Noted financial journalist Roger Lowenstein, formerly of The Wall Street Journal, recently wrote: “The upside of the current Great Recession is that it could drive a stake through the heart of the academic nostrum known as the efficient-market hypothesis."