Unconventional wisdom

After questioning the underpinnings of Jeremy Siegel's “stocks for the long run” fame in 2009, Lubos Pastor may spend next year poking holes in the message of Burton Malkiel. It's not that Mr. Pastor, the Charles P. McQuaid professor of finance at the University of Chicago, is out to skewer anyone. On the contrary, he just wants good answers to such nagging financial questions as the one he is currently working on: If actively managed mutual funds don't consistently outperform index funds, why do investors continue to invest in them? The behavioral-finance rationale — that investors believe their active manager will beat the others — is too facile, he contends. And he disagrees with Princeton University's Mr. Malkiel, who maintains that passive investing is the only rational response to efficient markets. Despite the record, there are sound reasons for active investing, Mr. Pastor believes, and he intends to find them. This year, Mr. Pastor, 35, was busy asking whether stocks are really less volatile in the long run. That question, the title of an academic paper he wrote with Robert Stambaugh, a finance professor at The Wharton School of the University of Pennsylvania, strikes at the heart of accepted investment wisdom. As depicted in the ubiquitous Ibbotson Associates Inc. chart showing how stocks have performed since 1926, the concept of “stocks for the long run” has become the orthodoxy of almost every financial adviser. Mr. Pastor's findings indicate that stocks may be good long-run investments — depending on an individual's time horizon, other assets and the nature of their human capital — but the risks of equities as measured by volatility of returns is probably greater than everyone assumes.
“Stock market returns have tended to revert to the mean in the past, but it's quite possible that other risks could outweigh the effect of mean reversion,” he said. In practical terms, that means a lower allocation to stocks probably is in order for most investors. And what does the champion of equity investing have to say about the work of his former teaching assistant, who was born in what is now Slovakia? “Although it suggests that stocks may be riskier in the long run than standard models predict, that is true of all asset classes, including bonds,” Mr. Siegel wrote in an e-mail. “My statement that over long periods of time, stocks are more stable than bonds is in no way contradicted by their analysis. [Mr. Pastor and Mr. Stambaugh's] statistical techniques allow for more uncertainty everywhere and will widen the standard error of mean returns for all asset classes.”