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The market wisdom of jelly beans

By: Rolf Agather, Managing Director of Research 

Market prognostication is often equated with reading the tea leaves, but in fact a simple jelly bean experiment may offer a better premise for reading investor and market behavior.

To explore this theory and in an homage to James Surowiecki’s famous Wisdom of Crowds book, FTSE Russell conducted our own jelly bean experiment on collective decision-making at Inside ETFs, the major industry conference held last month in Florida. The goal was to shed light on a key question that investors need to ask themselves: do I have better information than what is already embedded in market prices?

For those readers who are unfamiliar with the experiment, a group of participants is asked to guess the number of items in a container, i.e., jelly beans in a jar. Usually, none or very few of the individual guesses are right, but in most cases the overall average of the group guesses can be very accurate. This phenomenon has been tested in a variety of ways and has demonstrated that the “wisdom of crowds” can be very powerful at aggregating information. For the record, the Inside ETFs crowd as a group fairly accurately guessed the number of jelly beans (actually sour cherry candies) in our jar. Our jar contained 530 candies, and guesses were fairly well grouped around this number. Typical of what you see in many of these types of experiments, we did have to adjust for outliers since extreme guesses can have an undue influence on the results. A handful of individuals guessed less than 100 and one enthusiastic participant guessed more than 9,000. (There’s a lesson in data dispersion here as well).

As with jelly beans, the investment markets generally reflect with respectably consistent accuracy investors’ perception of its collective value. However, there are critical distinctions. First, while crowds may have a good track record guessing jelly beans, the lesson isn’t that crowds can predict the markets but rather the opposite. The markets with fairly consistent precision reflect the actions and sentiment of the crowd, wise or otherwise. Just as we observed outliers in the jelly bean jar experiment, there are times when markets get it wrong as well – and with severe results such as the dot com bubble in 2000 and the global financial crisis in 2007-2008.

In another respect, the jelly bean experiment underscores a much discussed theme at Inside ETFs: there’s a lot to be said for being average. Or put another way, the markets do tend to get it right over time, and there is a lot of quality information embedded in indexes that either mimic the broad market or broad investment strategies. This basic concept underscores the appeal of passive investing.  

There is also an appeal to active investing, but the lesson here for active investors is that to beat the markets, one must possess and have conviction in exceptional information. In today’s markets, that means having exceptional tools and data that allow investors to better segment and analyze the investment landscape.

A prime example currently would be factor-based products that focus on low volatility. A recent FTSE Russell Index IDEA, appearing on our FTSE Russell blog, analyzed performance by FTSE Russell smart beta indexes (in this case the Russell 1000® Low Volatility Focused Factor Index and the Russell 1000® Low Beta Equal Weight Index) which screen constituents based on lower volatility or lower beta characteristics among other factors, holding up well relative to their market capitalization weighted peer (in this case the Russell 1000® Index of US large cap stocks) amid recent market volatility as well as over the longer term.

Consistently beating the markets is challenging because crowds tend to be pretty accurate whether it’s guessing jelly beans or setting equity prices. Yet time and time again the markets show us that they are anything but average, and indexes can help investors both active and passive. As markets continue to prove their efficiency, new tools are keeping pace to help investors better understand market dynamics and make more informed investment decisions. 



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