Searching for Rational Investors In a Perfect Storm/A Response to Lowenstein's Searching for Rational Investors In a Perfect Storm

Louis Lowenstein*

ABSTRACT

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 1990s, 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 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, it is a remarkable fact that 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 turbulent 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 Standard & Poor's (S & P) 500?