“The envelope please. And the winner of the 2013 Nobel Prize for
Economics is…”
We’re quite sure that not many of
you were glued to your TV for this announcement at around 7 am Monday morning.
However, one of the 3 winners has had a significant impact on our firm, our
investment philosophy, and thus, your investments and your life.
Who is Eugene Fama and why is his research important?
Eugene Fama was awarded the 2013
Nobel Prize in Economics for his research that attempts to pick stocks and time
the markets were often fruitless. This research led to the development of index
funds and our approach to investing. Fama is widely recognized as the “father
of modern finance” for his academic work in developing this “efficient market
hypothesis.”
Fama was the principal scholar
whose groundbreaking research inspired the founding of Dimensional Fund
Advisors (DFA), the mutual fund company through which we primarily implement
our stock investment philosophy. DFA is now one of the top 10 mutual fund companies
in the US, managing over $300 Billion. Fama serves on Dimensional’s Board of
Directors and its Investment Policy Committee. Fama has been a professor at the
University of Chicago Booth School of Business since 1963.
What does this mean for stock picking?
Fama was selected for his
research beginning in the 1960s which show that stocks prices are “extremely
hard to predict over short (time) horizons.”
As stock prices react so quickly to any new information, he argues this
leaves little opportunity for profitable efforts by actively managed mutual
funds and hedge funds.
At a conference in September,
Fama said that since markets are efficient, he challenged the Wall Street
notion that investment managers such as high-fee hedge funds could outperform
market returns. His advice “…would be to avoid high fees. So you can forget
about hedge funds” and other high cost mutual funds.
How has our firm incorporated Fama’s research into your investments?
We believe in the thesis of
Fama’s research, which won him the Nobel Prize for Economics. To extend his
research, we do not feel it is possible to identify in advance investment
managers that will consistently outperform a respective benchmark over a long
period of time. There is a significant academic research which supports this
position, especially if fees and trading costs are considered.
Thus, we adhere to an index or
“passive” philosophy, which minimizes your costs and invests in a particular
asset class. We have chosen to primarily utilize DFA’s mutual funds to
implement this strategy based on their performance and very low costs.
Fama has continued to play a
major research role in the investment approach of DFA. Further research developed the strategies to
tilt towards small and value companies, both domestically and internationally,
as they have greater expected returns.
Conclusion
It is our role to be independent,
intellectually curious, and advise you in the manner that is best for your
interests. We are pleased that Professor Fama has been internationally
recognized for his research that has led to such a rationale and successful
investment approach. His continued guidance and work with DFA is truly
valuable. Keith and I have each heard him present at conferences in the past
and look forward to this even more in the future.
Note: This is the letter that is accompanying the third quarter, 2013 statements being sent to our clients.
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