nobel prize for dimensional board member
Eugene Fama has just been awarded this year’s Nobel Prize in economics1 in recognition of the contribution his work has made to the understanding of how financial markets work.
That’s important to us here at future perfect, because our investment philosophy is based upon much of his work, initially developed in the 1970s and still on-going. This award reflects the highest level of peer recognition for his work, which is still as relevant today as ever.
What sets Eugene Fama apart and makes his work so hugely influential is that his research findings are based upon empirical data.
efficient market hypothesis
His first significant work, published in 1970 in the Journal of Finance2, argued that share prices incorporate all available information. This is known as the Efficient Market Hypothesis.
The implication is that you cannot systematically outperform the market. The market analysis active fund managers undertake puts them in no better position than if they picked stocks by throwing darts at a board.
The impact of this theory was significant – it precipitated the creation of passive/index funds, which capture market returns. The first index fund was launched in the United States in 1975 by John Bogle, founder of Vanguard.
predictability of long term returns
Eugene Fama’s efficient markets work found that stock returns are not predictable over short time horizons, but his next great contribution, in the 1980s, was to show how returns are predictable over the longer term.
The findings in this series of papers3 are still being used by theorists of stock, bond, commodity and foreign exchange markets to this day.
three factor model
In the 1980s a new way of determining rates of investment return from assets was developed – the Capital Asset Pricing Model4.
In the 1990s, Eugene Fama’s work with Kenneth French5 developed this further identifying three factors. These were, investing in:
- shares (rather than bonds)
- smaller companies
- value (or out of favour) companies.
These three factors were shown to provide higher investment returns over the long term.
dimensional
Eugene Fama’s ground breaking work inspired the founding of Dimensional, one of the investment companies we use, in 1981. Today he sits on the board of the company and also serves on their Investment Policy Committee.
influence on future perfect
Our use of passive investments and future perfect’s portfolio weighting to small and value company funds clearly shows the influence of Eugene Fama on our investment philosophy.
In addition, his work on the predictability of long-term investment returns enables us to provide clients with an indication of the expected returns on their future perfect portfolios, helping them to make better financial and life planning decisions.
thanks eugene!
We’re delighted that Eugene Fama has been awarded this Nobel Prize. Aside from recognising his incredible thinking in the understanding of financial markets, his work has enabled millions of investors, including ourselves and future perfect clients, to access low cost and effective investment strategies.
Here’s a video of Eugene discussing the evolution of finance (don’t worry he’s an engaging speaker and the clip is only 3:12 minutes long!).
any questions?
If you’ve got a query about this, or any other aspect of your financial life, Nick would be delighted to help. You can email him on nick@futureperfectfp.co.uk.
notes
1 The 2013 Nobel Prize in Economics was received by Eugene Fama, Robert Shiller and Lars Hansen
2 ‘Efficient Capital Markets: a Review of Theory & Empirical Work’, The Journal of Finance, May 1970.
3 e.g. ‘Permanent & Temporary Components of Stock Prices’, Journal of Political Economy, April 1988.
4 Developed by Jack Treynor, William Sharpe, John Lintner and Jan Mossin.
5 ‘Cross Section of Expected Stock Returns’, Eugene Fama & Kenneth French, Journal of Finance, June 1992.
the small print
This commentary is provided for information purposes only and does not constitute advice to invest or not invest. Advice should always be obtained from an adviser before the decision to invest or sell is taken. Past performance is not a guide to future performance.