Yeske Buie Celebrates Eugene Fama’s Nobel Prize in Economics
We’ve spent the past two decades discussing with our clients the insights we’ve gained from studying the work of Eugene Fama, University of Chicago professor and one of the fathers of Modern Portfolio Theory. Over that time, we frequently found ourselves referring to him as a “future Nobel Laureate.” We’re tremendously pleased that we can now excise that word “future” from any and all citations going forward. On October 14, the Royal Swedish Academy of Sciences announced that it had awarded the Prize in Economic Sciences to Fama, along with Lars Peter Hansen, and Robert J. Shiller “for their empirical analysis of asset prices.”
Gene Fama was one of the developers of the notion of “efficient markets” – he was actually the one who first coined that phrase – which is simply the idea that markets rapidly incorporate new information into the prices of securities. The biggest implication of this is that stock prices are at all times reflective of everything that can be known about a company and will change only as new information emerges, rendering the research efforts of individual analysts redundant. Put another way, one cannot consistently “beat the market” through individual stock picking.
Working with collaborator Ken French of Dartmouth University, Fama also developed the “three-factor” model for explaining the cross section of stock market returns in 1992. We studied this work with great interest when it was first published and it immediately influenced how we assembled client portfolios. The three-factor model explains stock returns in terms of the stock market’s general propensity to produce higher returns than risk-free investments like Treasury Bills plus two additional “factors”: size and value. The evidence with respect to these “size” and “value” factors suggests that small company stocks produce higher returns than large company stocks and that stocks trading at low prices relative to their assets produce higher returns than high-priced “growth” stocks. Fama and French were not the only researches to have identified these factors but their model pulled it all together in a particularly compelling way. This is one of the reasons that our portfolios have such large allocations to small company and value stocks.
Professor Fama has also been deeply involved with Dimensional Fund Advisors (DFA), with whom we have a long-standing relationship and which contributes a significant number of funds to our client portfolios. DFA co-founder David Booth was a doctoral student under Gene Fama and Fama has served on the company’s board since its founding in 1981. Most of DFA’s portfolios are in one way or another based on or influenced by the research of Professor Fama.