Eugene Fama, whose groundbreaking work on asset pricing and capital markets has been at the core of our investment strategy since the late 1990s, has been awarded the Nobel Memorial Prize in Economics along with Robert Shiller and Lars Peter Hansen.
Widely recognized as the father of modern finance, Professor Fama is perhaps best known for his efficient market hypothesis (EMH). As we have described many times on these pages, the EMH asserts that stock prices rapidly incorporate all available information. The primary implication for investors is that no one can consistently outperform the market based on available information. Most investors, therefore, are best served by simply holding the entire market through an index-type mutual fund or ETF.
Fama, working with Ken French, went on to refine his theory by explaining that equity returns could be further explained by distinguishing between so-called growth and value stocks (measured by book-to-market ratios) and between small and large companies (measured by market capitalization). This distinction has allowed us to create portfolios designed to better match the risk preferences of our clients.
There is no shortage of EMH detractors among money managers as well as academics. Skeptics often point to anomalies that arise from time-to-time as evidence of “mispriced” assets, or to “bubbles” that resulted in overall market valuations that seem to defy rational pricing. Such criticism is often based on a misunderstanding of what the EMH says. EMH does not claim that market prices are correct; it simply asserts that they represent the best estimate of value based on information available. Bubbles, moreover, are obvious only in retrospect and therefore impossible to time consistently.
Market prices are in fact the best approximation of a firm’s value, so our approach is to invest as if markets are efficient, by utilizing well diversified index type funds to capture the returns of asset classes.
Also In This Issue
Quarterly Review Of Capital Markets
A Reader Inquires: Gold Coins
Debt Limits And Default: What Just Happened
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles
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