We are particularly pleased by Fama’s selection because of the invaluable academic work he has done over his lengthy academic career that provided the underpinnings for index funds, exchange-traded funds, and other market-based investment vehicles of which we are enthusiastic supporters.
Why the Nobel Committee Picked Fama
The Nobel Prize committee honored Fama due to his work involving his efficient market hypothesis. Fama, who is widely recognized as one of the pioneers of modern finance and portfolio management theory, long ago argued that the financial markets on Wall Street and elsewhere are efficient.
Stock prices, Fama believes, quickly reach equilibrium prices reflecting all public knowledge about a particular security. Secondly, he insisted that the movements of stock prices in the short term are impossible to predict.
Investing and Sheer Luck
If you buy Fama’s arguments, neither professional money managers nor individual investors can outsmart the market. Prices change daily, not because of anything that could have been forecast, but because of new information that becomes known about the stock that day.
If it’s impossible for investors to outsmart the market through research, hunches or crystal balls, it makes sense to stick with index funds, exchange-traded funds, or other passively managed mutual funds that simply track the market returns.
In a radio interview after the Nobel Prize announcement, F. William McNabb III, the chief executive officer of the Vanguard Group, which is an indexing powerhouse, called Fama’s research “seminal” and added that “a lot of what we have done is based on that work.”
Fama’s ground-breaking work inspired the founding of Dimensional Fund Advisors, which is an investment advisory firm that manages more than $287 billion. Fama is a director and consultant at Dimensional Fund Advisors, which sponsors many of the mutual funds used in Dowling & Yahnke client portfolios.
Fama has written two books and more than 100 articles in academic journals that have been cited more than 11,000 times.
Fama noted that the financial industry has been far less accepting of his research than his fellow academics because his research demonstrates that it’s futile to pay high fees for actively managed portfolios when picking specific stocks is a zero-sum game.