On October 14, 2013 Eugene “Gene” Fama was awarded the Nobel Prize for Economic Sciences, which begs the question: “Who is Gene Fama?” Unlike other more famous Nobel Prizes, the Economic Sciences prize tends to highlight the work of people who don’t often get much press, which of course changes when they win this prize.
The work of Gene Fama and his long time research partner Ken French has been a huge influence on my core investment philosophy and strategies that I bring to my clients.
While he actually won the prize on the less than exciting topic of “asset pricing”, he is most famous for his original thesis on market efficiency and is commonly referred to as the “father of modern finance.”
Dr. Fama was the first person to really harness the use of computers to analyze financial market data, so in some respects his great contribution is empirical. To quote John Cochrane, a colleague of Fama’s from the University of Chicago “Gene’s work is scientific in the best sense of the word. You don’t ask Gene, “what’s your theory?” you ask “what’s your fact?” Finance today represents an interplay of fact and theory unparalleled in the social sciences, and this fact is largely due to Gene’s influence.”
In a recent Behavior Gap blog, Carl Richards hit the nail on the head when he said: “Researchers like Dr. Fama don’t spend their time coming up with sound bites. Instead, they spend months and even years working on big ideas that have the potential to improve our understanding of wildly complex subjects. In short, their work often goes unrecognized by the wider world until something like the Nobel committee shines a light on their efforts.”
Why is this important and why should investors care about his work?
I will admit that market efficiency is not only a mouthful and a hard concept to grasp, not only for individual investors, but for most financial advisors as well. I would conservatively estimate that 90% of financial advisors either don’t understand the concept and/or simply choose to ignore the evidence and discount it completely.
In a nutshell, market efficiency means that stock and bond prices incorporate all available information into current prices. If you think about this, not only is it incredibly powerful but, it is liberating as well. Liberating because if you assume current prices incorporate all available information, you can ignore market predictions, investment strategies based on predictions and forecasts, the screaming negative media headlines and of course the talking heads on BNN and CNBC.
The following 3 minute video from Dimensional Fund Advisors does an excellent job of simplifying this concept. Armed with this information, investors can be more confident about how to harness the power of the financial markets.