Eugene Fama is Robert R. McCormick Distinguished Service Professor of Finance at the University of Chicago Booth School of Business. As James Montier noted Sunday evening, he may be the last person alive who accepts the efficient markets hypothesis. Even so, through his research he has brought an empirical and scientific rigor to the field of investment management, transforming the way finance is viewed and conducted. His presentation will focus upon his perspectives on financial research.
My session notes follow. As always, these are at-the-time notes. I make no guaranty as to their accuracy or completeness.
- Went from being a jock to the University of Chicago — “I knew I didn’t want to work for a living.”
- He works hard, but as an academic, it can be on his schedule.
- Why market efficiency and equilibrium are so important — the basis of capitalism (markets work).
- Efficiency and equilibrium jointly est each other; “the two can never really be separated.”
- “I was the first computer user” from the UC Economics Department (along with a Physics student).
- It’s important to “think differently” about something you’re working on — colleagues who push or influence you to do that are invaluable.
- Lessons from financial crisis — he tends to think it was an economic crisis that caused a financial disaster (and not vice versa); huge recession was the key (a pretty contrarian view).
- Per Fama, the sub-prime crisis (a U.S. phenomenon pretty much) wasn’t big enough to bring us down (Seawright: what about fragility and complexity?).
- “Too big to fail” is a huge problem and a major moral hazard; Dodd Frank cures none of this.
- He doesn’t expect the Volcker Rule to accomplish much either (and not optimistic about curbing insider trading either).
- Pension crisis — claimed liabilities are about a third of what they really are — it’s basic finance (not accounting); a period (or periods) of bad markets are essentially inevitable; per Fischer, finance DB plans with debt; some big state is likely to go bust due to pension obligations.
- Active management is a zero-sum game (net alpha is zero); some managers take alpha from others.
- A “good pick” is always balanced by a “bad pick.”
- After costs, only 3% of active managers are good enough to cover their costs (barely) — and they’re probably lucky.
- “Five or ten years of returns are basically garbage — noise. You need at least 35 years of data to be useful.”
- Lower discount rate means expected returns have gone down (about 4% real).
- Working on a paper that claims the Fed can’t really do anything to impact real rates. “It all comes down to saving and investing. There’s a glut of savings” (to make rates so low).
- Three-factor model (CAPM supporter prior) — what happened? CAPM had trouble explaining small cap. dividend stocks, etc.; in 1992 F&F put this all together (nothing new) and said CAPM “dead in the water.”
- 1993: developed 3-factor model. He sees value and size as risk factors that can’t be diversified away (even though we can’t explain why); price contains information not explained by market beta.
- Value outperforms growth; low beta outperforms; small not-so-clear.
- Growth stocks are simply expensive (high performing and highly priced).
- There are a plethora of value funds now (some of which don’t even know what that means), but “the market” (by definition) can’t lean one way or the other.
- For some it’s a matter of taste — “I like growth stocks and will take a lower expected return.”
- Momentum (a potential 4th factor) — the “biggest potential embarrassment to market efficiency”; what’s momentum today likely won’t be in three months.
- Behavioral finance valuable in the particular, but little more than ex post story-telling overall (no testable hypotheses).
- Behavioral story ” “People are born stupid and stay stupid” and professionals are prone to the same problems to the same extent.
- If everyone leapt on value, the premium would disappear (obviously).
- Obama Administration believes in “command and control” (e.g., regulation), but not incentives; most economists think that’s a problem, but not necessarily politicians.
- Excess-return low vol stocks are really low beta stocks — well-known for 50 years; has now come back into vogue (original CAPM assumed people could borrow at the risk-free rate).
- If we all exist passively (“I’m asked this question three times a day”): won’t happen.
- Bridgewater “risk parity” investing: “stupid.”
- Central bank balance sheet expansion — “The Fed has basically made itself powerless”; they are simply issuing bonds to buy bonds.
- Re debt, the question is how much to sacrifice the future for the present.
- We can inflate our way out of the crisis, but we might take ourselves down in the process via hyper-inflation.
- Simple fix: balance budget using 2007 expenditures — what have we added since then that’s so important?
- Active managers and advisors that use such funds are wasting their time and ripping off clients.
- The advantage that active management can add (assuming any can be added) is only about 1% or so — why take the risk required to accomplish so little?
- Small v. large: small premium seems to be decreasing, but prior measurement of “small” were really measuring value (no evidence of change).
- Value — expect long periods of underperformance.
- Value has now been verified world-wide (in every market — even bigger overseas), but no size premium.
- Fundamental fun of academics — you don’t know what you’re going to discover next week or next year.
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Fama’s a real giant. Lucky you for being there.
“If everyone leapt on value, the premium would disappear (obviously)”: true, but it can’t happen. Professional investors are hampered by so many factors that limit their ability to invest in value sector. Obviously, this is theoretical, but unless you believe that the market can be perfect, a disciplined small value investor can do quite well. The crumbs (and related transactions costs) just aren’t enough to justify investing in those areas for anyone managing significant amounts of money, even if you could aggregate all of the crumbs. But they are sufficient for the small investor.
As far as small, there are so many stocks with no analyst coverage, and too small for institutional investors. There is a lot of opportunity there, but small investors have a lot of information risk.
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