Fama Doesn’t Deserve a Nobel Prize?

/Fama Doesn’t Deserve a Nobel Prize?

Fama Doesn’t Deserve a Nobel Prize?

By | 2017-08-18T17:05:11+00:00 January 17th, 2014|Behavioral Finance|7 Comments
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(Last Updated On: August 18, 2017)

Marty Whitman makes a bold statement in his recent letter:

“I am disappointed that a Nobel Prize was awarded to Eugene Fama, who studies only markets and prices; and whom, I daresay, does not focus on Form 10-Ks or the footnotes to a corporation’s audited financial statements.”

Marty makes goes on to convey the message that he is able to identify inefficiency in the market because he does so much “homework” and analysis. In other words, his skill is much higher than that of other market participants.

Great story, Marty, but let’s analyze the evidence.

Larry Swedroe has a sweet counterattack to Marty’s claim. First, a comparison against Third Avenue Value Fund and the DFA Large Cap Value Fund, which uses simple quant methods to trade value:

The Third Avenue Value Fund (TAVFX) is a global fund that Morningstar classifies as large value. Thus, we can compare its returns with those of the DFA Large Cap Value Fund (DFLVX) and the DFA International Value Fund (DFIVX). TAVFX had annualized returns of 7.50 percent, while the two DFA funds returned 7.67 percent and 7.47 percent, respectively.

So Marty roughly generates what the braindead DFA Large Cap Value Fund generates. Marty does a lot of homework; DFA sorts stocks on book-to-market. Their performance is the same. The market may not be efficient (depending on your beliefs about the value factor), but it is certainly competitive when it comes to accessing the “value factor.”

What about Marty’s bread and butter Small Cap Value Fund?

We now turn to the performance of the Third Avenue Small Cap Value Fund (TASCX). Over the 15-year period, it had annualized returns of 9.13 percent. DFA’s Small Cap Value Fund (DFSVX) returned 11.90 percent, outperforming TASCX by 2.77 percentage points per year. I would add that while TASCX is mostly a domestic fund, it does have the freedom to buy international stocks. Morningstar showed that non-U.S. stocks currently made up about 6 percent of the fund’s holdings.

Larry’s article goes on with examples that highlights the irony of Marty’s comments. Enjoy…


Maybe Whitman is just mad because he’s getting beat by Fama in the marketplace?

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After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.
  • Aaron

    It’s definitely a punch in the gut when you realize a quant portfolio of stocks can do the same, or better, than individual stock picking. I’ve noticed the same thing on the momentum side. I can make a portfolio of momentum stocks that performs the same (at least on the return side) as I can individually picking out big growth stocks ala William O’Neil’s CANSLIM method.

    Most of the guys that are drastically outperforming simple quant strategies are using leverage to do it. Nothing against that, as intelligently using leverage without blowing up is nothing to sneeze at.

  • Al

    Can you clarify how economists measure skill? In colloquial usage, I might define skill as some outperformance relative to the mean, or adherence to some proven methodology, even if overall performance isn’t great. So, skilled would imply “skilled at…” But, you seem to be using skill like a residual term. If you can explain it, then it isn’t skill? Is this a term of art amongst economists, or is it discussion specific?

  • Al, great question. Economists like to measure skill via “alpha” which is essentially the intercept in a multiple regression where the y variable is excess returns on a strategy and there are a laundry list of “risk factors” as x variables. Understanding the distinction between skill/risk is a very interesting thing to discuss as an academic subject, but I doubt anyone will figure it out anytime soon.

    Here is how I think about “value-add” or “skill” in the investments industry: 1) identify what returns one can get for free (or very low cost) 2) identify the ‘free’ factors in which a manager is correlated 3) a manager has value-add if you can’t get all his/her return for free. For example, Manager A is a fundamental stock picker that equal weights a portfolio of 50 selected securities under $500mm. I can basically create an equal-weight portfolio of 50 low p/e stocks under $500mm. Let’s call is XYZ portfolio. If Manager A earns 20% and XYZ earns 25%, Manager A has not created any value add. If A earns 30% and XYZ earns 25%, you could argue they added 5%. Is that 5% skill? Well, I can’t get it for free and I’m probably going to be willing to pay for access to the 5% I can’t get for free, so I guess you could call that skill…

  • Al

    Thank you for the clear answer and thought provoking answer.