A Nobel Prize For Redefining Investment Advice.Posted on
During my career the question I asked myself most often was, am I best servicing the interests of my clients, by attempting to predict the future, or what if there was another way, a way that investors could understand and manage their expectations, a way that told the truth.
After all, what we do know is that capital markets work. Investing is not a game where one investor must lose so another can win. Any investor has the chance to capture the same capital market rates of return. Over the long run, markets reward investors with positive returns for taking risk and providing capital. If they did not, the capitalist system would have collapsed long ago.
I needed to explore if there was an approach that did not take predictions into account, but used principles grounded in academic finance? If there was, I and my clients could therefore avoid the risk of speculation, and benefit from the intelligence and stability of an approach based on solid theory and empirical evidence, and reward ourselves with an investment solution that earns and delivers the capital market rate of return.
[box] Adjective: empirical :based on, concerned with, or verifiable by observation or experience rather than theory or pure logic. “They provided considerable empirical evidence to support their argument” Synonyms: observed, seen, factual, actual, real, verifiable, first-hand[/box]
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When I began my research, I found that the City’s prevailing definition of investment advice (everyone promising that they can all outperform the market) is not the only one. A different definition had been developed within the academic world, based on decades of empirical research. The new approach is the culmination of the work of the academics; Eugene F. Fama, widely regarded as the ‘father of modern finance’ and Kenneth R. French, who is an expert on the behaviour of security prices and investment strategies.
Together, Fama and French have provided two anchor points for a new definition of investment advice; market efficiency and the risk dimensions of shares and bonds. In 2013 Professor Fama received the Nobel Prize in Economics for this work. Their views were that the financial markets actually work. Prices reflect the knowledge and expectations of all investors.
Although prices are not always correct, markets are so competitive that it is unlikely any single investor can routinely profit at the expense of all other investors. The conclusion therefore was like a lightbulb moment to me. If the markets are efficient instead of trying to beat the markets at any price…why not just buy the markets being offered at a much lower cost…..simples.