Early on in his lunchtime presentation at the Morningstar ETF conference on Thursday, Eugene Fama, the 2013 Nobel Prize winner in economic sciences, asked himself a simple question.
“When is active management good? The answer is ‘Never.’”
Instead, “it’s always a zero-sum game; that’s a difficult perspective to get people to accept.”
In response to a question on the role that active managers play in an efficient market, Fama said “The fallacy is that you need active managers to make the market efficient, but bad active managers make the market less efficient.”
So, then, why are so many people putting so much money into active strategies? “I don’t know,” said Fama, who still teaches at the University of Chicago. “Investors are clearly so much better off buying passive products rather than active,” he said, “it’s laughable.”
What if the best active managers reduced their expenses, even down to zero? Would that make them more appealing? “Yes,” he responded “if you get the good ones,” though “they might be good or they might just be lucky.”
Moreover, it’s still the case that “people are paying more than 1% to get the market when you can get it for a couple of basis points passively.” Even with zero expenses, he suggested, an active manager would still not be diversified enough to make the portfolio efficient.
In answering a question from the audience, Fama waxed on the theme of diversification. Saying that economists never pass judgment on a person’s tastes, he acknowledged that investors might have a preference for a specific asset class or investment. That’s understandable, but he counseled investors that when they do so, “pick your risk exposure, and then diversify the hell out of it.”
Fama disclosed that he and longtime collaborator Ken French are working on an update to their famous three-factor model on stock market prices that uses five factors, including the discounting of cash flows but also actual cash flows.
In addition to his disdain for active investing, Fama is not a big fan of behavioral finance. “Economics is all about behavior, so no economist would say” it’s an unimportant subject. But he sees “behavioral finance as cognitive psychology,” and separates the researchers into two groups. There are the serious researchers, like his Chicago colleague Richard Thaler, but then there are the others, who he said “dredge for anomalies” and whose ‘findings’ have “no roots in anything that comes out of behavioral science.”
In response to a question from an audience member, who seemed to suggest that he should update his research findings since additional investment vehicles are now available, Fama dismissed the notion. “I invest in a cap-weighted” passive equities portfolio, Fama said.
What about real estate or bonds, the questioner persisted? “I don’t mess with that stuff,” he said, channeling Moshe Milevsky: “I’m a tenured professor; the university gave me a bond.”
To a final question on the most famous active investor in America, Warren Buffett, Fama said: “He’s my hero. He says ‘I can buy a different company every couple of years,’ but otherwise go passive.”
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- Shiller vs. Fama: Which Nobel Winner Comes Out on Top?