factor investing vs hedge funds

In 1992 Eugene Fama and Kenneth French, two professors at the University of Chicago Booth School of Business, published a paper that showed how investors could beat the stock market’s returns … by taking advantage of two simple factors: the tendency of small or cheap companies to outperform over time.

… [T]he Fama-French paper was a bombshell, largely because Prof Fama is the father of the “efficient markets hypothesis”, which argues that investors cannot consistently beat the market.

These two factors are known as size and value. Additional factors have since been found to be important, especially these three: MOMENTUM, “the fact that assets with a positive trend tend to continue to do well, and those that are falling continue to slide” (This happens because investors “initially underreact to news but overreact in the long run, or often sell winners too quickly and hang on to duds longer than advisable”); VOLATILITY, the observation that steady stocks “actually tend to outperform more volatile ones over time, contrary to the view that investors should be compensated for the additional risk of buying more turbulent shares”; and CARRY, the observation that “companies with higher dividend yields tend to outperform their peers”.

Managers often take other factors into account as well. But even when managed funds beat the market, they seldom provide a good return to investors because fees are high for active management. Fund managers make out like bandits, though.

The best advice, in my opinion, is to invest in funds with low fees, that track a broad market index.

Robin Wigglesworth, “Can factor investing kill off the hedge fund?“, Financial Times, 23 July 2018.

 

Tags: ,

Comments are closed.