‘Sow and ye shall reap’ is the old adage about being patient. No one is more aware of this than Eugene Fama. He first began publishing his ideas on stock market prices in 1965 and on 14^th October 2013 (48 years later – and at the ripe old age of 74) he was announced as a joint winner of the 2013 Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.

That’s the Nobel Prize in Economics to you and me.

His idea was simple, brilliant and obvious (in hindsight): stock prices reflect all known information. But what are the implications of this simple statement?

Well, it makes it pretty hard to beat the market on anything like a consistent basis. Why? The price of a stock will be amended almost instantaneously to reflect new price sensitive information about it.  This idea became known as the Efficient Market Hypothesis and was the spark that eventually led to the creation of index tracking investments. After all, if you can’t beat the market you might as well own it, right?

Fama’s idea about market efficiency raised another important question: if it isn’t possible to beat the market (because prices reflect all current known information), where do excess returns come from?

Further research conducted in collaboration with Kenneth French began to answer this question. By 1992 they had identified three factors (market, value and size) that explained most of the differences in equity returns around the world.  The following year they identified two factors (credit quality and duration) that explained the variations in fixed income returns.  These are the ones we use in our portfolios today.

In 2012, Fama and French updated their three factor model to include a fourth factor based on profitability.

So how do we take advantage of this brilliant research and embed it in our portfolios? Well two of Fama’s students at the University of Chicago were David Booth and Rex Sinquefield. They independently developed the first two S&P 500 index funds in the US. In 1981 Sinquefield and Booth implemented the academic research of Fama and French in their newly formed investment fund company: Dimensional Fund Advisors (DFA).  Today both Fama and French still sit on the company’s board.

We use some of Dimensional’s funds to give use exposure to the value and size factors around the world (and avoid the two fixed income factors – but that’s another story).