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Summary (You can listen to the podcast by clicking here)
• In a live panel podcast hosted at Chicago Booth, the “father of modern finance” Eugene Fama and the business school’s namesake David Booth share their perspective of the on-going relevance of Fama’s efficient markets hypothesis.
• It’s a rare opportunity to listen to Fama, who is notoriously press-shy and whose acerbic wit can ruffle feathers in the industry. “The business-man’s pornography”, he replies when asked of his opinion of Wall Street-generated research, for instance.
• The discussion explores the two economists’ relationship, as Fama took on a mentorship position in Booth’s early career as he was impressed by his intellect, and helped him set up his first microfund from his apartment. They talk through their career trajectories and the impact of their work on people’s lives.
• The pair underscore the necessity of practitioners using robust academic models and of backtesting research to make sure it fits well with out-of-sample data (which is another one of Fama’s criticisms of many published papers). Fama and Booth both credit their work with helping people’s lives for the better.
• Booth especially notes that since the ‘60s, clients have seen their fees drop tenfold and risk controls have improved exponentially, and he’s proud to contribute to this legacy.
Why does this matter? As the author of many of the most widely-used financial models, Fama’s philosophy regarding active management is worth keeping in mind. Assuming markets are reasonably efficient (which he firmly attests is the case), active managers will barely break even after fees. This argues for passive investors and a grim future for active management. And if you do have a winning active manager, Fama suggests this is more likely due chance rather than skill. Given the dominance of passive management, his views have clearly been accepted by investors. But he doesn’t talk much about the liquidity flare-ups we have seen with this shift. Perhaps, the theory needs updating.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)