Updated Friday, July 25, 2014 as of 7:05 PM ET
Portfolio - Investment Insights
Fama’s Nobel Work: Active Managers Fated to Lose
Tuesday, October 15, 2013
Partner Insights

The work that earned Eugene Fama the Nobel Prize in economics provided the intellectual foundation for index-tracking funds, which have upended stock picking as investors abandon active money managers.

Fama, 74, has argued that financial markets are efficient and that stock-price movements are unpredictable, making it impossible for even professional money managers to gain an advantage. His conclusion that investors would be better off in low-cost funds that track the market’s performance helps explain the success of Vanguard Group Inc., the biggest U.S. mutual-fund company, as well as the rise of passive investments, which had more than $2.6 trillion in U.S. assets between exchange-traded funds and mutual funds at the end of 2012.

“His work has been seminal,” F. William McNabb III, Vanguard’s chief executive officer, said yesterday in an interview with Tom Keene and Sara Eisen on Bloomberg Radio’s “Bloomberg Surveillance.” “A lot of what we have done is based on that work.”

Funds that mimic the performance of markets gained momentum after 2008 when the Standard & Poor’s 500 Index fell 37 percent and investors lost faith in the ability of stock pickers to insulate them from losses. Over the past five years, index funds have been the most popular choice for investors, with assets in U.S. ETFs almost tripling in that period. Investors have pulled about $284 billion from actively managed equity mutual funds, while pouring $243 billion into stock index mutual funds since the end of 2008, data from Morningstar Inc. show.


“Index funds have gone from a whacky fringe idea to the point where they are now viewed as the default investment option for many people,” Russel Kinnel, director of mutual fund research at Chicago-based Morningstar said in a telephone interview.

Some of the most highly regarded active equity managers stumbled in the past decade, a period that included the biggest stock-market slump since the Great Depression. Bill Miller, the money manager best known for beating the S&P 500 Index for a record 15 years before the streak ended in 2006, was hurt in 2008 by a heavy bet on financial stocks. Miller’s Legg Mason Capital Management Value Trust slumped 55 percent in 2008.

Fama, a professor of finance at the University of Chicago, concluded in research done in the 1960s that financial markets were efficient, which meant that asset prices already reflected all relevant information. From that basic idea, it followed that trying to beat the market was an exercise in futility.

Vanguard, based in Valley Forge, Pennsylvania, opened the first U.S. index fund in 1976. The Vanguard 500 Index Fund today has $132 billion. Vanguard, which manages $2.3 trillion, in 2010 overtook Fidelity Investments as the biggest U.S. mutual-fund manager.


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