Our investment approach focuses on long-term, disciplined asset allocation. We refrain from picking individual stocks or attempting to time the market. This type of approach, grounded in academic research rather than marketing hype, has been influenced by the economist Eugene Fama, who won the 2013 Nobel Prize in Economics. Fama’s theories predicted that mispricings of securities do occur but not in patterns predictable enough that can be used by professional money managers to consistently “beat the market.”
We see confirming evidence in the data. Empirical studies have repeatedly demonstrated that professional money managers cannot consistently “beat the market” through security selection or market timing. In other words, gathering and analyzing information about stocks or bonds does not translate into higher returns. In fact, managers who attempt this (also known as “active managers”) typically underperform their respective benchmarks. After taxes (generated by higher levels of buying and selling securities), the degree of their underperformance is even greater.
Why is this? Because markets work. In other words, free markets reward investors for the capital they supply. Companies compete with each other for that capital, and millions of investors compete with each other to find the most attractive returns. This competition quickly drives prices to fair value – for every professional looking to sell a stock, there is a professional looking to buy that stock. Sellers and buyers need to agree on a price. When this negotiation occurs between millions of sophisticated investors, the price that is settled on is likely fair and incorporates available information.
Fama’s research helped inspire the development of the index fund (and the companies Dimensional Fund Advisors, for whom he still serves on the board of directors, and Vanguard Group), and the philosophy of emphasizing asset allocation over stock picking/market timing. Among many of the conclusions of his work was the notion that stock picking managers’ past performance does not predict their future performance. In this sense, relying on past performance to select such managers is akin to driving a car using only the rear-view mirror. Furthermore, stock pickers and market timers do not consistently beat the markets over the long-term, as information is quickly priced into securities prices.
Fama’s work also explained that investors are rewarded over the long-term according to the type and amount of risk that they take. Therefore, it is structure (and not stock picking or market timing) that is most influential in the long-term behavior of a portfolio.