Saturday, May 05, 2007

Finally got to an interview with Eugene Fama and Ken French in the March/April 2007 issue of the Journal of Indexes. The developers of the three-factor model of equity returns (beta, and the predominance of small-cap and value stocks in a portfolio) had a few choice words about the new “fundamental” indexes that are all the rage. French called the idea that these products are something new “ludicrous.” “It's a triumph of marketing,” Fama said. “It's a repackaging of old ideas.” The worst fundamental indexes of all are dividend-weighting schemes, they said, which produce the weakest value premiums. Consistently, market participants underestimate the amount of noise in security prices, leading to the belief that they can take advantage of market inefficiencies. “If it weren't for noise, 98% of investors would see what's going on and buy passive strategies,” French said.