Eugene Fama on the Keys of Investing

Eugene Fama, the ultimate random walker, has a video on the Dimensional Fund Advisors website in which he gives advice to investors. I encourage you to view the video in its entirety here. Here is a quote of the most important advice:

"The evidence is quite clear. If you do any systematic analysis of investment performance what you find is people basically get return for risk and then from that you subtract fees and expenses. It is the costs that basically determine deferentials in portfolio performance. Active managers charge more so they tend to do worse. But, that doesn't mean people will stop doing it. Especially MBA students, all the ones that want to be portfolio managers want to be active managers naturally since if they're lucky and they win they end up rich. And that is very, very attractive to them so lots of students in my class even end up being active portfolio managers. I don't know where they learn how to do it though. The evidence is also clear that what does matter in portfolio strategies is asset allocation. The choice of stocks versus bonds and within stocks a tilt toward value and a tilt towards small. Now those are basically the decisions you face, plus international diversification is another aspect of it."

I agree with Eugene in large part, though I'm sure most Hedge Fund managers would watch this video and laugh all the way to the bank. I was a little bit disturbed by the fact that international diversification seems like such an afterthought to Gene as I feel it is such a pivotal part of portfolio construction. I also personally feel that utilizing other asset classes -- such as REITS and commodities -- can be very valuable in portfolio construction particularly as a means to dampen volatility and drive returns during prolonged market downturns. It would be interesting to ask Gene his opinion on that question in person. It might be a while before I get that opportunity . . .