Editor’s note: This article was contributed by our Summer 2024 intern, Lionel Daily Lucero.
“How do you decide which investments to add to my portfolio?” That was the question a new client recently posed as we discussed their investment allocations. The short answer is that it’s based on our investment philosophy, a set of principles and beliefs we use to guide our investing decisions.
Every financial firm has an investing philosophy. Ours is inspired by Eugene Fama and Kenneth French, two of the most important figures in modern finance.
Leaders in Modern Finance
Eugene Fama, known as the “father of modern finance,” won a Nobel Prize in Economics Sciences in 2013 for his work related to the empirical analysis of asset prices. His research is heavily involved in the tradeoffs and connection between expected returns and risk and their impact on portfolio management. Fama earned a bachelor’s degree from Tufts University as well as an MBA and Ph.D. from the University of Chicago Graduate School of Business, where he is now a Professor of Finance.
Fama’s contemporary, Kenneth French, is currently a Professor of Finance at the Tuck School of Business at Dartmouth College. He also works as a Research Associate at the National Bureau of Economic Research and as an Advisory Editor of the Journal of Financial Economics. He earned his Ph.D. in finance from the University of Rochester and has served as faculty at the University of Chicago Booth School of Business.
Fama/French Three-Factor Model
In perhaps their most famous contributions to the world of finance, Fama and French developed an asset pricing model that served to identify common factors in stocks that tended to outperform others. The two researchers used data spanning from July 1963 to December 1991 in their analysis, which informed the creation of the asset pricing model.
Fama and French found three main factors that helped explain why some stocks performed well:
- Market risk: The researchers looked at how vulnerable the stocks might be in the event of a market drop.
- Company size: Fama and French determined that company size was a factor in how stocks performed. Their analysis revealed that smaller companies tend to do better than larger companies over time.
- Company value: Analysis determined that stocks with lower price-to-earnings (P/E) and price-to-book (P/B ratios) tend to outperform growth companies over long periods of time.
Fama and French’s Influence Vista’s Investment Philosophy
Vista considers and learns from Fama and French’s key findings and integrates them into our current investment philosophy. With a long-term plan and passive strategy in mind, we tilt our clients’ portfolios towards small and value companies with heavier weighting to help clients capture investment premiums. Supported by reliable data and Nobel prize-winning researchers, we feel confident that we can represent and serve our clients’ best interests—and we have these two scholars to thank for their contributions.