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11/21/2005
Briefly Speaking, by Victor Niederhoffer

The Fama-French model is the main academic model accepted by portfolio managers and the public that relates return to company characteristics. The key variables supposed to predict return are small size, high book to price, and systematic risk. Thus, it's guaranteed to lead the investor down the pike of oblivion to the home of losing so much much more than they have to. The main defect of the work is that it uses retrospective, irreproducible data from Compustat. Another weakness is data mining, searching for a million variables that impact, and finding a few from a cross section that worked in particular year.

But these critiques are variants of Dr. Zachar's "your own man says it's so" (having come back from Austria today where the custom is to call everyone and his wife Dr., George will excuse me), And the real critiques run so much deeper, including the fact that a prospective study of such factors would show that investment in growth stocks has led to wealth about 100 times greater than investment in value stocks over the last 30 years.

While Jim Lorie was alive, he always asked me not to be too harsh on Dr. Fama, despite the personal animus that Fama bore for Jim, because Fama was a man of varied scholarly interests. But now that Jim is dead, I can't refrain any longer from pointing out the myriad defects of the Fama-French study, including the fact that an enumeration of the companies involved would show that low priced, unbuyable companies account for the main part of even the irreproducible retrospective aspect of the work, and that the principle of ever-changing cycles shows that whenever investors get on the value bandwagon, it is likely to lead to prospectively below-market returns, as well as the economic arguments that show that value investing, with its eschewal of companies that have high returns on capital, consigns you to the commodity-type investments that Charlie had to browbeat the Sage out of before the tax credits ran out.

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