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Financial Happenings Blog
Wednesday, January 07 2009

Our Building Portfolios page sets out philosophy towards building investment portfolios for clients.  At the core of this philosophy is the 3 Factor model.

Academic researchers in the USA have identified two sources of additional return beyond just the average market return (the index return).  This research was conducted and published in the early 1990's by University of Chicago Professors Eugene Fama and Kenneth French, and their results are known as the ?3 Factor Model' of investing.  Importantly, Fama and French's research has been consistently repeated in markets around the world and shows that two factors - company size and value (or company health) are sources of above market average returns.

·        The Company Size effect identified that small company shares have higher expected returns than large company shares.  This is not entirely new to Fama and French's research, it had been proposed for some time.  An example of a small company would be the Bank of Queensland - much smaller than the Commonwealth Bank which is amongst the 5 biggest companies listed on the Australian stock exchange.


·        The Value Effect identifies that financially pressured or out of favour ?value' companies have higher expected returns than healthy and popular companies.  This does not seem to make sense at first glance.  One way to think about it is this, when a company is out of favour or under financial pressure everyone sells their shares.  The price of the company falls, and it is only once it has fallen a long way that people become interested in buying it again - only once they are attracted to the company by the higher expected returns that come about because its share price has fallen so far.

These same professors who developed this model have been sponsored by Dimensional to create an online forum.  The website offers a venue for them to share their ideas and perspectives with Dimensional investors, affiliated professionals, and the general public. The professors will use the forum to comment on financial topics, highlight current research, answer frequently asked questions, and point viewers to information sources they find engaging.

I really encourage you to take a look at this new website by clicking on the following link - Fama/French Forum and also to keep track of the ongoing discussions that occur there by subscribing to the RSS feed.


Scott Keefer

Posted by: Scott Keefer AT 08:57 pm   |  Permalink   |  Email
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