Lunch with economist Eugene Fama #NewsMarket

One thing to start: Welcome back to FT Asset Management. I hope you had a great summer and are raring to go for the autumn term.

‘Efficient markets is a hypothesis. It’s not reality’

Eugene Fama is arguably the world’s most famous and influential finance professor. This is owing to his revolutionary efficient market hypothesis — that stock market prices at any time incorporate all available information, thanks to the cumulative and unending efforts of millions of investors constantly trying to outfox it. The paradox is that as a result of their efforts, the stock market is in practice almost impossible to beat.

EMH is the closest finance has to a “theory of everything”, and won Fama the Nobel Prize for Economics in 2013. His work laid the intellectual groundwork for what is now the multitrillion-dollar passive investing industry, and indeed among his disciples are the likes of AQR’s Cliff Asnessand Rex Sinquefield and David Booththe founders of $740bn investment group Dimensional Fund Advisors.

In this must-read Lunch with the FT interview, FT Alphaville editor Robin Wigglesworth talks to 85-year-old Fama about how the kernel of the efficient markets hypothesis became dogma in financial academia — and why it remains as controversial today as it did when he first proposed it half a century ago.

Fama — currently a professor of finance at the University of Chicago — has famously acerbic views on the investment industry, once quipping “I’d compare stock pickers to astrologers, but I don’t want to bad-mouth the astrologers”.

He is surprisingly phlegmatic when it comes to defending his life’s work, echoing the famous British statistician George Box’s observation that all models are wrong, but some are useful.

The efficient market hypothesis is just “a model”, Fama tells Robin:

“It’s got to be wrong to some extent. The question is whether it is efficient for your purpose. And for almost every investor I know, the answer to that is yes. They’re not going to be able to beat the market so they might as well behave as if the prices are right.”

Secret superyacht trips and fake documents: how H2O tried to cover up a scandal

In the summer of 2019, H2O Asset Management faced a dilemma.

The UK’s Financial Conduct Authority had just asked the firm to hand over documents relating to a series of controversial investments it had made that were linked to Lars Windhorsta racy financier with a criminal past.

The regulator’s demand capped a torrid month for the asset manager, write my colleagues Robert Smith and Cynthia O’Murchu. An investigation by the Financial Times had recently revealed that it had poured substantial amounts of investor money into these illiquid securities, which led nervous clients to withdraw €8bn from the €34bn of funds it managed.

The request for evidence of the research and valuation work H2O had carried out posed a major problem: the firm had often performed little or no due diligence before buying the bonds and stocks, the FCA later found, while a valuation committee that was supposed to scrutinise the investments had not met for months.

Rather than owning up to these lax checks and balances, however, certain H2O employees falsified documents and even fabricated minutes of meetings that had never taken place, according to findings the British regulator published last month after a five-year investigation.

At the same time, H2O tried to hide from the regulator that its senior managers had for years been wined and dined by Windhorst — the notorious financier behind its illiquid investments — who had lavished the firm’s top brass with trips around the world on his private jet and superyacht.

When the FCA initially probed its dealings with the financier, H2O indicated that it had received no gifts and entertainment from Windhorst, the regulator revealed last month.

The alleged cover-up burst into public view when H2O last month agreed to pay €250mn to investors to help avoid a fine from the FCA, which described its regulatory breaches as “extremely serious”. The FCA accused H2O of attempting to “conceal certain matters” in order to “hide the severity of its due diligence and systems and controls failings”.

Read the full story here

Chart of the week

The value of European sustainable investment funds’ exposure to defence stocks has more than doubled since Russia’s invasion of Ukraine, as policymakers push the need for a strong defence industrial base.

About a third of funds in Europe and the UK focused on environmental, social and governance issues now have €7.7bn invested in the sector, write Lee Harris and Sylvia Pfeifer in London. This compared with €3.2bn in the first quarter of 2022, according to an analysis for the Financial Times by Morningstar Direct.

Although the rise in value is in part due to the share prices of defence companies soaring since Moscow’s full-scale attack on Ukraine in February 2022, many investors have also bought into the argument from governments that backing arms makers, long the subject of boycotts and student protests, should carry positive social connotations rather than exclusively downside risk.

“The situation in Ukraine has very much brought to the fore this idea of, ‘Can we actually defend ourselves?’,” said Sonja Laudchief investment officer at Legal and General Investment Management.

The fighting in Ukraine sparked a debate about whether military contractors can be viewed as an ESG investment.

While investment in controversial weapons such as cluster bombs and landmines as defined in international treaties is banned — a status that is well-established in the asset management industry — Laud believes defence can be seen as sustainable.

Companies would still need to be assessed individually, as would the weapons they make and which countries these were sold to, “but we would not exclude defence as a principle”.

10 top picks from while we were away

The meaning of the market sell-off: August’s rout signalled the end of post-pandemic stability and the beginning of a new period of unpredictability.

If at first you don’t succeed . . . Bill Ackman is seeking to resurrect the initial public offering of Pershing Square USA by offering sweeteners to early investors.

Lunch with the FT: investor and Labour donor Stuart Roden on the challenges facing Keir Starmer’s Britain — and why hedge fund management is like tennis.

The inside story of how hedge funds such as Ken Griffin’s Citadel are fighting back against the Securities and Exchange Commission’s ‘aggressive’ agenda.

Once considered a cash cow by dealmakers, Saudi Arabia’s Public Investment Fund has slowed spending on global investments, bringing an era of easy money to an end.

BlackRock’s support for ESG measures has fallen to a new low and Vanguard backed no environmental or social measures in 2024 proxy season.

Warren Buffett’s Berkshire Hathaway became the first publicly traded US company outside the technology sector to be valued at $1tn.

In the rolling hills of southern England, Blackstone boss Stephen Schwarzman has run into a formidable new opponent: the great crested newt.

Hargreaves Lansdownthe pioneering UK investment platform for retail investors, has agreed to a £5.4bn takeover by a group of private equity firms.

Chancellor Rachel Reeves wants to create a “Canadian-style” pensions model in the UK: here’s why Britain’s Local Government Pension Schemes present an opportunity.

And finally

Life, work and contemporary art come together in my friends’ Nicolas Mazet and Kate Davis’s sensitive renovation of an 18th-century manor house in Aix-en-Provence. Here’s the story behind a Provençal gallery-apartment.