Efficient Market Hypothesis (EMH)

Originally coined by Louis Bachelier in his 1990 dissertation called the Theory of Speculation as well as additional research by Paul Samuelson (MIT), Burton Malkiel (Princeton) and Eugene Fama (University of Chicago), the idea is that the professional managers as a whole cannot “beat the market.” EMH supports the idea that the existing stock prices reflect all the relevant and knowable information so it is impossible to speculate and forecast future prices. Once costs are considered, speculative analysis underperforms a “random walk” approach.

Abundance utilizes EHM in that it engineers a broad market portfolio comprised of various asset classes of investments without the need to speculate on future prices and earnings.

Modern Portfolio Theory (MPT)

Modern Portfolio Theory was developed by 1990 Noble Prize Winner Harry Markowitz. The underpinnings of MPT are that portfolio risk can be reduced by holding various assets that have dissimilar price movements. The cliché “don’t put all your eggs in one basket” is a simple way of explaining that since different types of asset classes do not move in step with one another, it is important to have differing types of investments to manage risk. MPT states that there are two specific types of risk:

MPT allows an investor to maximize their return for a given level of risk. Markowitz refers to this as the Efficient Frontier.

Three Factor Model

Eugene Fama, Sr. and Kenneth French of the University of Chicago identified that there are three factors that explain investment returns in a portfolio. By constructing portfolios based on this research, you have the potential to capture returns in the market. Until Fama and French developed this three factor model, most investment portfolios were constructed utilizing a single factor approach. This single factor approach known as the Capital Asset Pricing Model (CAPM) states that stocks are riskier than bonds but provide a higher return than bonds. William Sharpe (1990 Noble Prize) first expressed CAPM in the early 1960’s. Fama and French discovered the other two factors in the early 1980’s by researching stock market returns going back to the early 1920’s.

Free Market Portfolio Theory utilizes the Three Factor Model by engineering and constructing portfolios based on these three factors:

Rebalancing

Abundance monitors portfolios to ensure that asset categories do not deviate from their intended asset allocation weights and targets. By selling asset categories that have exceeded their target weights and buying more of the underperforming targets, Abundance is adhering to the maxim of selling when the prices are high, and buying when prices are low. This monitoring process is an ongoing discipline that is irrespective of future economic forecast or stock market outlooks and adheres to the principles of Modern Portfolio Theory and the Efficient Market Hypothesis