There is an investment approach backed by academic and Nobel Prize winning research called Free Market Portfolio Theory. Free Market Portfolio Theory is comprised of three academic and scientific components:

1. The Efficient Market Hypothesis
2. Modern Portfolio Theory
3. The Three Factor Model

The Efficient Market Hypothesis is based on the work of economists Adam Smith, who wrote Wealth of Nations in 1776 and is the backbone of our free enterprise system today, F.A. Hayek and Dr. Eugene Fama. Dr. Fama published a groundbreaking work in 1965 in the Financial Analysts Journal aptly named “A Random Walk in Stock Market Prices.” Borrowing from the work of Adam Smith and F.A. Hayek, Dr. Fama posited that the market prices goods and services appropriately and that prices are random and unpredictable. Further, since all knowable information is already in the current price, it is unlikely for someone to consistently find undervalued or overpriced securities. What this tells us is that it is not possible for anyone to consistently predict where prices will go. Since it is difficult to predict market movements and capture additional returns unrelated to risk. Therefore it is prudent to build portfolios that capture the returns of all markets including all global markets.

Modern Portfolio Theory (MPT) refers to an investment strategy that seeks to construct an optimal portfolio by considering the relationship between risk and return. MPT suggests that the risk of a particular stock or portfolio should not be looked at in a vacuum (but rather how its performance varied in relation to the overall market.) In using MPT a consultant’s goal is to identify a client’s acceptable level of risk tolerance and then construct a portfolio with the maximum expected return for that level of risk.

Three Factor Model, popularly known as Fama and French three-factor model, is one of the most followed portfolio management models. The model was developed in 1993 by Eugene Fama and Kenneth French; by modifying other very popular investing model Capital Asset Pricing Model (CAPM). Three-factor model is widely followed by investors and fund managers to analyze risk and return associated with instruments/markets and to make highest return for risk taken.