In the mid- to late-1990s, the performance of the pros was...

Name: Problem 6, Chapter 22: Fundamentals of Corporate Finance
Uploaded: 2020-07-11T22:39:18-08:00
Duration: 51 s
Channel: Achintya Suden
Description: In the mid- to late-1990s, the performance of the pros was unusually poor-on the order of 90 percent of all equity mutual funds underperformed a passively managed index fund. How does this fact bear on the issue of market efficiency?

In the mid- to late-1990s, the performance of the pros was unusually poor-on the order of 90 percent of all equity mutual funds underperformed a passively managed index fund. How does this fact bear on the issue of market efficiency?

Key Concepts

Performance Measurement and Costs

This concept encompasses the evaluation of investment performance relative to benchmark indexes while considering expenses such as management fees and transaction costs. The consistent underperformance of many mutual funds highlights that, after accounting for these costs, active strategies often fail to generate superior returns, further indicating that markets tend to price securities efficiently.

Efficient Market Hypothesis

This theory posits that asset prices reflect all available information, making it impossible to consistently achieve returns in excess of average market returns on a risk-adjusted basis. The performance of most actively managed funds, which underperformed a simple index strategy, lends support to the idea that market prices are efficient and that any advantage by active managers is quickly neutralized by market forces.

Active vs. Passive Management

Active management involves selecting securities and timing the market in an effort to outperform an index, while passive management tracks a market index with minimal intervention. The observed underperformance of the majority of actively managed equity mutual funds compared to passively managed index funds suggests that the additional costs and risks associated with active management may not be justified, which aligns with the implications of market efficiency.

Transcript

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