Imagine a world where we each knew everything there was to know about an investment and it’s prospects. A perfect world in which all information is available to every investor at the same time - a truly efficient market.
If this situation existed in the share market, for instance, we would all have to pursue a passive, buy and hold strategy because we, and everyone else, would know all there was to know about a particular share investment. We couldn’t have any extra insights that no-one else had been able to find and we certainly wouldn’t be able to consistently earn more than the overall market itself over time.
So how efficient are markets? How widely spread is information on potential investments.
Is it possible to hit the jackpot by digging further and deeper than everyone else and uncovering positive information that the market as a whole has not yet figured out.
When the efficiency of the market is discussed three different levels of efficiency are considered. The first level is the weak form. The weak form assumes that current share prices reflect all historical market information such as price trends, trading volumes and so on - things that have already happened.
If that is the case, then the trends of a share price movements will contain no useful information that will enable an investor to figure out what it’s value will be tomorrow, next week or in a years' time.
The next level is the semi-strong form which suggests that share prices rapidly adjust to the release of all new information into the public arena and so no investor can exploit publicly available information to earn above average returns.
The third and last level is the strong form of market efficiency. This form contends that share prices reflect all possible information be it public or non-public. A perfect world.
The good news for active managers is that, while there is good support for the weak form efficient market theory, and some support for semi-strong, there is general rejection of the strong form.
Therefore, fundamental company research can add value. Fundamental research is when a manager seeks to understand a company's value by looking at the underlying economic fundamentals, undertaking company visits and so on. If their calculation of the shares value is higher than the actual price the investor may be in position to profit. The assumption is that the market will eventually recognise true value - that the market is occasionally less than totally efficient.
We continue to incorporate some active management into our strategies believing that markets are not totally efficient.
