The term market efficiency refers to the degree to which market prices of securities reflect all available, relevant information. In an efficient market, securities are always fairly priced, and it is impossible to consistently achieve higher returns without taking on additional risk. 

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The concept of market efficiency is central to the Efficient Market Hypothesis (EMH) by Nobel Memorial Prize winner Eugene Francis Fama. According to the EMH, it is difficult to “beat an efficient market” through either technical analysis or fundamental analysis because stock prices already incorporate and reflect all relevant information. Therefore, it shouldn’t be possible to outperform the overall market through expert stock selection or market timing. As a result, the only way an investor can achieve higher returns than “the market” is by taking more risk (purchasing riskier investments).

With regard to the above, it is no surprise that the EMH is highly controversial, as there are obviously actively managed mutual funds available to investors which were able to beat “the market,” even over long-term periods.

That said, there are three types of market efficiency in the EMH:

Weak Efficiency: Prices reflect all past trading information, such as historical prices and volumes. Therefore, technical analysis can’t consistently predict future price movements.

Semi-Strong Efficiency: Prices reflect all publicly available information, including financial statements, news, and economic data. As a result, neither fundamental nor technical analysis can consistently achieve superior returns.

Strong Efficiency: Prices reflect all information, both public and private (insider information). Therefore, no one can consistently achieve superior returns, even with insider information.

While no market is perfectly efficient, understanding the level of efficiency helps investors make more informed decisions about their investment strategies and expectations for returns.

As a result, from the Efficient Market Hypothesis, it can be concluded that investors should use (cheap) passive investment products (ETFs or index funds) in highly efficient markets and actively managed products in less efficient markets. That said, literally all markets have become more efficient since the introduction of the EMH as more information is available in a timely manner to a wider public than it was in the past.

In addition, the number of investors who want to take profit from market inefficiencies, such as the so-called investment factors or the in-transparency in some emerging markets or in the small cap segment, has increased, which means there is more money chasing the same market inefficiencies. Therefore, these investors can be seen as arbitrageurs who will eliminate the respective inefficiencies even in markets with a weak efficiency over time. This means it becomes even harder to achieve superior returns in any market over time.

Nevertheless, there are active fund managers who are able to “beat the market” even over long-term periods. While some do question if this is by luck or skill, or if they have taken bets outside of “their market,” I would also see this as a sign that markets might not be efficient all the time.

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