Less Efficient Markets = Higher Alpha? | CFA Institute Enterprising Investor
Posted In: Alternative Investments, Drivers of Value, Economics, Equity Investments, Performance Measurement & Evaluation
On the other hand, some students decided early on to pursue careers in finance and studied accordingly. Telling them to build better fertilizers or rocket ships makes little sense. But finance career advice is getting harder and harder to provide. Why? Because global capital markets are already highly efficient and each day machines are grabbing more and more market share from humans. The career prospects for someone with a master’s degree in finance and some basic Excel skills are steadily diminishing.
Alpha Generation in US Equity Markets
US Equity Mutual Funds: Percent Underperforming Their Benchmarks
Sources: S&P SPIVA Scorecards 2020, FactorResearch
Equity Funds Underperforming Their Benchmarks over the Last Three Years
Equity Funds Underperforming Their Benchmarks: Developed vs. Emerging Markets
To be fair, the lack of alpha generation from mutual fund managers is nothing new. Academic research has flagged it for decades. Capital allocators emphasize that it is all about identifying the few funds that generate consistent excess returns. This is an interesting point to evaluate in emerging markets. Fund managers should have more opportunities to gain a competitive edge given higher information asymmetries compared to developed markets.
Performance Consistency: Percent of 2016 Top Quartile Funds Remaining in Top Quartile
Emerging Market Hedge Funds vs. Equities and Bonds
Sources: HFRX, FactorResearch
Image credit: ©Getty Images / Mats Anda
Tags: alpha, emerging markets, equities, Investment Management Strategies, Investment Products and Asset Classes, mutual funds, stocks, US equities
1 thought on “Less Efficient Markets = Higher Alpha?”	
“Management fees reduce alpha, to be sure, but the primary reason is that stock picking is simply difficult, regardless of the market.”
Let’s critically consider this statement.
If the main reason for the majority of active fund managers underperforming the index were indeed the “difficulty” in analyzing stocks, then why would a static, broad collection of arbitrarily chosen stocks (aka the benchmark or index) consistently outperform the curated lists selected by investment management professionals?
Under the author’s logic, this phenomenon would require an extraordinary explanation!
Nay, the real reason for underperformance is much simpler:
Real portfolios have friction costs (management fees, trading commissions, withholding taxes, market impact costs, implementation delays) that imaginary portfolios do not.