The efficient market hypothesis contends that asset prices perfectly reflect all available information at all times. The theory assumes that market participants always make rational decisions, that publicly available information is immediately reflected in asset prices and, therefore, that price always equals value.
A direct implication of the efficient market hypothesis is that active fund management cannot possibly work – the theory suggests that it is impossible to beat the market because there is no such thing as a mispriced asset.
Since it was first postulated in the 1960’s, the efficient market hypothesis has been fundamentally discredited by a series of booms and busts which have undermined the theory in a number of ways. Primarily, the idea that all market participants make rational decisions always, has been exposed as fatally flawed.
The fields of economics and investment are more art than science – an understanding of human behaviour is far more relevant than assumption-based quantitative modelling. As such, we know that individuals are not always rational and that, in aggregate, markets do not always price assets perfectly.
Subsequent relaxations of the original strict hypothesis have still not fully explained asset price movements, which continue to regularly deviate from true value, particularly in the short-term – in other words, opportunities for genuinely active, long-term fund managers remain abundant.