Question

1. Assuming the Efficient Markets Hypothesis correctly describes financial markets, what implications does this have for the performance of active portfolio managers?  What types of returns should investors expect to earn if the EMH is correct?

Answer 1

Efficient Markets Hypothesis correctly describes the financial markets states that the prices of investment are at their true value. The stock prices are neither overstated nor understated. This implies that in order to gain higher returns, the investor’s needs to invest in those securities which are riskier. As according to the risk-return theory, higher the risks of an investment/security, higher are the chances of return.

The active portfolio managers regularly look at the investment; active portfolio managers take active part in scanning and evaluating the returns of every portfolio. The active portfolio managers are even costly than the passive portfolio managers as they regularly monitor the investments. The implications on active portfolio manager are that their role has increased. They try to find out and build a distinct and attractive portfolio by judging the market such that the needs of investors are satisfied.

The returns which investors expect are in accordance with the securities in which they have invested. As under efficient market hypothesis, the prices of securities show true value of investment. The stocks are neither overvalued nor undervalued. So, in order to earn high returns, high risk investments are preferred.