Question

1. Critically evaluate the following statement: If markets are semi-strong efficient, then CAPM alpha produced by an active fund manager can only be explained by either random luck, fraud or insider activity.

Answer 1

The semi strong form of market efficiency says that you cannot use any publicly avoided information to predict the direction of future stock prices. It says that all the publicly available informations are already reflected in stock prices and there is no additional benefits by doing any fundamental analysis or by paying extra amount to Fund managers for profit.

By analysing historical data, it has been seen that this statement is true when compared with the returns generated by active fund managers and the index return. Index has performed than majority of such fund managers which indicates that the alpha produced by active fund manager is either due to randomness, fraud or insider informations.

But as a counter argument, there has been investors like Warren Buffet, Peter Lynch etc who has consistently outperformed the market. Also the underperforming of the active funds can be attributed to the high fees charged by the managers for managing the funds. Without considering the fee aspect, it has been found that active managers are overall better than the market.