In a theoretically ideal market in which participants have equal access and understanding of information, efficiency should occur. In this environment, actively managed portfolios should, on average, not be able to outperform indexed portfolios. Thus, the value added by actively managed portfolios – the difference between their return and a properly chosen benchmark – should be zero before costs. The review paper, “The Efficient Market Hypothesis and Its Critics” by the theory’s originator, Burton Malkiel, offers a comprehensive review and rebuttal of the modern critiques of the theory.

A dramatic display of market inefficiency is found in the “SPIVA Institutional Scorecard: How Much Do Fees Affect the Active Versus Passive Debate” [Ref. 3] published by S&P Dow Jones Indices (referred to in what follows as the SPIVA scorecard). Here, market inefficiency works in the opposite direction to what one might have expected: persistent underperformance by mutual funds and institutional accounts both gross and net of investment costs. The under-performance is measured in the SPIVA scorecard by the fraction of portfolios / accounts that under-perform their benchmark. Under-performance on average here extends across small, mid, and large cap. U.S. equities, value and growth tilts, emerging and global equities and several fixed income asset classes as well with only a handful of exceptions. The persistent underperformance begs the question, “who is winning?”.