Investing
In his September 2024 paper, The Less-Efficient Market Hypothesis, Cliff Asness reports that financial markets have become less efficient over the past 30 years. Asness, a former student of Eugene Fama, challenges the traditional Efficient Market Hypothesis (EMH), suggesting that markets are now less informationally efficient, especially in the medium term. He argues that this growing inefficiency leads to more stocks becoming disconnected from their fundamental values and taking longer to correct. As a result, while value investing can still outperform over time, the “long term” now stretches further than before.
Asness identifies three key factors driving this decline in efficiency: technological advancements—focusing on the rise of social media; the gamification of trading; and easier access to financial markets. Social media speeds up the spread of market sentiment, contributing to volatility that undermines rational pricing. He reports these factors have amplified price swings, causing stock movements based more on speculation and hype rather than fundamentals.
Asness’s firm, AQR Capital Management, has experienced highs and lows in its active management performance. Once one of the largest hedge funds peaking at $226 billion in 2018, AQR saw its assets under management cut in half due to underperforming systematic strategies. However, investment performance has rebounded strongly in the last two years, with its flagship Absolute Return strategy returning 44 percent net in 2022 and 19 percent net in 2023.
Morningstar data reflects mixed outcomes for active management. While only 29 percent of active funds outperformed passive peers over the 10-year period through June 2024, the 12-month period ending June 2024 saw 51 percent of active strategies outperform. This shift highlights that short-term market conditions may allow for periods where active strategies perform better than passive ones. (Morningstar’s Active/Passive Barometer report is a semiannual publication that compares the performance of active funds to their passive peers. The report analyses over 8,000 funds that represent approximately 55 percent of the US fund market.)
Fama, whose Efficient Market Hypothesis forms the foundation for much of modern financial theory, remains unshaken by Asness’s critique. His theory is that stock prices at any given time reflect all available information, making it extremely difficult for investors to consistently outperform the market. This idea has been foundational for modern finance, especially for the growth of passive investing, where funds track market indexes rather than actively picking stocks.
In a September interview with the Financial Times, Fama acknowledges markets are not perfectly efficient, but argues that the overall efficiency of markets remains intact because of the collective intelligence of millions of investors. He believes that while prices may be wrong at times, market forces correct mispricings over the long term. Fama stands by the EMH as a valuable framework for understanding financial markets, emphasizing that a long-term investment horizon and diversified portfolio are key to success in both efficient and less-efficient markets.
In conclusion, while Asness points to increasing inefficiencies, both he and Fama agree that a long-term perspective and diversification are essential for investors navigating today’s markets.