Question

Question 2 (40 Marks)

Your friend recommends an actively managed mutual fund to you. However, after you learned the Efficient Markets Hypothesis (EMH), you start to think about whether to buy the fund or not. Discuss the implications of EMH to your investment decision or strategy within 500 words. Use examples to illustrate your arguments and justify your conclusion.

Answer 1

The efficient market hypothesis states that the market price includes the impact of all kind of information available related to the particular security. Thus, as per EMH it is not possible to beat the market portfolio or the index and thus investing in an actively managed fund is a futile exercise since the fund won't be able to beat the index.

Thus building on the above stated hypothesis, it may not be a good idea to invest in a mutual fund which is actively managed and which charges a premium on fund management fees and then get a return equal to index fund only.

For example if the index fund produces a yield of 5% and the actively managed fund also produces a return of 5% and if the fund management fees is around 0.05% of the aum then the investor actually loses by investing in an active fund