Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 224

Are there opportunities for an active manager in an efficient market?

We view the Australian stockmarket as highly efficient. There are a large number of domestic research analysts, brokers, fund managers and investment professionals poring over the listed securities. In such an environment it is difficult, if not impossible, to regularly be smarter than the other informed market participants.

How does an individual stock picker outperform over long periods of time? Why would such a market present outstanding individual risk-adjusted opportunities for investors? It is a good question to ask if you are invested with an active manager. It has been a key question for researchers for a long time. Professor Eugene Fama’s Efficient Market Hypothesis (EMH) proposed that it is impossible to beat the performance of a liquid stockmarket over time because prices constantly incorporate and reflect all relevant information.

Opportunities come from cognitive biases

If we find a stock that we think is compellingly cheap, one of the first questions we ask is why we are getting the opportunity. What circumstances have led to the mispricing? What are people reacting to in order for the stock price to have deviated so far from our perception of fair value? The absence of a logical answer might infer a problem with the analysis, rather than an opportunity for an attractive purchase. The collective market is almost always more informed than the individual investor, assuming the investor is an outsider to the company under consideration.

We think we find opportunities for one predominant reason. Market participants have cognitive biases that lead to emotional rather than rational responses to new or changing circumstances. We are no different. We feel the same emotional responses. Our role is to invest as rationally as possible. We focus attention on the facts and try to remove the influence of the emotional response from our thinking.

Good investments typically come in one of three forms. The first is at the stock level. A company has a temporary setback or earnings revision and the market extrapolates the problem across the entire business. We focus on the medium-term outlook and ask whether we can make sensible, modest forecasts about earnings over the following few years. If earnings are delivered as expected, would this make buying at the current stock price attractive? A favourable answer means there’s a time horizon arbitrage in a company we would like to own for a long time.

Secondly, sometimes a whole sector might screen as attractively priced because the market is focused on a threat that appears overblown. An example is shown in the chart below.

In May 2014, the Federal Government proposed a restrictive and somewhat unpopular budget to assist in repairing the budget deficit. Over the following six months, the market sold retail stocks that many assumed would be significantly impacted by any cut to disposable income. The likely numerical impact of any budget measures on consumer discretionary spend was, on our analysis, likely to be small and transitory in nature. It gave an attractive entry point into a number of high quality retailers that we had been watching for some time.

Thirdly, there may be a market-wide reaction to a particular event, such as the surprise election of Donald Trump or UK’s Brexit vote. Participants in the domestic market reacted to Brexit by selling financial stocks in the weeks that followed. We believed the risks to corporate earnings were relatively low. Similarly, it was unclear why the election of President Trump would negatively impact the earnings of Australian companies, yet at one point in the afternoon of the election the domestic stockmarket was down nearly 4% (as highlighted below). Many individual stocks were down considerably, having already fallen on the uncertainty heading into the election.

Need to be patient for these opportunities

Outstanding opportunities do not come along frequently, and certainly not predictably. In the intervening periods, investors should be as patient as possible, remaining focused on their existing portfolio and ready to respond rationally. There may be an opportunity to invest sensibly in familiar companies with quality attributes.

We agree with the notion that the market is most often efficient, but that the difference between ‘often’ and ‘always’ is like night and day. Opportunities for the value investor occur when the majority of market participants are distracted from the immediate opportunity by an issue where the impact is either exaggerated or transitory. This is when we become most interested and plan to take full advantage for the long-term.


Tim Carleton is Principal and Portfolio Manager at Auscap Asset Management, a boutique Australian equities long/short investment manager. This article is general information and does not consider the circumstances of any individual. A person should obtain the Product Disclosure Statement before deciding whether to acquire, or to continue to hold, units in any Auscap fund.


Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates


$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reason to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies will benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.


Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated investors' can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.



© 2021 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.