You are reading the 2026 curriculum (exams up to November 2026). Sitting in February 2027 or later? Go to the 2027 Equities guide.
What efficiency means for analysts and for active vs passive investing
If markets are weak-form efficient, technical analysis cannot earn abnormal returns. If they are semi-strong efficient, fundamental analysis of public information cannot either, on average, yet it is exactly that analysis that keeps prices efficient. The more efficient the market, the stronger the case for low-cost passive investing.
Before this: Weak, semi-strong and strong-form efficiency
On the exam
- Explain the implications of each form of market efficiency for fundamental analysis, technical analysis, and the choice between active and passive portfolio management
Explain the implications of each form of efficiency for fundamental analysis, technical analysis and the choice between active and passive management. Expect: which analysis can still earn abnormal returns under a given form; what a portfolio manager still adds in an efficient market; an active return after fees.
How deeply to learn each part
- Know the idea
- Understand it in general. It frames other topics, but you will not calculate with it.
- Use it
- Understand it well enough to solve a question with it. Recognize when it applies.
- Memorize
- Learn it by heart. The exam will not give it to you.
You know this one. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still do.
You tested strong here. The full lesson is folded away. The takeaways, formulas and checkpoint below are your quick refresher, and the checkpoint is a fair test of whether you still know it.
What does each form of efficiency imply for analysis?
Each form removes one more way to earn abnormal returns. Weak form removes technical analysis. Semi-strong removes fundamental analysis on average. Strong form removes everything.
Technical analysis studies patterns in past prices and trading volume to guide trades. Fundamental analysis estimates a security’s intrinsic value from company, industry and economic data, then buys what is priced below it and sells what is priced above it.
- Weak-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis can still add value
- Active management can work, using fundamentals
-
- Semi-strong-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis none on average from public data, yet it keeps prices efficient
- Active management passive favored; active must justify its fees
-
- Strong-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis no abnormal returns
- Portfolio management passive; the manager still adds value through fit
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Read it by asking which information set the method uses. Technical analysis uses past market data, the weak-form set, so it fails under all three forms. Fundamental analysis uses public information. It fails under semi-strong and strong, but can still earn abnormal returns when only the weak form holds. Inside information is the only edge left when the market is merely semi-strong efficient.
If prices already reflect public information, why do analysts exist?
Because their work is what puts the information into prices. When analysts research a company and trade on what they find, the price moves to reflect it. That is how semi-strong efficiency comes about.
If everyone stopped doing fundamental analysis, prices would drift away from value and the work would start to pay again. So fundamental analysis is necessary for efficiency, even if on average it does not earn abnormal returns after its costs. Analysts who are faster, better informed or more insightful can still win. The average active manager cannot, after fees.
Technical analysts play a similar part for the weak form. Suppose a profitable price pattern exists. Many investors will find it and trade on it. Their trades erase the pattern, which maintains weak-form efficiency.
What does efficiency mean for active versus passive investing?
If prices reflect past and public information, active trading is unlikely to beat the market consistently, so low-cost passive investing should do better. Funds tend to match the market before fees and expenses, and trail it after them.
The measure is the active return : the portfolio’s return minus the benchmark’s.
A fund returns 7.30% after fees. Its benchmark returns 7.60%. The fund's active return is closest to:
7.30% − 7.60% = -0.30%
Active return-0.30%
- 7.3−7.6=-0.3
- 7.3ENTER7.6−-0.3
ENTER enter (on the HP, puts the number on the stack)
Exam tip Always check whether a return is before or after fees. The exam likes to give one and ask about the other.
What does a portfolio manager do in an efficient market?
The job is not to beat the market but to build a portfolio that fits the client. With no stock-picking edge, a manager still earns a fee by getting the following right.
- Risk tolerance how much volatility the client can bear
- Time horizon and liquidity needs when the money is needed
- Taxes the client's tax position
- Diversification and asset allocation spread risk across assets
A retiree who needs income and a young saver who can ride out falls should hold different portfolios, even in a market where neither can beat the index. That is where a manager’s value lies. Index investing also needs this work: choosing which indexes to hold, in what mix, is a decision about risk, horizon and taxes.
Go deeper Does technical analysis survive in practice?
Studies of developed markets find that trading rules based on past prices do not earn consistent abnormal returns after costs. Some patterns persist for a time, but exploiting them is expensive and attracts competition that removes them. Evidence from some developing markets is more favorable. Technicians also argue that simple tests miss their sophisticated and subjective methods, and since there are endless possible rules, that claim is hard to refute. The 2026 Level I curriculum has no separate technical analysis module, so only the efficiency link is examined here.
Go deeper A caution when reading fund studies
Studies of fund performance must handle survivorship bias: funds that perform badly are closed or merged and drop out of the data, which flatters the average. Even with that adjustment, the typical fund does not beat the market after fees. Index funds are not free either, but their costs are far lower.
Memorize this
MemorizeThe implications grid
| If efficient at… | Technical | Fundamental | Portfolio management |
|---|---|---|---|
| Weak form | no abnormal returns | can still add value | active can work |
| Semi-strong | no abnormal returns | none on average | passive favored |
| Strong form | no abnormal returns | no abnormal returns | passive, manager adds fit |
Memory hook Technical dies first, fundamental second, inside information last. Weak form kills technical already.
Know it cold Fundamental analysis is the engine of efficiency. Managers add value through risk, diversification, taxes and client fit.
- Weak-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis can still add value
- Active management can work, using fundamentals
-
- Semi-strong-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis none on average from public data, yet it keeps prices efficient
- Active management passive favored; active must justify its fees
-
- Strong-form efficient Memorize
- Technical analysis no abnormal returns
- Fundamental analysis no abnormal returns
- Portfolio management passive; the manager still adds value through fit
-
- Risk tolerance how much volatility the client can bear
- Time horizon and liquidity needs when the money is needed
- Taxes the client's tax position
- Diversification and asset allocation spread risk across assets
Quick example
A portfolio returns 12.5% and its benchmark returns 11.2%. 12.5 − 11.2 = 1.3%. Use the return after fees to judge what the investor kept.
- 12.5−11.2= 1.3
- 12.5ENTER11.2− 1.3
ENTER enter (on the HP, puts the number on the stack)
How it is asked
-
Weak-form but not semi-strong
A market is weak-form but not semi-strong efficient. Which approach can earn abnormal returns?
Analysis of published financial statements. Moving-average and momentum rules use past data, already reflected.
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Semi-strong and fundamental analysis
What is fundamental analysis in a semi-strong efficient market?
Necessary for efficiency, but no abnormal returns on average. Trap: "useless".
-
Strong form and managers
In a strong-form efficient market, how does a manager add value?
Diversification and fit to risk tolerance and taxes, not stock picking or timing.
-
Active return
Fund returns 10.2% before 0.9% of fees. Benchmark 9.0%. Active return after fees?
10.2 − 0.9 − 9.0 = +0.3%. Trap: +1.2% ignores the fee.
Exam traps
- Saying semi-strong efficiency makes fundamental analysis worthless. It is what produces the efficiency.
- Saying portfolio managers have no role in an efficient market. They fit the portfolio to the client.
- Placing technical analysis under the semi-strong form only. It already fails under the weak form.
- Judging active managers before fees. The average fund roughly matches the market before fees and trails it after.
Checkpoint
4 exam-style questions. About 90 seconds each.
1If a market is weak-form efficient but not semi-strong-form efficient, an investor is most likely to earn abnormal returns using:
2In a semi-strong-form efficient market, fundamental analysis is best described as:
3In a strong-form efficient market, a portfolio manager most likely still adds value by:
4A fund returned 10.2% before fees and charged fees of 0.9%. Its benchmark index returned 9.0%. The fund's active return after fees is closest to:
Key takeaways
- Weak form defeats technical analysis. Semi-strong defeats fundamental analysis on average. Strong form defeats everything.
- Fundamental analysis is the engine of efficiency.
- The more efficient the market, the stronger the case for low-cost passive funds.
- Managers still add value through risk, diversification, taxes and client fit.
Quick example
A portfolio returns 12.5% and its benchmark returns 11.2%. 12.5 − 11.2 = 1.3%. Use the return after fees to judge what the investor kept.
- 12.5−11.2= 1.3
- 12.5ENTER11.2− 1.3
ENTER enter (on the HP, puts the number on the stack)
Questions about this lesson?
Where this comes back
- Market anomalies: calendar, momentum, size, value and more Market Efficiency
- Portfolio Management: An Overview Portfolio Construction
Questions candidates ask
Does market efficiency mean active management is pointless?
Not entirely. In less efficient markets skilled managers can add value. In highly efficient ones, low-cost passive funds tend to win after fees.
Can technical analysis work if markets are weak-form efficient?
No. Weak-form efficiency means past prices and volume are already reflected, so trading rules based on them cannot earn abnormal returns.
Why do we need fundamental analysts if markets are efficient?
Their research and trading are what make prices efficient in the first place.
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