Down 2,000 points; up 3,000 points; down 1,000 points; then up 1,300 points. The daily volatility in the Dow Jones Industrial Average during the COVID-19 crisis has left investors aghast. The drastic swings in stock prices seem untethered from the business environment, instead reflecting the extremes of investor hopes and fears as prospects for containing the virus ebb and flow.
Yet for economic recovery to begin after the crisis has passed, markets and business reality need to become reconnected, so that the prices of securities reflect the value of the assets underlying the securities.
This type of market “efficiency” is the cornerstone of developed economies. Efficient markets allow corporations to make more informed capital allocation decisions, given that prices reflect underlying value. In addition, their transparency encourages broader investor participation, thereby increasing liquidity, while making it easier for investors to diversify risk.
Active management, therefore, is a crucial driver of market efficiency. As part of the security selection process, active managers perform research on issuers, analyze assets underlying securities and assess values. Through the buying and selling process, active managers establish the market prices for securities. As a result, active managers can counteract biases in the marketplace by aligning price and value. Active managers can also play a role in providing intraday liquidity to other traders.
To learn more about the critical role of active management in market efficiency, take a look at these Active Managers Council publications: