In a bold challenge to modern finance, Cliff Asness, co-founder of AQR Capital Management, has published a new paper arguing that financial markets are becoming less efficient. His “Less-Efficient Market Hypothesis,” released in September 2024, directly questions the work of his former professor, Nobel laureate Eugene Fama. Asness claims that factors like social media and easier market access are causing stock prices to stray from their true value for longer periods.
Asness’s Case for a Less-Efficient Market
The central idea of the new paper is that the long-standing Efficient Market Hypothesis (EMH) no longer fully captures the reality of today’s financial world. While the EMH suggests that all available information is quickly baked into stock prices, Asness provides evidence that this process is slowing down.
He argues that while strategies like value investing still work, the time it takes for an underpriced stock to return to its fundamental value has grown longer. Asness points to three main reasons for this growing inefficiency:
- Technological advancements, with a focus on social media.
- The gamification of trading, which encourages speculation.
- Wider accessibility to financial markets for less-experienced investors.
Social media platforms like Twitter and Reddit are singled out as major contributors. They can amplify market sentiment and speculative trends, leading to sharp price movements that have little to do with a company’s actual performance. This creates more volatility and makes it harder for the market to correct itself quickly.
AQR’s Wild Ride as a Real-World Test
The experience of Asness’s own firm, AQR Capital Management, serves as a compelling case study. Once a giant with $226 billion in assets in 2018, the firm saw its assets cut in half after its rules-based strategies, which depend on market efficiency, struggled.
However, AQR has staged a remarkable comeback. In 2022, the firm’s main fund delivered an incredible 44 percent return, followed by another 19 percent in 2023. This turnaround supports Asness’s argument that while markets may be less efficient, these conditions create bigger opportunities for skilled active managers who can spot and exploit mispricings.
The Active vs. Passive Debate Heats Up
This new theory adds fuel to the fire in the long-running debate between active and passive investing. Data from Morningstar shows a complex picture. Over the last 10 years, passive funds have been the clear winners.
However, in the most recent 12-month period ending in June 2024, the tables have turned slightly, with a small majority of active funds beating their passive rivals. This recent trend seems to support Asness’s claim that current market conditions are more favorable for active management.
| Time Period | Percentage of Active Funds that Outperformed Passive Peers |
|---|---|
| 10-Year Period (Ending June 2024) | 29% |
| 12-Month Period (Ending June 2024) | 51% |
Despite the recent success, the long-term data still shows that only 29 percent of active funds outperformed passive peers over the 10-year period, reminding investors that consistent success is hard to achieve.
Fama Defends His Cornerstone Theory
Eugene Fama, the father of the Efficient Market Hypothesis, remains confident in his theory. In a September 2024 interview, he admitted that markets are not perfect but argued they are efficient enough to make outperformance extremely difficult for most.
Fama believes that even if individual stock prices are wrong sometimes, the collective wisdom of millions of investors eventually corrects them. His work laid the foundation for passive investing, which involves tracking a market index like the S&P 500 instead of trying to beat it.
“The key to success in any market—whether efficient or not—is maintaining a long-term investment horizon and a diversified portfolio,” Fama stated, reinforcing his long-held advice for investors.
