Market Efficiency, Investment Decisions, and Portfolio Management

This report provides an in-depth analysis of market efficiency, exploring both efficient and imperfectly efficient market scenarios. It examines the strategies investors can employ in each market type, including the importance of company performance analysis in efficient markets and the potential for profit through identifying undervalued or overvalued securities in imperfect markets. The report delves into asset allocation techniques, the role of diversification, and the significance of long-term holding periods. Furthermore, it investigates the investment philosophy of asset management companies, emphasizing the advantages of diversification, the need for active participation, and the importance of thorough research. The report also discusses the systematic and unsystematic risks associated with investments and how diversification can help mitigate these risks. The report concludes by discussing the investment philosophy of an asset management company, highlighting diversification as a key strategy and its benefits in terms of risk management and return generation.

Asset Management Company
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Market efficiency
Market efficiency means that situation in the financial market where the expected return of the market is
equal to the required rate for return (Hamid, 2017). The market price of the securities is equal to the
intrinsic value of the security and they should not be either overpriced or underpriced.
The strategy used in the efficient market by the investors
In an efficient market the price of the securities nor undervalued neither overvalued and is not expected to
fluctuate in the future period also apart from unforeseeable events that can influence the price of the
security. Thus in this type of market the only sensible way to earn better return is to invest in the company
which is performing better than others and giving higher returns as compared to the other companies in
the market. The prediction of the future price is worthless as the prediction of stock price is simply
prediction of the future which is not practical. Simple trading is the better option and a good strategy to
earn good return. The positive and negative information that are associated with the security should be
evaluated and studied as they can change the price of the stock in the future. The external factors
associated with the stock will become more important as that they become the price fixture for the
investors in the financial market. The market portfolio stated in the answer will be the portfolio of all the
securities that are presently available in the market. The market portfolio is calculated by weight age of
each type of securities (Paranjape, 2013). Therefore in this case the weight of the each type of security is
calculated by dividing the market value of the security with the aggregate market value of all the
securities that are available in the market
The investors can use asset allocation technique in an efficient market situation the asset allocation
techniques provide the investors and option to maintain risk of their portfolio as per their expectation and
return of the portfolio can be decided to the highest keeping in mind the risk to be maintained (Andonov,
2017). The asset location is also a good technique for hedging the portfolio. Different securities have
different return and risk which, some securities provide higher risk but the return coming from that
particular stock is also high and some investing option can provide constant and less return but are less
risky from financial point of view. In an efficient market holding period of the security should be long as
the market is less volatile and the good stocks once purchased will give a high return for a very long time.
Investment decision in an imperfectly efficient market
Imperfectly efficient market is the market where the security is either undervalued or overvalued. The
imperfectly efficient market provides the investors with some profit making opportunities (Martin, I.,
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2017). If the security is undervalued the security should be purchased and a long position should be
created by the investor. But if the security is overvalued than a short position should be created by the
investor by selling the securities in the market (Weinstein, 2014). The imperfectly efficient market gives
profit making opportunities to those only that can make accurate calculation of the intrinsic value of the
shares. The overvaluation of undervaluation of the security is determined only if the correct intrinsic
value is calculated by the investor (Korinek, 2016). The determination of the undervalued and overvalued
security gives the investor opportunity only if that recognition is made within proper timeline.
The overvaluation of the security can be due to much reason and some of them are due to high demand of
the particular stock in the market, overvaluation can also be due to the rumors about the stock which state
that the stock will bring more than average return in the future market. The undervaluation of the stock
than the intrinsic value of the shares is also due to the same reasons as mentioned above (Prat, R., 2016).
In the perfectly inefficient market investing options diversification is the perfect and best strategy for the
investors. The investors should concentrate to making the portfolio that generate highest return with
lowest risk and the highest return can be achieved with the help of these underpriced and overpriced
securities.
The portfolio management in the imperfectly efficient market is made by considering the required rate of
return of the investors which will be the minimum return which the investor will be expecting from the
security. The required rate of return of the security is generally more than or equal to the market return
rate. The investor make sure in the overpriced and underpricing of the security is calculated with due care
as diligence. The proper calculation of the price of the security will generate the opportunity to make
profit in the over and underpricing situation of the stock.
Investment philosophy for an asset management company
An asset management company is company that takes the money of its clients and invests the money into
different investment option that is available in the market. The motive behind investing the pooled money
of clients in the different investing option is to earn a higher return which could not be earned by the
client if they invested themselves in the market. The different investing options of the asset management
company are mutual funds, pension plans and hedge funds. The asset management company earns profit
from its business activities by charging some percentage of commission on the profit earned by the clients
on their investment in the company (VAIDYA). The asset management company usually invests large
amount money into different portfolio. This money comprised of different clients and not from single
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client. The asset management company is more professionally capable than the individual investors
therefore there is higher chance of getting higher return form asset management company.
The main and most successful investment philosophy of the investment used by the asset management
companies are diversification of the investing option. This investment philosophy helps in getting higher
returns in the market and also can be used to hedge against the risk of the market. This philosophy
however does not ensure complete success in the industry of asset Management Company but is far better
investment philosophy than any other known in today’s time. The diversification allots following main
advantages to the asset management company:
Diversification allots a lot of options: The diversification is mainly focuses on investing in different stock
options. The finance market is comprised of large number of investing options such as mutual funds,
hedge funds, pension plans, equity and debentures etc. the diversification of the investment distributes the
risk in all the area rather than concentrating it on a single investment option.
Diversification requires active participation: diversification strategy is not a onetime strategy. It means
that the diversification strategy has to be supervised from time to time to ensure that the portfolio is
bringing higher return (Campbell, 2016). The larger the diversification more numbers of experts will be
required by the asset management company to look after the portfolio. These experts should be experts in
their own field of investment.
Research of diversification: the diversification strategy involves a deep research in the different
investment option and the best possible option should be selected by the asset management company. The
different investment option available for asset management company possess their own advantage and
disadvantages and these should be considered by the asset management company in order to achieve their
pre-determined target. There are two type of risk available in the market that are systematic and
unsystematic risk and proper diversification helps the asset management company in reducing both the
risk to a minimum level however these cannot be reduced to the full extent even after such a strong
strategy as diversification.
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References
Hamid, K., Suleman, M.T., Ali Shah, S.Z., Akash, I. and Shahid, R., 2017. Testing the weak form of
efficient market hypothesis: Empirical evidence from Asia-Pacific markets.
Martin, I., 2017. What is the Expected Return on the Market?. The Quarterly Journal of
Economics, 132(1), pp.367-433.
Andonov, A., Bauer, R.M. and Cremers, K.M., 2017. Pension fund asset allocation and liability discount
rates. The Review of Financial Studies, p.hhx020.
Paranjape-Voditel, P. and Deshpande, U., 2013. A stock market portfolio recommender system based on
association rule mining. Applied Soft Computing, 13(2), pp.1055-1063.
Weinstein, R., 2014. Firm recruiting strategies, educational attainment, and the labor market return to
higher education(Doctoral dissertation, Boston University).
Prat, R., 2016. Five Objections Against Using a Size Premium When Estimating the Required Return of
Capital with the Capital Asset Pricing Model.
Korinek, A. and Serven, L., 2016. Undervaluation through foreign reserve accumulation: Static losses,
dynamic gains. Journal of International Money and Finance, 64, pp.104-136.
Campbell, J.D., Jardine, A.K. and McGlynn, J. eds., 2016. Asset management excellence: optimizing
equipment life-cycle decisions. CRC Press.
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