The efficient market hypothesis originated from an empirical observation on the activity within the stock market, in particular the consistency of individual stocks out performing active managers. This observation documented the obvious data points on the price movement of these stocks’ vs active managers. Hence why in 1965, everything changed within financial securities market and not just for Eugene Fama.

1. Why index funds outperform active
funds
The efficient market hypothesis originated from an empirical observation on the activity
within the stock market, in particular the consistency of individual stocks out
performing active managers.
This observation documented the obvious data points on the price movement of these
stocks’ vs active managers. Hence why in 1965, everything changed within financial
securities market and not just for Eugene Fama.
Investors were instilled with a new sense of confidence having been told by their
accountants, financial advisors, friends, family, colleagues and radio that they could
have success in the stock market because the efficiency of a particular firms pricing is
not necessarily determined on the basis of a company’s fundamental indictors but on
the assumption that:
Because all market participants have the same access to the same information, the
prediction of price movement is not a necessary exercise. Instead, investors should
diversify their investments, taking advantage of market anomalies (anomalies in price
movement are often attributed to legal, political and economic risks).
It is on this basis that any investor who diversifies their portfolio and makes purchases
in stocks with the intention of long-term investment would outperform active managers.
What about the capital asset pricing model contradiction?
The expectation of anomalies within the EPH is consistent with prediction of price
movement with stocks identified as “under-valued” in activities known as value
investing.
An example of value investing would be identifying stocks within the ASX 200 and
ASX 300. These stocks would then be subject to fundamental analysis and using the
relative valuation models which is done by comparing the profit to equity ratio of

2. companies within the same sector to ascertain the perceived value of the company vs
the “actual value”.
Absolute valuation is an analysis based of the fundamental indicator of that particular
stock and comparing companies with similar activities.
The obvious criticism of value investing is that because every stock is different many,
its not possible to have success by following the same strategy for analysis when
attempting to make a prediction. The partial defense to this criticism is that because it
has been identified as undervalued the question changes from “if there is a price
movement” to “when there will be a price movement”, this question then becomes
further scrutinized through volatility analysis, which makes semi-accurate prediction
within the immediate short-term but is not as useful in the long term.
But as always, “No guarantees”.