Active fund management has taken something of a battering in recent years. The rise of low-cost index investing and the structural underperformance of the average manager suggests that battering may have been deserved.

 Does the scale of the bruising also vindicate the Efficient Markets Hypothesis? As Eugene Fama (and others) posit, can markets instantaneously, digest all new information and reflect it in prices? Is it only luck that allows managers to beat the market consistently?

Can it be the case that all information is indeed immediately reflected in process but not all information is relevant? Do prices capture both noise and signal?

As this paper by De Long, Shleifer Summers and Waldmann states:

“Noise traders falsely believe that they have special information about the future price of the risky asset. They may get their pseudosignals from technical analysts, stockbrokers, or economic consultants and irrationally believe that these signals carry information. Or in formulating their investment strategies, they may exhibit the fallacy of excessive subjective certainty

 In response to noise traders' actions, it is optimal for sophisticated investors to exploit noise traders' irrational misperceptions.”So how to differentiate noise from signal? We believe that the best way is to understand an industry and understand a company to derive the most relevant information. This is done without reference to the biggest source of noise – the market. By fully understanding a business and its competitive environment, we can arrive at the valuation at which we are comfortable owning the stock. Then we can be patient, waiting for the noise to move the price to meet our signal - which happens on rare occasions.

 That’s the time when active managers should be active.