Refresher Reading ■Market Efficiency2C F A I N S T I T U T E M E M B E R U S E O N LYEXAMPLE 1 Market Efficiency and Active Manager SelectionThe chief investment officer (CIO) of a major university endowment fund has listed eight steps in the active manager selection process that can be applied both to traditional investments (e.g., common equity and fixed- income securities) and to alternative investments (e.g., private equity, hedge funds, and real assets). The first step specified is the evaluation of market opportunity:What is the opportunity and why is it there? To answer this ques-tion, we start by studying capital markets and the types of managers operating within those markets. We identify market inefficiencies and try to understand their causes, such as regulatory structures or behavioral biases. We can rule out many broad groups of managers and strategies by simply determining that the degree of market inef-ficiency necessary to support a strategy is implausible. Importantly, we consider the past history of active returns meaningless unless we understand why markets will allow those active returns to continue into the future.1The CIO’s description underscores the importance of not assuming that past active returns that might be found in a historical dataset will repeat themselves in the future. Active returnsrefer to returns earned by strategies that do notassume that all information is fully reflected in market prices.