Which statement about market efficiency and active vs passive management is correct?

• A. If markets are efficient, passive/index strategies may be optimal; inefficiencies may create opportunities for active strategies
• B. Active strategies always outperform passive in efficient markets
• C. Passive strategies never work in any market
• D. Efficiency has no impact on management choice

Answer: (C)

Market efficiency shapes where active value-add is even plausible and where it isn’t. In efficient markets, prices already reflect all available information, so consistently beating the benchmark through stock picking after costs is unlikely. That makes a passive, index-based approach a sensible choice because you capture broad market returns with lower fees and turnover. If markets aren’t fully efficient or there are exploitable mispricings, frictions, or behavioral biases, active management can potentially generate alpha by taking advantage of those opportunities—though it isn’t guaranteed and often comes with higher costs and risk.

So the best-fitting idea is that passive strategies may be optimal in efficient markets, while inefficiencies can create opportunities for active management. The other statements overstate or misstate the relationship: active strategies do not always outperform in efficient markets, passive strategies can work in practice, and efficiency does influence whether passive or active management is more appropriate.