500 by mid-1999. Many institutional investors now hold indexed bond as well as indexed stock portfolios. Mutual funds offer portfolios that match a wide variety of market indexes. For example, some of the funds offered by the Vanguard Group track the Wilshire 5000 index, the Sa- lomon Brothers Broad Investment Grade Bond Index, the Russell 2000 index of small- capitalization companies, the European equity market, and the Pacific Basin equity market. Ahybrid strategy also is fairly common, where the fund maintains a passive core, which is an indexed position, and augments that position with one or more actively managed portfolios.     CONCEPT C H E C K ☞ QUESTION 3 What would happen to market efficiency if all investors attempted to follow a passive strategy?     The Role of Portfolio Management in an Efficient Market   If the market is efficient, why not throw darts at The Wall Street Journal instead of trying rationally to choose a stock portfolio? This is a tempting conclusion to draw from the no- tion that security prices are fairly set, but it is far too facile. There is a role for rational port- folio management, even in perfectly efficient markets. You have learned that a basic principle in portfolio selection is diversification. Even if all stocks are priced fairly, each still poses firm-specific risk that can be eliminated through diversification. Therefore, rational security selection, even in an efficient market, calls for the selection of a well-diversified portfolio providing the systematic risk level that the in- vestor wants. Rational investment policy also requires that tax considerations be reflected in security choice. High-tax-bracket investors generally will not want the same securities that low- bracket investors find favorable. At an obvious level high-bracket investors find it advan- tageous to buy tax-exempt municipal bonds despite their relatively low pretax yields, whereas those same bonds are unattractive to low-tax-bracket investors. At a more subtle level high-bracket investors might want to tilt their portfolios in the direction of capital gains as opposed to dividend or interest income, because the option to defer the realization of capital gain income is more valuable the higher the current tax bracket. Hence these in- vestors may prefer stocks that yield low dividends yet offer greater expected capital gain income. They also will be more attracted to investment opportunities for which returns are sensitive to tax benefits, such as real estate ventures. Athird argument for rational portfolio management relates to the particular risk