The investment industry has been benchmark-obsessed for the last three decades, so much so that currently there are an “absurd super-abundance” of indices versus individual stocks, the team of analysts said.
There are just over 1 million indices in the world but only about 43,000 stocks globally, with the number of liquid stocks closer to 3,000.
But far from representing a “triumph of indices”, the Alliance Bernstein analysts believe the superfluous quantity of benchmarks signifies the “last hurrah” of a dying mode of investing.
The proliferation of indices has presented problems for both active and passive managers, the team argued.
“Active managers clearly see the threat from passive but we do not think that they sufficiently grasp how this is evolving. The commoditisation of factor strategies means that active managers face a multitude of benchmarks. It is not good enough ‘just’ to beat a regional index but they have to outperform cheap factor indices too.”
Meanwhile, passive managers face an altogether different problem, they continued.
“With more indices than stocks it begs the question of who gets the job of choosing an index? Can passive managers own that process too? Yet the act of asset or factor allocation is unavoidably active.”
Allocation will become king
At a time when the Financial Conduct Authority is relentlessly reviewing the asset management industry’s delivery of value for money, the Alliance Bernstein analysts suspect it isn’t long before client outcomes supersede an individual fund’s benchmark-beating ability.
“This need will become more acute if average capital market returns are half what they have been for the last 35 years, which we think is an entirely reasonable assumption,” the team added.
“Merely beating a benchmark does not mean that the benchmark was important for the ultimate client aim, or that the weight given to it is appropriate or even significant given the evolution of an investor’s liabilities.
“Likewise, the passive manager’s claim to help clients avoid making expensive active decisions also does not help if the number of categories that one can passively track is greater than the number of underlying entities being classified.”
Against this backdrop, the team believe allocation-based fee structures will be the norm for both active and passive managers.
“Instead it would seem to be more fruitful to pay for allocation and implementation in proportion to how they aid client outcomes. This implies new fee structures, a change in incentives, different targets for managers and new thinking on the part of asset owners.”
