In Bernstein’s view the price of these products should come down to a similar level as current market cap ETFs as “periodically sorting a group of securities by a very simple (we stress simple) factor, say price/book, is no harder than sorting them by market cap, so why pay more for that?”
But, it adds, this starting point has massive implications for asset managers because, should this happen the dividing line between active and passive as it has previously been constructed has been obliterated.
Factor huggers
“What about a fund that is notionally active in that decisions are taken to buy and sell single securities, but it turns out that 99% of the results are explained by a Value ETF and a Quality ETF that can be bought at close to zero cost and where the constituents are rebalanced on a pre-set calendar basis with pre-set transparent and simple rules? Regulators would not currently classify such a fund as being a potential closet index fund, but why not? Because, at the moment, the definition of closet indexing is predicated on a univariate benchmark. If that constraint is relaxed, then this would be seen as a closet factor hugging fund.”
Such a pronouncement begs the question: what is left then that is active? For Bernstein it is that part of the return that cannot be explained either by market cap weighted index or by a factor set, that part of the return that is unambiguously active.
Such ‘idiosyncratic’ returns can be split out in a number of ways and involve everything from correctly timing a factor call, to better than average stock picking ability, but in every case, will serve to better identify what investors are actually willing to pay for.
In the long term, a greater ability to identify what one’s actual alpha is, is going to be benefit the active management sector, but for those that are unsure there is liable to be more pain to come and, adherence to old benchmarks that are, at best, inadequate will not be an option.
