AllianceBernstein: Smart Beta Is Poorly Constructed

However, smart beta is here to stay as it has the fastest falling management fees in the industry  

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Editor, etf.com Europe
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Reviewed by: Rachael Revesz
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Edited by: Rachael Revesz

Smart beta strategies are “poorly constructed” and small investors are often not educated enough to make big bets on these funds, but smart beta is here to stay due to fast falling management fees, according to new research.

Investment and research firm AllianceBernstein said in its latest report, called “The State of Fund Management: Quants Have Destroyed the Active-Passive Distinction”, published 9 November, that allocation to smart beta strategies is “generally even worse” - implying investors are not using smart beta correctly.

“We worry that so far this is done poorly and does not receive the attention that it should get. Smart beta products in theory provide an opportunity to make strategic allocation to factors in the market and also to in theory make tactical allocations where people think they have skill in that area,” the report read.

Another concern in the research is the likes of a small pension fund taking a large bet on a smart beta fund to cut active fund fees, and these investors need help in making these one-off allocations.

Yet smart beta is here to stay as their cost is “falling faster than anything else in fund management”.

Fees in smart beta are approximately halving every year, with a multivariate long-only equity smart beta fund in the U.S. priced around 9 basis points. (Data shows the average smart beta fund was around 0.85 percent back in November 2011, and so-called low volatility ETFs were in line with active fund fees before the crisis of 2008.)

“The gap with full active management fees is huge and active managers need to clearly show where they add value,” noted the report.

AllianceBernstein forecasts annual fees to fall below 5 basispoints as large institutional buyers place more pressure on costs, as they believe passive funds should not be more expensive than market cap-weighted ETFs.

The investment firm said there is no longer a clear distinction between active and passive management, and the distinction is in the eye of the beholder.

“The emergence of smart beta strategies that lie somewhere in between means there is now a continuum of activity level which will likely lead to a continuum of fee level.”

As the fee gap becomes more apparent between smart beta and active funds, the report suggested the benchmarking of active funds’ performance will have to change i.e. a value fund being compared to a passive value-focused benchmark.

 

 

Rachael Revesz joined etf.com in August 2013 as staff writer. Previously an investment reporter at Citywire, she has a background in writing content for retail financial advisors and has covered a wide range of subjects in finance. Revesz studied journalism at PMA Media, which has since merged with the Press Association. She also holds a B.A. in modern languages from Durham University, as well as CF1 and CF2 financial planning certificates from the CII.