What do ETFs and Karl Marx have in common?
That may sound like the setup to a corny joke, but for a research team led by Inigo Fraser-Jenkins, it's no laughing matter. In a note boldly titled "The Silent Road to Serfdom: Why Passive Investing Is Worse Than Marxism," the Bernstein investment strategist sets out to prove that the rise of passive investing is a serious problem for the economy as a whole.
The posited problem with predominantly passive capital markets is that they cannot possibly allocate capital efficiently.
Fraser-Jenkins' favorite type of market for capital-allocation-efficacy reasons is a "capitalist society with functioning capital markets," followed by a Marxist one, followed by a capitalist society with predominantly passive markets.
In the first type, markets "rapidly reallocate capital into expanding and shrinking industries," leading to "superior economic growth." In the second, "at least someone is doing the planning of capital allocation," even if the central planner will likely do a worse job of allocation than investors as a group. In the third, no party is making an attempt to allocate capital effectively, leaving an odd vacuum in which decisions are not made by parties lacking accountability or fiduciary responsibility. In fact, the decisions that are made do not even appear to be decisions.
This logic may be sound, but it has an odd implication: When couched in such a framework, the decision to invest one's money in actively managed funds can take on the strange air of philanthropy.
As it is now widely understood, to the extent that passive investors generally succeed in tracking the market as a whole, then active investors must perform neither much better nor much worse than the market as a group before fees, and thus must deliver worse returns net of fees. This logic and the actual performance data in accord with it have obviously been a big driver of the move to passively managed funds.
But the strategist calls the lower net-of-fee return in actively managed funds a "non sequitur," and retorts: "A given investment in active may or may not be the best decision for an individual particular investor but for the system overall there is a benefit in the efficient allocation of capital."
Congruent with this save-the-whales tone, Fraser-Jenkins' case is aimed not toward potential investors but toward policymakers, exhorting them to "care about active fund management" since it is "a force for social good."
To be sure, Fraser-Jenkins and his cohorts have something on the line here. In the midst of a long and absorbing note that flits from Soviet Russia rail projects to communist-tinged performance art to the cruelty of Emperor Tiberius, Bernstein's London-based head of global quantitative strategy and European equity strategy lets drop this:
Ultimately this goes to the heart of the question, what is the social function of active management in equity markets, and indeed of sell-side equity research? In the wake of the financial crisis we think it is even more important than normal to demonstrate that there is indeed a social function. A field of endeavour that performs no social function is ultimately unsustainable if it has a cost that is imposed on the rest of society. Any such activity will, in the ultimate analysis, simply be regulated out of existence. However, there is a clear and distinct task that active management (and, by extension, sell side research) performs.
If Fraser-Jenkins is right, perhaps active managers should worry less about seeking alpha, and more about seeking alms.