Speaker 1: Hello, and welcome to another episode of the Odd Lots podcast.
Speaker 1: I'm Joe Wisenthal and I'm Tracy all the way, Tracy,
Speaker 1: we're gonna have a debate today. I know. It's our
Speaker 1: first ever Odd Thoughts debate. It's pretty exciting. I think
Speaker 1: we had one like a few years ago about like
Speaker 1: fiscal policy in India or something like that. I feel
Speaker 1: like we've had at least one before, but maybe not.
Speaker 1: Maybe I'm a hallucinating that. Yeah, I don't think so.
Speaker 1: And this one is kind of on a topic that
Speaker 1: we've we've touched on a few times this year. But
Speaker 1: it's the terrible under performance of quant investing in recent times. Yeah,
Speaker 1: exactly right. So for people who aren't its familiar. But
Speaker 1: as we've been talking about a lot, like a lot
Speaker 1: of traditional native strategies, quantitative signals have only done so so.
Speaker 1: So the most sort of obvious example, it's quantitative strategies
Speaker 1: that are built around value investing, identifying stocks that look cheap,
Speaker 1: buying them, shorting the ones that look expensive. Things like that,
Speaker 1: where you're sort of like take a screen or some
Speaker 1: sort of method and sift out hundreds or thousands of
Speaker 1: stocks that always turned them um a various sorts. They
Speaker 1: really have not delivered the performance that they did in
Speaker 1: the past, or that the performance that somely the academic
Speaker 1: work underpinning them would suggest would happen. Yeah, And I
Speaker 1: think a big part of this existential crisis for quant investing,
Speaker 1: if you will, is that a lot of that underperformance
Speaker 1: could be forgiven in you know, a lot of things
Speaker 1: have changed. There's been a lot of unexpected developments this year,
Speaker 1: to say the least, but even before quant investing or
Speaker 1: systematic investing, or factors such as value however you want
Speaker 1: to put it, they haven't been doing as well as
Speaker 1: one might have expected. So this is sort of a
Speaker 1: long term decline and has really just hammered at home.
Speaker 1: And I guess the question is and we'll get to this,
Speaker 1: but to me, the question is, is this like, are
Speaker 1: we waiting for the mother of all mean reversions? So
Speaker 1: you have years and years of underperformance for a strategy,
Speaker 1: and if you just hold out a little longer, then
Speaker 1: the big swing back towards historical norms happens. Or is
Speaker 1: there something uh deeper in systemic systemic such that maybe
Speaker 1: if everyone is engaging in the same strategies or the
Speaker 1: strategies are well known beyond beyond the universe of academics. Uh,
Speaker 1: they just don't work anymore because you know, we talked
Speaker 1: about the concept of alpha decay all the time that
Speaker 1: if everyone knows a winning strategy, then it doesn't work
Speaker 1: as well. So there's sort of seems to be like
Speaker 1: two big questions like which one is it? Or is
Speaker 1: it just a matter of quantitative strategies could still work,
Speaker 1: they just need to be sort of updated at their approach.
Speaker 1: Is it different this time? I have a feeling our
Speaker 1: two guests on this episode are going to have different
Speaker 1: opinions on that topic. Well, let's bring in our two guests.
Speaker 1: I'm super excited about having both of them on. We're
Speaker 1: gonna be speaking with Inego Fraser Jenkins. He's a quantitative
Speaker 1: strategist at Bernstein and UH. Last in October he actually
Speaker 1: uh published a piece an essay, and in it he
Speaker 1: said I'm no longer a quant and he kind of
Speaker 1: had this big rebuke to the industry. So we'll get
Speaker 1: to his arguments why and for a different perspective. Will
Speaker 1: also be speaking with Aaron Brown. He's a professor at
Speaker 1: the Math Institute at n y U. He's an author,
Speaker 1: he's a Bloomberg opinion contributor, and for a long time
Speaker 1: he was the head of financial markets research at a
Speaker 1: qu R, which is a big quant shop. So really
Speaker 1: delighted to have both of these guests on the show.
Speaker 1: Uh Indego, thank you very much for joining us. Thank
Speaker 1: you having me, and uh Aerin appreciate having it as well.
Speaker 1: Thank you very much, Joe. So let's get started, uh
Speaker 1: in Ago, why don't you just give us, you know,
Speaker 1: sort of dramatic And I have to say, you're kind
Speaker 1: of known for your dramatic statements because prior to prior
Speaker 1: to blasting the entire quant world, you famously attacked passive
Speaker 1: investing is worse than Marxism. I think you came on
Speaker 1: the podcast and said maybe your statements were a little overblown,
Speaker 1: but you certainly know how to uh say something provocative.
Speaker 1: So tell us why the sort of very high level
Speaker 1: view of why you think quant as we know it
Speaker 1: is busted. So be happy to and I want to
Speaker 1: be can start off by saying that the essay wasn't
Speaker 1: really intend to be anti quant funds per se, because
Speaker 1: the market is more systematically driven than it's ever been.
Speaker 1: Ye before, But I do want to kind of reject
Speaker 1: the canonical view of what kind of quantity is and
Speaker 1: how it's used in the market. I think there are
Speaker 1: a few different levels to this um you know. At
Speaker 1: one point that's but Tracy mentioned just now, which is yes,
Speaker 1: has been an under performance of quant funds this year.
Speaker 1: I think that's actually excusable given the high correlation of
Speaker 1: stocks in the market. That there's more tricky issue of
Speaker 1: the under performance of many quant strategies over last three
Speaker 1: years or more, and that's frankly harder to explain. And
Speaker 1: that's even true for some of the more so new
Speaker 1: approaches have been applied rather than just those exposed traditional
Speaker 1: factors UM and linked to that, there's inevitably the question
Speaker 1: of the value factor that maybe we can come back
Speaker 1: to at some point, I mean, the discussion and van
Speaker 1: the whites end value is dead or not dead. But
Speaker 1: then are two deeper questions too. So one is around
Speaker 1: the world of diversification, and the quant strategies tend to
Speaker 1: be diversified in two different ways. One is at a
Speaker 1: single security level and the others at the factor level.
Speaker 1: And there's plenty of really good reasons for this, because
Speaker 1: most quant models work on average rather than through high
Speaker 1: conviction and through tight risk control, and so when wants
Speaker 1: to be diversified. But the problem is that diversification generally
Speaker 1: speaking has counted against fund performance in recent years. That's
Speaker 1: true not just the quants actually, but for fundamental investors too. Now,
Speaker 1: some parts of that might well be temporary, but I
Speaker 1: would argue that that in the regime where real rates
Speaker 1: are held are very low for a long time, that
Speaker 1: might be more a long run concentration in the market. Um.
Speaker 1: And the other big issue is this assumption that the
Speaker 1: future is going to be like they passed and I
Speaker 1: applying back tests to making future investment decisions. Now, of
Speaker 1: course that's a really good way as a process for
Speaker 1: avoiding simply forming investment views by shooting from the hip,
Speaker 1: and I wouldn't want to advocate that. But equally, at
Speaker 1: the same time, I think there's an argument who made
Speaker 1: that the regime has changed. You know, if COVID doesn't
Speaker 1: counts the regime change, I'd struggled to see what would
Speaker 1: counts regime change. Now, we have be very careful in
Speaker 1: you know, constantly overlaying discretion your views on models that
Speaker 1: are meant to be systematic. That process has a troubled
Speaker 1: past in many cases. But equally, you know, I think
Speaker 1: that there is plenty of evidence that occasional regimes do
Speaker 1: change have been a very big way UM. And one
Speaker 1: particular aspect that now is a policy response to inflation
Speaker 1: post COVID and have that effective the formance of things
Speaker 1: like the value factor, but also just a mechanism of
Speaker 1: the interaction and macro forces and policy. I mean, I
Speaker 1: think we've been very used to a thirty year period
Speaker 1: where the main job cushioning the the economy of the
Speaker 1: business cycle and left to technocrats and central banks. That
Speaker 1: approach has been running out of ammunition for some time.
Speaker 1: I think the future is very different. It's a blend
Speaker 1: of fiscal and monetary policy, a blend that inevitably has
Speaker 1: more politics in it um and a long runway UM
Speaker 1: and it's sort of messier and harder to forecast. And
Speaker 1: so in that kind of environment, I think we need
Speaker 1: to be very careful about applying back tests onto the future.
Speaker 1: So there's clearly a ton to unpack there. I want
Speaker 1: to focus for now on the the point about narrow
Speaker 1: leadership by mega caps and that being a negative for
Speaker 1: quant factors that basically focus on diversification, or quant portfolios
Speaker 1: that focus on diversification. This is something that Aaron actually
Speaker 1: picked up in his response to your note you go,
Speaker 1: and he argued that, you know, people were saying similar
Speaker 1: things back in the late nineties nineties during the tech bubble.
Speaker 1: They were saying it was different this time, and maybe
Speaker 1: investors should go out and just buy the really hot
Speaker 1: tech stocks. And of course we all know how that
Speaker 1: panned out. So, UM, Aaron, maybe just to begin with,
Speaker 1: could you dig into that that mega cap leadership point
Speaker 1: and how it relates to quants. Sure, thanks, Tracy. Um,
Speaker 1: we may not get as a vibrant to debate as
Speaker 1: you want. Most of the stuff I heard, uh going
Speaker 1: to go so far? Um. I agree with um, not
Speaker 1: all of it, and uh, you know it's uh a
Speaker 1: little more nuanced than the headline of of his research piece. Yes,
Speaker 1: we have a technical name in quant finance for extended
Speaker 1: periods where the value factor underperforms, and we call them bubbles. Uh.
Speaker 1: The overvalued stuff gets more overvalued, the undervalued stuff gets
Speaker 1: even more ignored. Um. But but I do agree that
Speaker 1: this particular value drawed in we're seeing really goes back
Speaker 1: to the financial crisis. We have never in history and
Speaker 1: hundreds of years seeing a value draw down to this extent.
Speaker 1: And I and and one of the ways I agree
Speaker 1: with UH and Ago is that I think the issue
Speaker 1: here is not in the numerator, but in the denominator.
Speaker 1: Whenever you look at a price, you're looking at a price,
Speaker 1: you know in dollars per share st market hasn't changed
Speaker 1: fundamentally in ten years. UM. The dollar has quantitative easing,
Speaker 1: near zero interest rates, UH, massive FED purchases, massive fiscal imbalances.
Speaker 1: I don't think those are I mean, those are some
Speaker 1: of the reasons that we're seeing that the dollar has
Speaker 1: become different. If you do value factors using everything in gold,
Speaker 1: we find value is doing much better. I think that
Speaker 1: there is a fundamental process going on, and it is
Speaker 1: the market is awakening to the possibility of extended periods
Speaker 1: of significant negative real rates, and that's causing a lot
Speaker 1: of repricing in the market, and that makes the dollar
Speaker 1: a bad thing to value, a bad thing to use
Speaker 1: to measure value. So that's what I would say going
Speaker 1: on there. I don't think we're in the mother of
Speaker 1: all bubbles in the sense that you're going to make
Speaker 1: a huge amount of money shorting the SMP five hundred
Speaker 1: or buying puts. But I do think we could see
Speaker 1: a extended period five years, ten years longer really mediocre
Speaker 1: equity returns. I think that is the risk to investors
Speaker 1: more than an immediate crash. So intego, I mean, how
Speaker 1: much of this really is just a macro question in
Speaker 1: your view? And you know, this is again another thing
Speaker 1: that frequently comes up on our discussions, with lots of
Speaker 1: different guests coming at the question from different sort of
Speaker 1: intellectual frameworks, which is that, Uh, as long as we
Speaker 1: are sort of in this mode where the only like
Speaker 1: game in town, or the only sort of entity that
Speaker 1: stabilizes the economy is the FED, and the FED is
Speaker 1: sensitive to asset prices and doesn't want to see any
Speaker 1: draw down, etcetera, how much of this is essentially nothing
Speaker 1: is going to work until we get out of this regime,
Speaker 1: this economics. Yes, so I think there are a blend
Speaker 1: of macroshies and microshies here. I mean not that I
Speaker 1: want to in any way claim that count investing is
Speaker 1: just about the values, but value does tend to be
Speaker 1: a large exposure in many quant approaches and certainly would
Speaker 1: help if value had to turnaround. And I think there
Speaker 1: are you know, in the debate that's gone on the
Speaker 1: last ten years around is value dead or not dead? Um?
Speaker 1: And I said a view that is not dead ultimately,
Speaker 1: but equally I can see that there are headwinds for it,
Speaker 1: some which macro and some which a micro. So you know,
Speaker 1: I guess some of the more micro headwinds are around
Speaker 1: the technology change, destroyed moats around certain industries, uh, and
Speaker 1: the change in the basis by which corporate make investments
Speaker 1: more than intangible assets rather than tangible assets, and so
Speaker 1: something the measurement of value has been wrong. But one
Speaker 1: thing has been clearly missing, I think, and that is inflation.
Speaker 1: And you can show that of the last five years
Speaker 1: on daily data, the last ninety years on quarterly data,
Speaker 1: that period and inflation picks up tend to be generally
Speaker 1: can the good ones for value. And so in a
Speaker 1: sense you to say, well, we're waiting for a policy
Speaker 1: shift here. And I happened to think that once the
Speaker 1: immediate doest settled and we're out of our short term
Speaker 1: deflationary shock, then actually the policy response to COVID is
Speaker 1: going to be inflationary. In a sense that is part
Speaker 1: of what value investor is waiting for a long time.
Speaker 1: But with the enormous caveat. But I think there are
Speaker 1: plenty of good reasons why the policy response to that
Speaker 1: inflation when it comes will be different, and so there's
Speaker 1: I think a likelihood as I mentioned that real rates
Speaker 1: are held low for a long time, and what that
Speaker 1: leads to I think is something of a bifurcation and
Speaker 1: the value factor, where if value is an undervalued sickle company,
Speaker 1: then find it can respond and do very well and
Speaker 1: rebound a mean reverting that kind of environment. But the
Speaker 1: value is a financial company, then it's much less likely too.
Speaker 1: So if we're relying on simple baccess and what value
Speaker 1: does inflation environments, then I think it might be be disappointed,
Speaker 1: but more nuanced approach actually could potentially find some areas
Speaker 1: of value that outperformed. The problem is that it requires
Speaker 1: overlaying a regime policy view, which happens to be a
Speaker 1: subjective discretion we kind of core um. And the other
Speaker 1: thing I'd say linked to that is I really really
Speaker 1: want to be able to believe in MIANA version. I
Speaker 1: mean because without because with that MENA version, we're left
Speaker 1: relying on forecasts and huing things are not tertally good
Speaker 1: at making those um and in a world where I
Speaker 1: would argue that actually all asset classes are pretty expensive,
Speaker 1: you know, equities, credit, sovereign bonds, private equity, maybe the
Speaker 1: value factor is the only cheap thing that we can
Speaker 1: go and buy. The problem is that the way the
Speaker 1: goals are phrased in the industry, and the way the
Speaker 1: people think about their personal career risk, which can't be
Speaker 1: hedged away. You could be wrong for a period of
Speaker 1: time that makes almost impossible to hold it. And although
Speaker 1: the engine of mean version might look like it's very strong,
Speaker 1: we also do know that policy can simply override that
Speaker 1: for every long period of time. So I have a
Speaker 1: follow up question based on that, which is I mean
Speaker 1: you ago you sort of touched on this in your
Speaker 1: first answer, But one of the reasons people like quant
Speaker 1: investing or systematic investing is that you sort of avoid
Speaker 1: that shoot from the hip style of investing, where people
Speaker 1: can sometimes I guess, become too reliant on their gut
Speaker 1: feelings or irrational in one way or another. So should
Speaker 1: quants be attempting to factor in these kind of big
Speaker 1: macro calls into their portfolios. I think we need to
Speaker 1: be very careful about adding a continuous series of discretionary
Speaker 1: overlays onto what are meant to be systematic approaches to investing.
Speaker 1: And the fact is generally the shoot from the hip
Speaker 1: approach to investing, I think is going to struggle in
Speaker 1: a structural way. Frankly, in a world where there's so
Speaker 1: many cheap, semi passive ways to go and buy things
Speaker 1: used to be thought of as active, and I'm thinking
Speaker 1: you have sort of so called a beta strategies. Um,
Speaker 1: that's very hard to have an approach that you know,
Speaker 1: the only reminds on that. Having said that, occasionally, I
Speaker 1: think there are huge regime shifts that do take place,
Speaker 1: and I think this is one of them. I guess
Speaker 1: most obviously UM in the policy environment and the way
Speaker 1: the policy interacts with the market overall. En sure regime
Speaker 1: shift is a nice sounding term for this time is different,
Speaker 1: and quant is really based on the idea that sure
Speaker 1: things do change, but people overestimate the change. People overreact
Speaker 1: to the last six months, the last three years, the
Speaker 1: last ten years, and if you look at things over centuries,
Speaker 1: if you look at the same factor in many different markets,
Speaker 1: and context, and you stick to that. You're not right
Speaker 1: all the time, but you're right of the time. If
Speaker 1: you go with whatever is popular, you're basically never right. UM.
Speaker 1: And there are regime shifts in our day. It we
Speaker 1: have the transition from gold standard defeat money in nineteen seventy,
Speaker 1: we have the broken breaking of inflation in nineteen eighty two.
Speaker 1: Going further back, we've got World War two, the Depression,
Speaker 1: World War One. So we've seen regime changes before. They're
Speaker 1: in the data, and there's no reason to have a
Speaker 1: special way to deal with them now. Really, we've been
Speaker 1: talking about quantitative factor investing in US large camp equities,
Speaker 1: and that's that's one part of quant There is a
Speaker 1: whole quant macro UH strategy UM that is trying to
Speaker 1: take advantage of these macro things. You can be macro
Speaker 1: and still be quant you know, speaking of regime shift, uh,
Speaker 1: Aaron and Nego sort of hinted at it. I mean,
Speaker 1: you know, one of the things that strive to me
Speaker 1: I think about sometimes is you know, a lot of
Speaker 1: what was once UH sophisticated strategy is now like I
Speaker 1: can go into any online broker and quickly with a
Speaker 1: few key strokes by some sort of so called value
Speaker 1: e t F very cheaply. That used to be something
Speaker 1: that you know, powerful people of powerful computers and hold
Speaker 1: teams of traders had to do now super simple. Is
Speaker 1: that a regime shift? And is that a contributor to
Speaker 1: the alpha decay of some of these strategies? That the
Speaker 1: ease with which sort of anyone can replicate them. We
Speaker 1: don't need a whole team of geniuses. It's say an
Speaker 1: a q R to do them per se. Yeah, well, um,
Speaker 1: and about the geniuses, but we have a lot of
Speaker 1: degrees at hqu are No, I don't think so. For
Speaker 1: one thing, when more people pilo in, it tends to
Speaker 1: strengthen the strategy. Right, if everybody is buying value stocks
Speaker 1: and values going to value stocks will do well. If
Speaker 1: everybody is doing momentum, and momentum will do well. The
Speaker 1: problem comes when people change their minds. But also this
Speaker 1: is just a natural way of financial markets. You know,
Speaker 1: you start building a hedge fund strategy, you know, with
Speaker 1: new assets, with new ways of doing things. But then
Speaker 1: as you get better at it, as more people learn
Speaker 1: about it, as liquidity improves, Uh, it becomes a beta
Speaker 1: product that every retail investor can buy an et F forms.
Speaker 1: We should all be very happy about this. It is true.
Speaker 1: One of the downsides of doing cutting edge financial research is,
Speaker 1: you know, you don't get rich forever. You have to
Speaker 1: come up with a new idea every uh well frequently,
Speaker 1: basically constantly. You have to keep them, you know, improving
Speaker 1: your ideas and coming up with something new because the
Speaker 1: basic product becomes generic very quickly. But I'm to agree
Speaker 1: with Aaron. I don't think just because money has gone
Speaker 1: into alex cool and smart be two factors that it
Speaker 1: undermines the efficacy of the factors. Um, yes, okay, to
Speaker 1: are examples perhaps of of apparent inefficiency in the market,
Speaker 1: to have too much careful invested them and then they
Speaker 1: stopped working. But I think there are plenty of the
Speaker 1: reasons and why. But the slight value factors in the
Speaker 1: markets do have some long one efficacy behind them. And
Speaker 1: also it's a practical point if you look at where
Speaker 1: money to be invested in smart beta e t S,
Speaker 1: at least of that is indexed to the US market.
Speaker 1: But the apparent lack of performance in value is something
Speaker 1: that has been evident in European markets and to some
Speaker 1: extend nation markets has done blessed well to in recent years.
Speaker 1: I think that what's more interesting is this question of
Speaker 1: what that does for the goal of investing. And it's
Speaker 1: basically shifted the alpha beta boundaries somewhat. So on one
Speaker 1: hand you can think about as being a pain for
Speaker 1: an active manager to just raise the bar. What they
Speaker 1: have to do is not just enough to beat the market,
Speaker 1: but now they have to beat the market and value
Speaker 1: and quality and low foal and momentum. But equally, I'll argue, actually,
Speaker 1: ultimately good thing. So it makes it very clear what
Speaker 1: the true goal of act investing is. It's a generation
Speaker 1: of idistancretic alpha, and if you can do that, it
Speaker 1: goes to the heart of why people should a premium
Speaker 1: for an active fund. One of the topics that we've
Speaker 1: been talking quite a lot about it is value investing,
Speaker 1: of course, and whether or not if you did value
Speaker 1: investing in some different way, for instance, by including intangibles
Speaker 1: in book value, whether or not that particular factor would
Speaker 1: look a lot different and maybe be even brought back
Speaker 1: from the dead in one way or another. I'd be
Speaker 1: curious to get your views on value investing specifically, is
Speaker 1: there a way to resuscitate that strategy, and what does
Speaker 1: um A new regime shift if there is one, actually
Speaker 1: look like, well, thissten's aaron um. Adding intangible assets I
Speaker 1: think would not be a good idea. That's that's kind
Speaker 1: of sticking opinion into what should be a quantitative measure.
Speaker 1: There is active research in the value factor, and we
Speaker 1: shouldn't talk about it like it's dead everywhere. The large
Speaker 1: cap US equities yes, European equities yes, other equities not
Speaker 1: so much. Commodities no, in test rates no, real assets no.
Speaker 1: So so value is still working many places, um, but
Speaker 1: there is very active research. As I mentioned earlier, most
Speaker 1: of the focus on the research is not on the assets,
Speaker 1: but on the dollar. You know, it's the dollar still
Speaker 1: a valid measure of value, of value of a valid thing,
Speaker 1: and measure value in on my side, I you know,
Speaker 1: I think that there are headmand as the value factor.
Speaker 1: You know I mentioned sum early on. You know this
Speaker 1: idea that some set there's a lots of offensive motor
Speaker 1: around them, and so their value not just because of
Speaker 1: a a passing higher risk premeum attached them at some
Speaker 1: point a business cycle, because the structural problem is also
Speaker 1: the apparently monotonic move down in rates has kind of
Speaker 1: messed up the process of UNI version as well. But
Speaker 1: as I said earlier, I think that one thing that's
Speaker 1: clearly been missing is a macro force in the form
Speaker 1: of inflation, and probably not plausibly the first time. Intend
Speaker 1: I think that's a good reason to think why inflation
Speaker 1: kind of could materialize, And so the idea of finding
Speaker 1: you know, cyclical undervalued companies which fundamental or quant research implies,
Speaker 1: and not going bankrupt through the kind of COVID kind
Speaker 1: of period um, they should respond very well indeed to
Speaker 1: an uptick inflation you know that occurs on us a
Speaker 1: one year for the horizon, and the whole binds of
Speaker 1: policy tools and goals of policy that have changed to
Speaker 1: make that a relative possibility. I think in a way
Speaker 1: that but that it wasn't before. So I think that
Speaker 1: there could be a partial macro resuscitation of the value factor.
Speaker 1: As I said, though that implies a split though of
Speaker 1: value perhaps working in in course cyclicals in in in
Speaker 1: commodity stocks were probably not in financials um and then
Speaker 1: so so some structural headwinds are there in the background,
Speaker 1: but I think such I'm some of them come be
Speaker 1: resolved as well. So we start this conversation or debate
Speaker 1: about quant investing and then, not surprisingly, it ends up
Speaker 1: turning into a debate or question about value investing and
Speaker 1: when it's if it's dead, Which oft of these discussions do?
Speaker 1: Why not just look for other stuff? Why this sort
Speaker 1: of like you all this research and to value investing,
Speaker 1: it's value investing dead, etcetera. Why not just move on
Speaker 1: and find some new factors, find some new find some
Speaker 1: new dimensions of quant and UH sort of leave this
Speaker 1: debate behind. Well, of course people are doing that and
Speaker 1: there are you know, arbitrage is good, Momentum investing is
Speaker 1: doing very well. But value is fundamental to quant. You know,
Speaker 1: the day quant gives up looking for real economic value
Speaker 1: in things, UH is the day that it just becomes
Speaker 1: another form of technical analysis. It is very difficult for
Speaker 1: me to imagine UH, you know, robust quant UH investment
Speaker 1: management business that doesn't have at its core value. You know,
Speaker 1: there's all this other stuff and it's great and it
Speaker 1: has great returns. I mean, it has great properties, but
Speaker 1: if you remove value from it, you have no anchor.
Speaker 1: We agree with that, and that at least for the the
Speaker 1: vast majority of quant approaches, we have investment horizons that
Speaker 1: are we're measured in quarters or longer. It's hard to
Speaker 1: imagine not havn'ting, but not having some kind of value
Speaker 1: anchor in that. Of course, it's been a a huge
Speaker 1: um an investment of time and dollars in trying to
Speaker 1: discover new factors. I mean, I'm skeptical of extent that
Speaker 1: that is a worthwhile activity, but I think that certainly
Speaker 1: at least applying uh same machine learning techniques to extracting
Speaker 1: data that we didn't have at our disposal ten years
Speaker 1: ago at least seems like a worthwhile thing to go
Speaker 1: and try. But equally, there's a danger there that one
Speaker 1: ends in a sort of sort of I T arms race,
Speaker 1: trying to discover new factors before they're are petraged out
Speaker 1: in the market. So that can certainly work for certain
Speaker 1: business models. I'm not so sure that um that as yet.
Speaker 1: At least there's evidence that can work for long horizon
Speaker 1: and for a mass market approach. But one thing I
Speaker 1: would say is that if we, you know, think about
Speaker 1: what else quant can do? You know, and yes you
Speaker 1: can be more than the value factor, but it could
Speaker 1: be more than just thinking about new factors as well.
Speaker 1: You know, I think the one of the you know,
Speaker 1: kind of key questions that interests me is where can
Speaker 1: progress really be made in finance and investing. I mean,
Speaker 1: I think it's hard to argue that progress is really
Speaker 1: made in how you make directional investment decisions, in the
Speaker 1: sense that given a view on the security now is
Speaker 1: unlikely to be more valuable than similar view arrived at
Speaker 1: several decades ago because markets more efficient. Likewise, it's hard
Speaker 1: to innovate, I would argue in a more kind of
Speaker 1: theoretical sense in finance. But where progress can be made
Speaker 1: I think is on investment process, and there they can
Speaker 1: actually be a series of incremental improvements over time that
Speaker 1: are not things that simply arbitraged out by the market.
Speaker 1: So things I had in mind might be the process
Speaker 1: of portfolio construction, how that's applied to a different kinds
Speaker 1: of ways that author's generated. Well, also the way the
Speaker 1: goals are set. Frankly, I think it's a huge issue
Speaker 1: for the pension front and a Dowmond industry at the
Speaker 1: moment just to think about how they set long one
Speaker 1: goals and how they then use those to issue mandates
Speaker 1: to fund managers, and those are things that actually can
Speaker 1: be improved on incrementally over time. And there's no reason
Speaker 1: why quant can't be brought to bear to help with
Speaker 1: to help with issues like that. So, Aaron, you mentioned
Speaker 1: this idea that the dollar might not be as valid
Speaker 1: as it once was as a way of actually measuring value,
Speaker 1: and that that might be part of what's going on here.
Speaker 1: I'd be curious on that last note that Intego made
Speaker 1: about actually improving the investment process. Is there anything that
Speaker 1: investors could do when it comes to the dollar or
Speaker 1: how they're incorporating that into their portfolios. If you're a U.
Speaker 1: S Dollar US citizen, you know, run your affairs in
Speaker 1: US dollars, it's pretty hard to ignore that. But I
Speaker 1: would argue the biggest investment risk if you're looking, you know,
Speaker 1: will I have enough money to retire in ten years
Speaker 1: or something like that, You really have to think about
Speaker 1: what's the dollar going to be worth? Um? You know,
Speaker 1: what's a tax regime going to be, what's the inflation
Speaker 1: regime with purchasing power? Will you know, Libra or bitcoin
Speaker 1: be the mode of transaction at that time? Um? Will
Speaker 1: the law allow you to spend your money? The way
Speaker 1: you want to spend it. Will the FED have bought
Speaker 1: so many assets that everything you want to buy you
Speaker 1: have to go to the FED to buy a loaf
Speaker 1: of bread. You know, we just we have huge uncertainties
Speaker 1: about that much more so I would argue that you know,
Speaker 1: what's the some PEF hundred going to be in UH,
Speaker 1: you know, real economic terms, which companies will be profitable
Speaker 1: and so on. I don't think that's really been true
Speaker 1: that level of uncertainty about the US dollar. You have
Speaker 1: to really go back to maybe nineteen seventy, in the
Speaker 1: nineteen seventies to think about when when you know the
Speaker 1: risk of the currency was greater than the risk of
Speaker 1: the equity market. I want to go back to UH.
Speaker 1: And you know something you said both of you made
Speaker 1: this point, but this idea that historically, speaking empirically, it
Speaker 1: suggests that periods of a greater inflation, which is possible
Speaker 1: that well you have in the post COVID UH period.
Speaker 1: But I think that's highly TBD have historically been um
Speaker 1: better for value investing or the value factor. Is there
Speaker 1: an intuitive reason for that? Like what we can talk
Speaker 1: about regime macro regime shift leading to quant regime shift
Speaker 1: but what's the sort of logic behind or why should
Speaker 1: we expect that to be the case? I mean, on
Speaker 1: my side, um, I see these one part of that
Speaker 1: reason as being you know, essentially a signal of of
Speaker 1: of way on the business cycle and the ability of
Speaker 1: certain kind of corporates to raise prices um and an
Speaker 1: equities being in the main real assets, but the but
Speaker 1: in the benefits, but that certain corporates can get on that.
Speaker 1: So normally those are those upswings and inflations a signal
Speaker 1: assigning of macro regime change or but the other way,
Speaker 1: you know, if there's disinflation as we've seen you know,
Speaker 1: the last ten years, and every episode of of higher
Speaker 1: risk of this inflation tends to be signaling a cychnical
Speaker 1: risk um and a increase in risk aversion which tends
Speaker 1: not to be good for value companies. That's so much
Speaker 1: high inflation as inflation uncertainty. If you hit a consistent
Speaker 1: six percent inflation every year and everybody knew it, I
Speaker 1: don't think it would be matter very much. But the
Speaker 1: fact is, you know, if you just don't know what
Speaker 1: inflation is going to be, if it could be zero percent,
Speaker 1: it could be twelve percent um that makes value hard
Speaker 1: to measure in dollars. Mm um Eron, you said, so
Speaker 1: they want to go back talking about value x equities,
Speaker 1: which is something that I haven't heard that much discussion
Speaker 1: of because in my mind I have this sort of
Speaker 1: like intuitive sense of what it means to find value
Speaker 1: with inequities, whether it's some measure of assets or earning
Speaker 1: his power. But talk to us a little bit more
Speaker 1: about value approaches or quant approaches outside of the traditional
Speaker 1: equities realm, and what really that means and what what
Speaker 1: what's pursued there? Sure, Uh. Well, one one classic quant strategy,
Speaker 1: of course is to borrow money and low interest rate
Speaker 1: currencies and UH invested in high interest rate currencies to
Speaker 1: earn the carey spread there. But you need a value
Speaker 1: uh overlay in that to protect yourself against hyper inflating currencies,
Speaker 1: currencies where the high interest rate is really illusory or
Speaker 1: countries where the low interest rate is is an illusion
Speaker 1: due to currency problems. UM. In commodities, people do uh,
Speaker 1: you know, analysis of supply demand, actual use value of
Speaker 1: commodities and use that as a quantitative way to decide
Speaker 1: which which commodities are over and undervalued. Real assets, real
Speaker 1: estate forestry minds. Things like that people do the same
Speaker 1: strategy of buying cheap stuff and shorting very similar, highly
Speaker 1: correlated expensive stuff. Doesn't work all the time. Time again,
Speaker 1: you know, with all these quant strategies important to emphasize.
Speaker 1: You know, they work fifty one percent of the time
Speaker 1: if you're lucky, if you get it right, and you
Speaker 1: have to be very uh. You have to be rigorous
Speaker 1: about containing costs because you don't have a huge amount
Speaker 1: of alpha. You don't have the kind of alpha where
Speaker 1: you can just run out and buy the stuff you
Speaker 1: like in short the stuff heedlessly. You have to watch
Speaker 1: prices very carefully, keep your costs down, and you can
Speaker 1: eke out um you know, a hundred basis points two
Speaker 1: hundred basis points a year with very low volatility, and
Speaker 1: therefore you can combine a bunch of these strategies and
Speaker 1: leverage it up and make a nice safe return most
Speaker 1: of the time. I think that cross asset angle is
Speaker 1: actually super important. I mean, I end up, I say,
Speaker 1: you really thinking about Okay, So there's been this recent
Speaker 1: problem with traditional quant strategies. You know, everyone's running the
Speaker 1: quant approach, the welcoone look to see as some competition
Speaker 1: can growing market. And I think that probably the big
Speaker 1: the problem in investment right now is the problem of
Speaker 1: saving for retirement and the idea of how an earth
Speaker 1: pension plans are going to be able to preserve purchasing
Speaker 1: kind of the long run. If we end up in
Speaker 1: a world where the cross asset return of traditional asset
Speaker 1: classes is low and inflation goes up, it's a horrible
Speaker 1: combination which really I think upset the horr a time
Speaker 1: and model that's been in place for the last for
Speaker 1: thirty years, and even potentially challenges with the idea that
Speaker 1: you can hand on retirement risk to individuals. And so
Speaker 1: I think factors have to play an enormous role in that.
Speaker 1: And so I there's an interesting angle for a kind
Speaker 1: of quant to you know, think about perhaps a slightly
Speaker 1: a different kind of kind of client base. I I
Speaker 1: see some quants already there, but in a world where
Speaker 1: asset class beatas are going to be lower and also
Speaker 1: frankly not off enough diversification amongst themselves, then I think
Speaker 1: there is potentially quite a big bid for thinking about
Speaker 1: the factor type strategies within strategic asset allocation in a
Speaker 1: much bigger way has been attempted historically Austin that the
Speaker 1: trouble with that is we don't see a huge correlation
Speaker 1: among you know, if value is not working very well
Speaker 1: in US stocks, that doesn't tell you very much about
Speaker 1: whether value is going to be useful in commodities. We
Speaker 1: played a lot with trying to do factor based asset allocation,
Speaker 1: and really it's hard to come up with anything better
Speaker 1: than risparity. Uh, you know, the correlations are too uncertain.
Speaker 1: The factor correlations are no better than the gross uh
Speaker 1: you know, rock correlations. Um. So I don't I don't
Speaker 1: disagree that this would be very useful if somebody could
Speaker 1: do it, But until somebody can beat risk parity consistently,
Speaker 1: I don't see there's much value here. Yeah. Well, I mean,
Speaker 1: so you mentioned risk parity, and it's not quite the
Speaker 1: same thing, but it seems like in many cases it's
Speaker 1: a more advanced version of you know, the sixty forty
Speaker 1: portfolio in many cases is and there's so much talk
Speaker 1: about that being dead because the bonds component of a
Speaker 1: traditional diversified portfolio. In theory, treasuries don't have that much
Speaker 1: more to rally of interest rates in the US don't
Speaker 1: go below zero like is are these Are you worried
Speaker 1: Aaron about like these sort of like basic bread and
Speaker 1: butter portfolio allocation strategies because it seems like intego is
Speaker 1: and I'm curing both of your takes. But um, are
Speaker 1: you concerned that the sort of like what's sort of
Speaker 1: simple and has worked for a long time could be
Speaker 1: coming to its end just for sort of mathematical reasons
Speaker 1: like that? Well, let mean, you know, never worked, never
Speaker 1: had any theory behind it, was never a good idea.
Speaker 1: Risk parity is is considerably more Okay, Yeah, people, people
Speaker 1: have been saying bonds are dead for really as long
Speaker 1: as I've been in finance, but so for you know,
Speaker 1: they've they've outperformed other asset classes. I do believe there
Speaker 1: is a significant possibility in the future of sustained periods
Speaker 1: of imificant negative rates, meaning treasuries could do very well.
Speaker 1: But I also agree that it's uh, you know, you
Speaker 1: have to consider the fact, you know, is zero really important?
Speaker 1: Is there are a reason? You know? And in the
Speaker 1: basically most uh you know, most risk parity allocations would
Speaker 1: have something like a quarter of the risk allocated to
Speaker 1: major market major currency interest rates. Um, you know, is
Speaker 1: there a reason to look for other investments within that
Speaker 1: bucket that might give a better return. I'm certainly not
Speaker 1: ready to say you should do that yet, but I
Speaker 1: know a lot of people are looking into that, and
Speaker 1: it is a little scary buying minds at zero percent.
Speaker 1: So having had this conversation, I feel like there's actually
Speaker 1: a bit of a consensus forming, which is that quant
Speaker 1: investing might change in one way or another, but in
Speaker 1: another way, the demand to systematically invest in assets, whether
Speaker 1: it's a single type of asset or cross assets like
Speaker 1: we were discussing earlier, is probably always going to be there,
Speaker 1: and it's just going to change in shape and form.
Speaker 1: And the thing that really reminds me of is, you know,
Speaker 1: a few decades ago, no one would have thought that
Speaker 1: low volatility would be a desirable thing, and yet nowadays
Speaker 1: we have all these low volatility e t f s
Speaker 1: and products and factors and things like that. Is that
Speaker 1: where we're heading. Could you maybe give a summary of
Speaker 1: what quant investing is going to look like in say,
Speaker 1: five or ten years. Is it still here but it's
Speaker 1: just changed in its nature? Why don't we start with indigo? Um? Okay, yeah,
Speaker 1: I think the way heading towards a world where there's
Speaker 1: no one kind of canonical view of what quant investing
Speaker 1: actually is. Is the first thing I'd say, I can
Speaker 1: imagine a number of routes to being explored. So one
Speaker 1: would be an area where, in fact, but there ceases
Speaker 1: to be a distinction between a quantum fundamental invest and
Speaker 1: so for example, you know, if in the future an
Speaker 1: analyst forming a view on a single stock happens to
Speaker 1: form that view via a model that's written in Python
Speaker 1: rather than an Excel, you know, is that a quant
Speaker 1: model or fundamental model? Well, I don't really know. I
Speaker 1: don't really care frankly, um, but you know, it ends
Speaker 1: up with a kind of blending of quantum fundamental approaches.
Speaker 1: So that's one possible route um, you know, I think there,
Speaker 1: you know, will be a further attempt to make kind
Speaker 1: of traditional quantum approach is going to work in a
Speaker 1: turning value and it would help with that. I think
Speaker 1: there's the possibility of exploring quant approaches which are less
Speaker 1: diversified and have longer holding periods, which is an uncomfortable
Speaker 1: area for quants to be in for all kinds of
Speaker 1: good reasons. Be equally, you know, I think that's there's
Speaker 1: something that kind of could be explored. UM, there's the
Speaker 1: potential of applying a new techniques to new data sets.
Speaker 1: I said, I think that is something that will continue
Speaker 1: to be a huge interest, but I think probably as
Speaker 1: a commercial proposition, something that's only relevant probably for a
Speaker 1: small group of asset managers. And then also, as I mentioned,
Speaker 1: you know, just using factors embedded as a way to
Speaker 1: try and solve a long on pensions problem through strategic
Speaker 1: decisions and allocations to them. UM. I would say that,
Speaker 1: you know, if we define quant broadly as any kind
Speaker 1: of systematic investing, and that's you know, that's clearly only
Speaker 1: going to grow. It will become more machine learning and
Speaker 1: artificial intelligence dominated. UM. But I use quant a little
Speaker 1: more narrowly. I mean sort of the current academic and
Speaker 1: professional consensus around kind of mainstream quant ideas. UM. If
Speaker 1: these ideas were somehow overthrown, if they stopped working, people
Speaker 1: would not go back to you know, looking for the
Speaker 1: next war in Buffetter David Ironhorn for you know, looking
Speaker 1: for individual loan geniuses that can't really be scaled. They
Speaker 1: would look for new systematic want method I think that
Speaker 1: the basic academic quant consensus is pretty safe for the
Speaker 1: next ten or twenty years. There is always research. It's
Speaker 1: always evolving. You know, it looks may look the same
Speaker 1: if you're you know, from the outside, but having been
Speaker 1: in this industry for decades, it uh, you know, it
Speaker 1: changes enormously. The research is going on. But some fundamentals
Speaker 1: like value, like momentum, like quality, like low volatility. I
Speaker 1: think those are those are going to be there. They
Speaker 1: may be interpreted by machine and and and no individual
Speaker 1: human can understand them. Uh, they may be marketed and
Speaker 1: pitched in different ways. There will certainly be improvements and
Speaker 1: how they're measured and how they're exploited, and as Intego
Speaker 1: is emphasized, how they're constructed into portfolios. One thing we
Speaker 1: haven't really mentioned is even the most sophisticated quant shops
Speaker 1: tend have very crude ways of forming portfolios. You know,
Speaker 1: you do a value you go along thet of stocks
Speaker 1: that are most undervalued and go short to their percent
Speaker 1: that are most overvalued. Um. I mean it's a little
Speaker 1: more sophisticated than that, but it's not. There's nowhere near
Speaker 1: the amount of sophistication there is in measuring these factors.
Speaker 1: You know, risk parity. You just wait, everything can inverse
Speaker 1: proportion to its volatility. You know. That's those are pretty
Speaker 1: crude uh techniques, So I suspect there will be a
Speaker 1: lot of uh improvement in those, But I I have
Speaker 1: faith in the basic quant out look. I think the
Speaker 1: same people who are successful kuant investors today, if they
Speaker 1: don't retire, will be successful kuant investors in ten or
Speaker 1: twenty years. Well, uh, that was really awesome. I really
Speaker 1: appreciated both of your perspectives. Intego Frasier Jenkins at Bernstein
Speaker 1: and Aaron Brown, longtime veteran of the industry, author and professor.
Speaker 1: Thank you very much, both of you for joining us.
Speaker 1: Thank you. Thank you. Joe and Tracy and in Ago,
Speaker 1: thank you. It's so funny, Tracy had, like so many
Speaker 1: of our conversations all end up being about the same
Speaker 1: thing these days, and even when we start with like, oh,
Speaker 1: this is a different topic than this, it sort of
Speaker 1: all comes back to the same thing. But actually, yeah, yeah,
Speaker 1: I was also thinking that was such a polite debate,
Speaker 1: you know, I was hoping it would sort of descend
Speaker 1: into a drama and a shouting match, and at some point,
Speaker 1: like Inigo would say something like you killed my factor
Speaker 1: prepared to die or something like that. Um, but we
Speaker 1: didn't really get that. It felt like there was a
Speaker 1: sort of underlying consensus, which is that investing as we
Speaker 1: know it might die in one sense or another, but
Speaker 1: it's not really going to leave in the wider sense,
Speaker 1: and that instead it's probably and the morphin evolve along
Speaker 1: with the broader macro environment. Yeah. And I guess, you know,
Speaker 1: like as I was saying, like so much ends up
Speaker 1: coming down to this question. And I guess it's empirically
Speaker 1: the case with the success of a lot of quant
Speaker 1: factors of whether we get a change in the macro situation,
Speaker 1: and the macro situation doesn't seem to be so much
Speaker 1: about growth or recessions or whatever, but whether we get
Speaker 1: a change of the macro regime, which is a central
Speaker 1: banks being so um inclined to fight any any sort
Speaker 1: of volatility, uh, you know, sort of limited fiscal response.
Speaker 1: Like so many of our discussions come down to that,
Speaker 1: including this question of whether the quant factors work. Yeah,
Speaker 1: I do think anygoes point on that that want investors
Speaker 1: rules based investing strategies might not be that good at
Speaker 1: capturing UM. Sometimes erratic policy or you know, unexpec acted
Speaker 1: policies by regulators, um central banks and the government. Like,
Speaker 1: I think that is actually a fair point. And we
Speaker 1: know that cell side analysts tend to be pretty bad
Speaker 1: political analysts, So it's going to be really interesting to
Speaker 1: see how the quant world rapples with that, because we
Speaker 1: do see this consensus emerging about governments taking on a
Speaker 1: broader role in the economy post COVID. I guess the
Speaker 1: question is like how long can you wait? Like if
Speaker 1: like you know, you could say, like, okay, a lot
Speaker 1: of these strategies haven't done well since the Great Financial Crisis,
Speaker 1: so we're talking like twelve or thirteen years or ten
Speaker 1: or eleven years now. You know, it's like that's a
Speaker 1: pretty big chunk of someone's career. Okay, maybe we're you're
Speaker 1: like waiting for like yeah, when mean reversion. Yeah, when
Speaker 1: I'm when I'm you know, finally the mean reversion is
Speaker 1: going to happen, and then I'm gonna make up for
Speaker 1: decades of underperformance. Like it's kind of a lot of faith. Yeah,
Speaker 1: like I think that I think will one day be
Speaker 1: in like a new system. But man, like you know
Speaker 1: that's kind of like, yeah, I kind of want to
Speaker 1: like find something that works in the meantime. Yeah. Actually,
Speaker 1: I kind of feel bad. We should have asked about
Speaker 1: momentum strategies um in that podcast, which we didn't. But um,
Speaker 1: we'll have to come back to it. I guess plenty
Speaker 1: more to talk about. Yeah. I have a feeling on
Speaker 1: whatever our next episode is, it's going to come back
Speaker 1: to the death of value investing or something similar. Um
Speaker 1: for sure. All right, shall we leave it there? Let's
Speaker 1: leave it there. Okay, this has been another episode of
Speaker 1: the Ad Thoughts Podcast. I'm Tracy Alloway. You can follow
Speaker 1: me on Twitter at Tracy Alloway and I'm Joe wi
Speaker 1: isn't though you could have follow me on Twitter at
Speaker 1: the Stalwart. Follow our producer Laura Carlston. She's at Laura M. Carlton.
Speaker 1: Follow the Bloomberg head of podcast, Francesca Leavy She's at
Speaker 1: Francesca Today, and check out all of our podcasts at
Speaker 1: Bloomberg under the handle at podcast. Thanks for listening to