Speaker 1: This is Master's in Business with very Rid Holds on
Speaker 1: Bloomberg Radio.
Speaker 2: This week we have an additional extra special podcast live
Speaker 2: from future Proof, I sit down with AQR's Cliff Astness.
Speaker 2: He is the co founder and chief investment officer at AQR,
Speaker 2: one hundred billion dollar plus hedge fund that specializes in
Speaker 2: a run of strategies ranging from quantitative analytics to value investing,
Speaker 2: and a whole run of different things in between. I
Speaker 2: found this short discussion to be really quite intriguing. Cliff
Speaker 2: talks about all the things he got wrong, which, to
Speaker 2: be fair to him, is much less than all the
Speaker 2: things he got right. AQR is in the middle of
Speaker 2: an incredible performance run, having been positioned correctly for a
Speaker 2: variety of things that took place, not just equities coming
Speaker 2: out of the pandemic, but really approaching the rise and
Speaker 2: interest rates and the increase in inflation in just a
Speaker 2: way that took full advantage of it. He is always
Speaker 2: one of my favorite people to talk to, not just
Speaker 2: because he's so mathy and brilliant on that side, but
Speaker 2: he's one of the few quants that is so articulate
Speaker 2: and funny on the inless side, and so you get
Speaker 2: the best of both words with Cliff, with no further
Speaker 2: ado my future proof Master's in Business Live discussion with
Speaker 2: Cliff astness. You threw away a promising career in academia
Speaker 2: to go into finance. Tell us a little bit about
Speaker 2: what led to AQR and why you thought, Hey, I
Speaker 2: think I can do this better than everybody else.
Speaker 3: Well, I never had. Maybe that feeling was implied, but
Speaker 3: I wouldn't say that even I know not to say
Speaker 3: that out loud. It's funny sitting here in Newport Beach.
Speaker 1: We're in Newport Beach, right.
Speaker 2: Huntington Beach, Newport Beach. Yeah, it's right up the road,
Speaker 2: all right.
Speaker 3: My hotel I think was in Newport Beach. Can I
Speaker 3: say Newport Beach?
Speaker 1: All right?
Speaker 3: Because Newport Beach and Pimco actually features in my personal story.
Speaker 3: I was at the University of Chicago studying for a
Speaker 3: PhD in finance. I first went to Goldman Sachs for
Speaker 3: a summer. I had a professor from undergrad who worked there.
Speaker 3: One of my best friends worked there. Like you can
Speaker 3: name drop, feel free to oh John Biner. He was
Speaker 3: CEO of CIO of Fixed Income for about twenty years
Speaker 3: at g SAM.
Speaker 1: Then I went for a year. I was still writing
Speaker 1: my dissertation.
Speaker 3: I was writing my dissertation at night on value and
Speaker 3: momentum to choose individual stocks while working at Goldman during
Speaker 3: the day. It was It was the probably the second
Speaker 3: hardest time in my life. The heart artist was when
Speaker 3: my wife and I mainly her, but my wife and
Speaker 3: I had two sets of twins eighteen months apart.
Speaker 1: Four kids in eighteen months.
Speaker 3: Is she gets mad at me when I refer to
Speaker 3: our family planning as a gross failure of risk control.
Speaker 1: But it was true.
Speaker 3: So I was there about a year and I was
Speaker 3: actually just trying to decide do I want to stay
Speaker 3: at Goldman. I was having a good I was enjoying.
Speaker 3: It didn't feel like what I was supposed to do.
Speaker 3: I was a portfolio manager. I was trading. It was fun,
Speaker 3: but you know, I was studying academic finance.
Speaker 1: Dumb luck.
Speaker 3: I had written one paper in the Journal of Portfolio Management.
Speaker 3: It was called option adjusted Spreads and a Steep yield curve.
Speaker 3: You've seen the movie Chart Least then is in it.
Speaker 1: It's really very good.
Speaker 3: They read it and being fellow geeks, they liked it,
Speaker 3: asked to talk to me.
Speaker 1: Ended up fly me out.
Speaker 3: I met with with them. I remember one thing. I'm
Speaker 3: telling you too many stories. This is the first time
Speaker 3: I ever ate sushi. The guy from uh Pimpkoh I
Speaker 3: didn't eat fish at that point. I like fish now.
Speaker 3: But the guy from Pimco guy Nam, he's passed away now.
Speaker 3: But a guy named Frank Furbinovich is a great guy.
Speaker 3: Said to me, Hey, sushi okay for lunch? And this
Speaker 3: is something if there are any twenty somethings in the
Speaker 3: audience you think you're you gotta say fine to that.
Speaker 1: You don't realize the person asking you will be totally.
Speaker 3: Okay with you going. Actually, I don't love sushi. You
Speaker 3: feel like you're gonna blow the whole thing. So I'm like, yeah, no,
Speaker 3: sushi's wonderful. So on this interview, I chewed one piece
Speaker 3: of sushi for about fifteen minutes, and I did spit
Speaker 3: it into a napkin when he wasn't looking. And they
Speaker 3: still offered me a job to go out there and
Speaker 3: start a research group. It kind of light bulb went off.
Speaker 3: I'm like, wait, doing academic research, but an applied way.
Speaker 3: I get to study the same things. I get to
Speaker 3: see if they work for real, and I think Pimpko
Speaker 3: pays better academia, so good idea. So I told Goldman,
Speaker 3: I think I'm doing this, and Goldman said, you know,
Speaker 3: we're thinking of doing that. To this day, I don't
Speaker 3: know if that's true, but I decided Manhattan is much
Speaker 3: more attractive than Newport Beach.
Speaker 2: And needs this weather look but cloudy overcast. Who wants
Speaker 2: to be in California?
Speaker 3: Anyone who's happy where they ended up, who doesn't admit
Speaker 3: that there was a fair amount of luck. Now, you
Speaker 3: can make your own luck, and effort counts ability accounts,
Speaker 3: but luck counts too.
Speaker 1: I got lucky at various stages.
Speaker 2: In this I hear that on a regular basis from
Speaker 2: guests on Masters in Business.
Speaker 3: It's terrible advice to give. By the way, what first
Speaker 3: get lucky? Well, not useful?
Speaker 1: Well the table.
Speaker 2: There are lots of people who are very smart and
Speaker 2: very hard working who don't achieve outstanding, amazing success, a
Speaker 2: top point one percent success.
Speaker 4: What separates some of them? You've mentioned this repeatedly.
Speaker 2: There's a little serendipity in everything. So, speaking of serendipity,
Speaker 2: you're at Goldman, you meet some folks tell us how
Speaker 2: AQR came about.
Speaker 3: So I started this group. This was nineteen ninety four.
Speaker 3: I know, I look around, I look for the people
Speaker 3: who were born in ninety before nineteen ninety four, and
Speaker 3: I want to say hi, shout out to them. So
Speaker 3: we started this group was initially four people with a
Speaker 3: very general, scary general mandate. They had no idea why
Speaker 3: they wanted this group. They just knew other people were
Speaker 3: starting quant groups on Wall Street. Ironically, the then success
Speaker 3: of long term capital management.
Speaker 1: Made get us.
Speaker 3: Some of that made a lot of the firms think
Speaker 3: we need applied academics here. I don't think we've ever
Speaker 3: done anything particularly similar to long term capital management.
Speaker 1: But they actually helped me out too. So we started
Speaker 1: this group with no mandate, just see if you can help.
Speaker 3: We kind of went around like door to door, quants
Speaker 3: around g SAM saying does anyone need anything quantitative?
Speaker 1: And the first job they asked us to do was
Speaker 1: to help.
Speaker 5: They had an active global equity product, you know, concentrated
Speaker 5: stock picking, that had kind of a SOSO record, and
Speaker 5: if you analyze their record, it was really strong within
Speaker 5: each country, but they were always in the wrong countries.
Speaker 3: So they'd have client meetings that would be well. The
Speaker 3: good news is are Norwegian stocks crushed the Norwegian index.
Speaker 1: The bad news is there was a kup in Norway.
Speaker 3: That doesn't mean in a kup in Norway since nineteen forty,
Speaker 3: but they approximated it. So they turned us and they said,
Speaker 3: can you guys help pick countries? And here's where you know,
Speaker 3: luck meets hutzba. At this point you don't go, well,
Speaker 3: I don't know, I've never really tested picking countries.
Speaker 1: You go, hell, yes, we can help pick countries.
Speaker 3: We went into a very tiny room, four of us
Speaker 3: and kind of it's embarrassing how simple it was. We
Speaker 3: spent about three days before we hit on the obvious solution,
Speaker 3: which was to pretend countries were individual stocks and treat
Speaker 3: them like what we had studied in academia, the early
Speaker 3: work on value, momentum, even size for predicting individual stocks.
Speaker 3: We ended up writing a paper on and it held
Speaker 3: up for countries, and we just kept growing it individual stocks, bonds, currencies,
Speaker 3: applying the same philosophy over and over again. And then
Speaker 3: after about four or five years of that, we had
Speaker 3: one of my co founders, David Cabillar, started a full
Speaker 3: year of working on me saying, you know, you could
Speaker 3: do this on your own, and he was a little
Speaker 3: bit of the Mephistopheles, so I was very.
Speaker 1: Scared of doing that. It's scary to leave Goldman Sachs.
Speaker 3: Goldman Sacks is really good at terrifying you too, by
Speaker 3: the way, when you say you're thinking about leaving, if
Speaker 3: you're honest, if you don't just give him a fade
Speaker 3: a company and say I'm considering this, which I did.
Speaker 3: You sit down with very senior people and they kind
Speaker 3: of say, you know, you only get to leave Goldman
Speaker 3: Sachs once.
Speaker 1: Young man, and then you shrivel and you go, I'll stay.
Speaker 3: So I did that a couple rounds till finally end
Speaker 3: of ninety seven, early ninety eight took the plunge.
Speaker 2: And to Goldman's credit, they're very good at keeping hooks
Speaker 2: and people. They become your prime broker. They're selling you transactions, trades.
Speaker 3: This is this is getting really into some nitty gritty details.
Speaker 3: But when you leave Goldman, the part you left is
Speaker 3: quite mad at you. The rest of Goldman is quite excited.
Speaker 3: Because the money we were managing at Goldman, I did
Speaker 3: not expect to get into this kind of stuff. But
Speaker 3: the money we were managing at Goldman, we could not
Speaker 3: trade with Goldman for rather obvious reasons.
Speaker 1: Once we leave, suddenly we're.
Speaker 3: A potential and that did help smooth the relationship over
Speaker 3: and Goldman is still certainly one of the alternates.
Speaker 1: It bounces around a bit and one of the top
Speaker 1: two or three people we trade with these days.
Speaker 2: So you leave Goldman, you set up your own own shop.
Speaker 2: At what point do you get a sense, hey, this
Speaker 2: can work. We're having clients come in. The numbers look
Speaker 2: pretty good. A performance doesn't stink. When does it dawn
Speaker 2: on you? This was a good decision to hang our
Speaker 2: own shin.
Speaker 1: I don't know. I'm hoping it kicks in soon, one
Speaker 1: of these days. Soon. We had a very strong start
Speaker 1: prior to trading. We left.
Speaker 3: It took us about nine months to We didn't take
Speaker 3: a thing out of Goldman. We were building and rebuilding.
Speaker 3: We had a road show, we made it. What I
Speaker 3: think is I've been saying for years was an era,
Speaker 3: and it was an era. When we were at Goldman,
Speaker 3: we ran all kinds of different mandates. We saw quantitative
Speaker 3: tools is a very general thing, and you could run
Speaker 3: an aggressive hedge fund style long and short market neutral
Speaker 3: a lever to be to try to make a lot
Speaker 3: of money, or you could be long only and try
Speaker 3: to beat a benchmark by one and a half percent
Speaker 3: a year. You could use the tools either way. When
Speaker 3: we launched our own firm, we said we're only going
Speaker 3: to start. We intend to do it all eventually, but
Speaker 3: we're going to start with the very aggressive version of
Speaker 3: our hedge fund product.
Speaker 1: Partly, I think it was an era. Partly I think
Speaker 1: we didn't have a tremendous amount of choice.
Speaker 3: When you're thirty and starting your own firm and you
Speaker 3: say you want to run traditional long only assets, people,
Speaker 3: your potential clients kind of look and go come back
Speaker 3: when you've been doing it for five years and you
Speaker 3: look more like I look now than I looked. Then
Speaker 3: when you say we're launching an aggressive hedge fund then
Speaker 3: we're closing, they go, oh cool, we're in. So apparently
Speaker 3: if you charge two and twenty it's a lot easier
Speaker 3: to get new clients at that point in your career
Speaker 3: than if youre and we don't charge two and twenty anymore.
Speaker 3: But that's that's the old days. So we launched a
Speaker 3: very aggressive version. We took it for the fellow geeks
Speaker 3: in the audience. I assume there were a couple in
Speaker 3: the load to mid twenties. In terms of targeted volatility,
Speaker 3: that's north of a naked equity market exposure. We raised
Speaker 3: a billion dollars I do believe was the largest standing
Speaker 3: starret hedge fund launch to that point. So in that sense,
Speaker 3: we were successful immediately. It is not.
Speaker 1: It's been way bigger one since then. We've been eclipsed
Speaker 1: by that.
Speaker 3: The next eighteen months of actually running money were very,
Speaker 3: very bad. We started running money in August of ninety eight.
Speaker 3: I'm gonna mention them again again. I didn't mean to
Speaker 3: mention them once, let alone twice. But August of ninety
Speaker 3: eight is when the LTCM kind of death spiral began.
Speaker 3: Russia defaulted, and it's always Russia and LTCM began a
Speaker 3: few months our initial you know, the stock market was
Speaker 3: down about twenty percent in August of ninety eight. I
Speaker 3: always think of this as like the crash nobody remembers,
Speaker 3: and I think no one remembers it for two reasons.
Speaker 3: It wasn't one day. It was kind of fairly steady
Speaker 3: all month, and it came back pretty quickly. After it,
Speaker 3: so there's no scarring moment, and there was there's no
Speaker 3: accompanying pandemic.
Speaker 1: We did well during that crash.
Speaker 3: Then something called the dot com bubble took off, and
Speaker 3: I have written a lot about this.
Speaker 1: I think in the last five.
Speaker 3: Years people think of us maybe too much as value investors.
Speaker 3: It's a big part of what we do, but it's
Speaker 3: far from all. We go through decade long periods where
Speaker 3: we hardly talk about it because many of the other
Speaker 3: things are dominating. In giant bubbles, the value portion of
Speaker 3: what we were doing suffers. And that happened in ninety nine,
Speaker 3: two thousand, and it happened in nineteen and twenty. So
Speaker 3: we were down in this account about thirty five percent
Speaker 3: sole product. You won one product in your first eighteen months,
Speaker 3: you're down thirty five percent.
Speaker 1: Now, if the.
Speaker 3: Fellow quants in the room are saying, well, you were
Speaker 3: taking twenty three percent volatility, that's barely maybe two standard deviations.
Speaker 3: Whoever's thinking that as a moron, I was thinking it
Speaker 3: at the time because I'm thinking the world thinks about
Speaker 3: risk adjusted returns. Right we were We had up three
Speaker 3: triple digit years in this.
Speaker 1: Kind of account at Goldman not a good way to
Speaker 1: start a business.
Speaker 2: So let's talk about you mentioned you started with a
Speaker 2: long short. You've become known as value guys, but really
Speaker 2: you'll run a variety of different strategies and different different silos.
Speaker 2: Let's talk a little bit about how that developed. How
Speaker 2: did you go from hey, we're going to run and
Speaker 2: gun a long short and take an occasional thirty percent
Speaker 2: hit to adding diversified approaches to not just risk management,
Speaker 2: but where are you going to generate your alpha from?
Speaker 3: Partly, that's just been always what we've been done, even
Speaker 3: in our time at Goldman Sachs.
Speaker 1: As I just told you guys, we started out.
Speaker 3: First models we built were about what equity countries looked
Speaker 3: more attractive. We quickly poured those two bond markets.
Speaker 1: At that time.
Speaker 3: The world has gotten deeper, the factor world has gotten deeper,
Speaker 3: but value and momentum were the two main factors.
Speaker 1: When you go to a bond market, you go what's value.
Speaker 3: Everybody who does this will claim, and I will too,
Speaker 3: that their models are much better and more subtleness. But
Speaker 3: if you just looked at prospective real bond yield across
Speaker 3: twenty countries, the ones would higher yields tend to be
Speaker 3: scarier like value things often are and tend to on
Speaker 3: average do better. Momentum is ridiculously easy. Everywhere you go,
Speaker 3: things tend to keep trending in the same direction. So
Speaker 3: by the time we left Goldman, we already traded countries,
Speaker 3: stock markets, bond markets, currencies, and individual stocks, which is
Speaker 3: really what a few of us had written our dissertations
Speaker 3: on Globally. At AQR we've expanded that. Again, this is
Speaker 3: twenty five years, so it's not like we just walked
Speaker 3: in and did this into many different factors, not one hundreds.
Speaker 3: Sometimes people people refer to the factor zoo.
Speaker 1: I get annoyed.
Speaker 3: They're about five to ten major things that most and
Speaker 3: I'm speaking in general of the exceptions that most quants
Speaker 3: probably believe in. Cheap tends to be expensive, good momentum
Speaker 3: both priced and then later on importantly, fundamentals, things getting
Speaker 3: better tend to keep getting better. Lower risk things measured
Speaker 3: both fundamentally and in terms of the quant measures bita
Speaker 3: volatility tend to do better than you would think. Higher
Speaker 3: quality assets, more profitable, higher return on whatever you'd like to.
Speaker 1: Measure it on.
Speaker 3: Expanding the set of things beyond value and momentum, and
Speaker 3: then expanding the places we do it. We didn't do
Speaker 3: emerging markets at Goldman. When you add that, you get
Speaker 3: two wonderful things at once. Actually you could fail utterly.
Speaker 3: If it works, you get two wonderful things at once.
Speaker 3: You get another strategy to add, which is correlated.
Speaker 1: You shouldn't pretend it's not.
Speaker 3: But it's not perfectly correlated, so it's somewhat diversifying, and
Speaker 3: you get another little out of sample tests. Statisticians quants,
Speaker 3: we have very strange dreams. We don't dream about cars
Speaker 3: and houses and significant others. We dream about out of
Speaker 3: sample tests. It's kind of the gold standard. You often
Speaker 3: don't have enough. Sometimes you gotta wait thirty years to
Speaker 3: get a good out of sample test or something. But
Speaker 3: when you go to a new market you haven't looked
Speaker 3: at yet, and it holds up, you go, maybe we're
Speaker 3: actually onto something here. By the way, we think, if
Speaker 3: we have good out of sample tests, we will get
Speaker 3: nice cars and houses and significant others. We're not indifferent
Speaker 3: to that, we just take a different path. So we've
Speaker 3: been expanding both how we measure things and where we
Speaker 3: do it.
Speaker 2: I'm glad you reference that not geographically. But let's talk
Speaker 2: a little bit about one of the issues that seems
Speaker 2: to really have come into its own over the past decade,
Speaker 2: which is tax aware investing.
Speaker 4: It's people talk about.
Speaker 2: Asset location, and hey, I'm going to put my highest turnover,
Speaker 2: most active account into my tax deferred portfolio and the
Speaker 2: long term boring index stuff I'll keep in my taxable account.
Speaker 2: That seems to be the conventional wisdom. You seems to
Speaker 2: have moved in a direction opposite that tell us about that.
Speaker 3: Well, first, the conventional wisdom isn't wrong if you're owning
Speaker 3: a traditional, say, actively managed long only stock portfolio with
Speaker 3: some decent turnover that doesn't have very attractive tax properties.
Speaker 3: Where we got into this starting the research about ten
Speaker 3: years ago, writing our first paper, we've been fairly public
Speaker 3: about this stuff. A first paper I think on this
Speaker 3: was in twenty fifteen. Were a few different sets, and
Speaker 3: here again we got lucky. We got lucky in that
Speaker 3: we are ready were in both the traditional long only
Speaker 3: world and the long short world. And it turns out
Speaker 3: that first the very act imagine you have an active
Speaker 3: beat the benchmark traditional stock portfolio. Now imagine you separate
Speaker 3: that into an index fund and a long short portfolio.
Speaker 3: And just for the sake of this argument, imagine if
Speaker 3: you add those two together, you get back to the original.
Speaker 1: The long short is the over and the underweights that
Speaker 1: you had before.
Speaker 3: Just that active separation makes something far more tax efficient.
Speaker 3: The index fund a cruise, like all index funds are
Speaker 3: fairly tax efficient, and the active part you only pay
Speaker 3: tax if you make money.
Speaker 1: You have a bad year, you don't pay a tax
Speaker 1: on it.
Speaker 3: In a traditional long only portfolio, imagine markets they do
Speaker 3: go up on average over time, and you want to
Speaker 3: sell something you actually haven't produced alfin you just don't
Speaker 3: like the stock anymore. You get a tax hit from that.
Speaker 3: So simply the separation gets far more efficient. Then you say, well,
Speaker 3: can I do any better about this? And here it's
Speaker 3: the last time I'll try to mention luck. Not again,
Speaker 3: this will be the last time I'll mention luck. But
Speaker 3: the average turnover of our stock selection models, and this
Speaker 3: was not by design.
Speaker 1: This is why it's luck. It's about a year. You know,
Speaker 1: you know what averages means.
Speaker 3: Some things are fairly quick, some things be old for
Speaker 3: five years, but average is about a year.
Speaker 1: A year is a magic number. In stock a year
Speaker 1: and a day.
Speaker 3: Right, you know you have a big winner at eleven
Speaker 3: and a half months, you're kind of an idiot if
Speaker 3: you sell it, right and lets unless you have illegal
Speaker 3: inside information.
Speaker 1: Wait two weeks in a day.
Speaker 3: It turns out that in a long short portfolio with proxy,
Speaker 3: with not tremendous turnover but decent turnover and an average
Speaker 3: kind of one year holding period, there's a tremendous amount
Speaker 3: of optimization around that you can do.
Speaker 2: So, so the optimization on holding something beyond the to
Speaker 2: get to the lower long term capital gains tax is
Speaker 2: pretty obvious.
Speaker 4: What about the flip side of that?
Speaker 2: What about tax lost harvesting to offset those some of
Speaker 2: those gains.
Speaker 4: We're big fans of that. How do you approach this?
Speaker 3: Yeah, essentially, what we do you can think of as
Speaker 3: a I hope this sounds arrogant, a more advanced form
Speaker 3: of tax loss harvesting.
Speaker 1: We are certainly waiting to sell the winners.
Speaker 3: By the way, if something's a winner in three months
Speaker 3: and we think the price has just gotten stupid, the
Speaker 3: alpha models will dominate the tax models. It's not a
Speaker 3: pure tax product. This is a decision when it's at
Speaker 3: the margin. But we also will rather savagely say, this
Speaker 3: thing's on the edge of where we want to sell it,
Speaker 3: and it's eleven and a half months, so let's take
Speaker 3: the short term loss on that. So I think of
Speaker 3: it as just a more entirely simple I mean, tax
Speaker 3: strategies that are based only on tax are very dodgy.
Speaker 3: Our friends at the Eternal Revenue Service don't particularly like
Speaker 3: tax strategies that are being done for pure tax purposes.
Speaker 3: But I hope we never live in a world where
Speaker 3: someone can go you probably want to sell that, but
Speaker 3: you have to wait two and a half weeks. So
Speaker 3: we're fairly savage in those portfolios about bolt minimizing the
Speaker 3: tax will gains and taking losses when we can. And
Speaker 3: your original question of why you wouldn't hold this in
Speaker 3: a tax free account, well, the simple answer is if
Speaker 3: you do this, and again, this is not really magic,
Speaker 3: This is not some esoteric These are not my friends
Speaker 3: in private equity with the carried interest whatever.
Speaker 1: This is the twelve month thing.
Speaker 3: If you do that systematically, not even over aggressively, you
Speaker 3: generate more tax benefit that you can use in the
Speaker 3: standalone portfolio. The standalone portfolio is already turned into a
Speaker 3: long term gain, and you can use those extra losses elsewhere.
Speaker 3: And if you put that into a taxable account, you
Speaker 3: can't take those losses out of taxable account and use
Speaker 3: them elsewhere. So I do think the conventional wisdom. I
Speaker 3: won't I won't be mean about it. It is for
Speaker 3: most conventional portfolios. I think it is the right wisdom.
Speaker 3: But I think you can do better.
Speaker 4: So let's let's pivot a little bit and talk about value, which.
Speaker 3: You tenn one from the irs is here are they were?
Speaker 1: But they're very comfortable with what we're doing.
Speaker 3: But I don't don't want to push it.
Speaker 4: They do a nice job with guns. They let you
Speaker 4: know what you can and can't get away. Just follow
Speaker 4: the rules. It's easy, yes, not that difficult. You got
Speaker 4: you have an accountant, right, No, I did it all myself.
Speaker 2: All right, Well we'll talk afterwards. Return like this right manually?
Speaker 2: You thought at with a pencil.
Speaker 1: Right.
Speaker 2: So let's talk a little bit about value, which is
Speaker 2: how a lot of people traditionally think about you. Value
Speaker 2: had a horrific decade in the twenty tens, and anybody
Speaker 2: who was paying attention to mean reversion was waiting for
Speaker 2: it to come waiting for it to come. What made
Speaker 2: the twenty tens such an unusual period for value, and
Speaker 2: how long can the current run of value playing catchup?
Speaker 4: Last four?
Speaker 3: Right, Barry just asked me a twenty seven minute answer question.
Speaker 3: So I'll try not to I'll.
Speaker 1: Try not to abuse it.
Speaker 4: You got a let nine.
Speaker 1: First, You are right.
Speaker 3: I think we have been known to me in particular
Speaker 3: for value only because I've been screaming about it since
Speaker 3: about twenty nineteen. I also casally write things pointing out
Speaker 3: that I go through decades where I never mentioned value
Speaker 3: from about post GFC, he said twenty ten.
Speaker 1: I think that's about right.
Speaker 3: Through two thousand and maybe eighteen, most traditional forms of
Speaker 3: value had a pretty bad run. You can always find
Speaker 3: somebody with their own indicator that they won't tell you
Speaker 3: what it is, and it's proprietary, and it would have
Speaker 3: worked like a charm. But almost ubiquitous se value strategies
Speaker 3: did poorly. We actually, I'm not going to hide from
Speaker 3: a very bad period for us. I'm about to get
Speaker 3: to it, but we actually had a really good run
Speaker 3: from twenty ten through twenty seventeen while value was suffering.
Speaker 3: Because it's not all we do it's not more than
Speaker 3: half of what we do, and pretty much everything else
Speaker 3: we do worked. Momentum work, fundamental momentum where quality investing work,
Speaker 3: low risk investing worked.
Speaker 1: I think a lot of the reason for this is
Speaker 1: values loss over that period.
Speaker 3: Was because and I don't mean I hope, I don't
Speaker 3: mean this in a deep moral sense, but it deserved
Speaker 3: to lose. The companies underperformed, they under executed. The fundamentals
Speaker 3: were not good. And it turns out that if one
Speaker 3: runs a pure quantitative you know, the Gram and Dodd
Speaker 3: people think of value very differently, more holistically, but in
Speaker 3: the quant world, values generally price compared to fundamentals.
Speaker 1: It's a pure bargain searching.
Speaker 4: You use the phrase cheap for a reason.
Speaker 3: Cheap cheap for a reason is what the Graham and
Speaker 3: Dodd people might say, and it's what our model as
Speaker 3: a whole would say.
Speaker 1: I'm going to segue for a second.
Speaker 3: I think the quants and academics messed up this conversation
Speaker 3: twenty five years ago by calling the famous farm and
Speaker 3: French farm and French with my dissertation advisors.
Speaker 1: I love them.
Speaker 3: I don't even think they called it value early on,
Speaker 3: but that became called the value factor price to a fundamental.
Speaker 3: Nobody just really disagrees with the Graham and Dodd world
Speaker 3: that that's not value. Value is what you're paying compared
Speaker 3: to fundamentals in context of is it a good company,
Speaker 3: is it executing well? What?
Speaker 1: Or it's growth? How risky is it? In the quantitative
Speaker 1: academic world, you get there.
Speaker 3: By this thing they call the value factor, which I
Speaker 3: think really should be called the low price or, if
Speaker 3: you want to be more long winded, the low price
Speaker 3: to fundamental factor.
Speaker 1: I like that factor.
Speaker 3: On average, it wins, it doesn't win nearly as much
Speaker 3: as if you combine it with some measures of is
Speaker 3: it does it deserve to be cheap? One simple way
Speaker 3: to think of twenty ten through about eighteen is the
Speaker 3: does it deserve to cheap?
Speaker 1: Which is cheap which is more than half of what
Speaker 1: we do work like a charm.
Speaker 3: So value can lose, and somebody who's has that as
Speaker 3: part of their process but doesn't dominate their process can
Speaker 3: do fine. Now and as late as late twenty seventeen,
Speaker 3: I was actually taking the opposite side of some famous
Speaker 3: a handful not just one of famous value managers who
Speaker 3: are saying, we've had eight terrible years. That's never happened before.
Speaker 3: It has to reverse, and we measure this thing called
Speaker 3: the value spread. How cheap does value look? If you
Speaker 3: do the Fama French type world, and by the way,
Speaker 3: we do a lot more complex things in price to book.
Speaker 3: I'm using shorthand, But if you look at cheap versus expensive,
Speaker 3: a blaring question is always how cheap and how expensive?
Speaker 3: If their a smidge indifference, maybe not as interesting as
Speaker 3: if they're a big difference. As late as twenty seventeen,
Speaker 3: even a pure academic style of value strategy, which had
Speaker 3: a terrible eight year run, didn't look cheap because the
Speaker 3: fundamentals had driven its loss. When you lose because your
Speaker 3: egoes down by half, if your p goes down by half,
Speaker 3: two you didn't get any cheaper. You stayed the same.
Speaker 3: And it turns out that's actually a pretty good environment
Speaker 3: for people like us. What happened nineteen and twenty eighteen,
Speaker 3: to some extent, but largely nineteen and twenty is that
Speaker 3: I don't like to use the word bubble a lot.
Speaker 3: I'm still scared of gene fauma enough that that saying
Speaker 3: the word bubble, I feel like, you know, something's gonna
Speaker 3: come down from the rafters. But I do think nineteen
Speaker 3: and twenty, much like ninety nine in two thousand, was
Speaker 3: a kind of crazy bubble. And in that world, and
Speaker 3: I'm going to self servingly describe it, this is a
Speaker 3: rational strategy, not good to be a rational strategy. Value
Speaker 3: loss there because of a mania, not because the companies
Speaker 3: were losing on the fundamentals. And I'll be brutally honest,
Speaker 3: we don't have a lot to protect us.
Speaker 1: From that kind of environment.
Speaker 3: To win in that environment, you need to find a systematic,
Speaker 3: long term factor that makes money on average, that does
Speaker 3: really well.
Speaker 1: In a crazy bubble.
Speaker 4: Sounds like momentum.
Speaker 3: Momentum is one of the few you have hopes on.
Speaker 3: Momentum is a flighty thing to put all your eggs on.
Speaker 3: For one thing, a momentum standalone has a horrific left
Speaker 3: tail when momentum reverses if you get it wrong. Also momentum,
Speaker 3: you can think you have a good environment on average.
Speaker 3: It works in a bubble. It did add value in
Speaker 3: this bubble, But if you get a few wiggles that
Speaker 3: are crazy.
Speaker 1: Momentum is more sensitive.
Speaker 3: So momentum is one of the few you have hopes
Speaker 3: on and it's interesting you raise it, because to find
Speaker 3: one that will help it has to be something that.
Speaker 1: Works in a bubble but works on average over the
Speaker 1: long term.
Speaker 3: I'm excluding massively perfect timing. I'm not obviously. If you
Speaker 3: can say do value all the time except nineteen and twenty,
Speaker 3: that's great.
Speaker 4: So is it a coincidence that your dissertation was value
Speaker 4: and momentum together? And is that useful?
Speaker 3: If it is as a happy coincidence, So how useful
Speaker 3: was that? It was certainly useful, though if I can
Speaker 3: admit to this crowd, I think I should have listened
Speaker 3: to it a little more in late twenty nineteen. We've
Speaker 3: always described trying to time factors and the market as
Speaker 3: an investing sin, and we have always said with a
Speaker 3: little bit of a smile on our face, and we
Speaker 3: recommend you sin a little, just a little, meaning when
Speaker 3: you see things that you that you are fairly convinced
Speaker 3: and you put the work in cannot hold long term,
Speaker 3: that are just at epic levels. And by late twenty nineteen,
Speaker 3: the spread between cheap and expensive was approaching the dot
Speaker 3: com bubble wides. We think you can do a little
Speaker 3: more of it and I wrote, and I was very
Speaker 3: honest about this. I said, I'm not listening to the
Speaker 3: momentum trend part of this because I don't know it
Speaker 3: could this time. It momentum is flighty, Like I said,
Speaker 3: he works on average, not always. It could come back
Speaker 3: in the next three days, in which case momentum is
Speaker 3: going to have kept you from the opportunity. If I
Speaker 3: can go back in time, it still has worked out
Speaker 3: for us, and I'm happy. But if I go back
Speaker 3: in time and say, Cliff, why don't you, why don't
Speaker 3: you listen to yourself and wait till it starts to work,
Speaker 3: would have been even better.
Speaker 2: So let's talk a little bit about this decade and
Speaker 2: last decade. Value didn't do well when capital was cheap,
Speaker 2: rates were low, inflation was practically non existent. Growth really dominated.
Speaker 2: Now it's a new regime. The ten year is foreign changed,
Speaker 2: the Fed funds rate is five and change. Even though
Speaker 2: inflation has rolled over, everything is still elevated in price.
Speaker 2: What does that mean looking at forward versus what we
Speaker 2: just came out of. Is this possibly in an environment
Speaker 2: where that spread is gonna narrow or reverse?
Speaker 4: Or how do you look at this regime change?
Speaker 3: I think the macro world influences this, but maybe a
Speaker 3: little less than other people. I think the spread between
Speaker 3: cheap and expensive historically is only mildly related to interest rates,
Speaker 3: real or nominal.
Speaker 1: The story is good.
Speaker 3: When interest rates are really high, people prefer value because
Speaker 3: the cash flows are short term, and when they're really low,
Speaker 3: you prefer growth because cash flow is a very long term.
Speaker 3: One of the problems is when you actually look at
Speaker 3: expensive versus cheap companies, the realize growth differentials of broad
Speaker 3: diversified portfolios I'm not talking about picking in video or
Speaker 3: something are very small, so there really is not a
Speaker 3: very strong theoretical reason. I think occasionally hit manias and
Speaker 3: manias are very very hard to model. I don't trust
Speaker 3: anyone to say what we know A bunch of the
Speaker 3: conditions for a mania. Technology innovation and cheap money are
Speaker 3: probably part of it. Technological innovation will certainly continue, but
Speaker 3: as I love to point out, people who think value
Speaker 3: can't do well in technological innovation are ignoring the fact
Speaker 3: that it did well in the last one hundred and
Speaker 3: fifty years. You know, we started out with steamships. The
Speaker 3: strategy can survive that. I do think a extremely cheap
Speaker 3: money is probably in a even if I can tell
Speaker 3: you it should not be theoretically linked as much as
Speaker 3: it is, it's probably in a looser, harder to prove way.
Speaker 1: Correlated to people going nuts write that down.
Speaker 3: This is very quantitative academic people going nuts.
Speaker 1: And I do think that era.
Speaker 3: You know us, we don't try to make massive macroeconomic forecasts.
Speaker 3: But I think for ten years we lived in a
Speaker 3: world where maybe the most significant macroeconomic thing to me
Speaker 3: is the central banks around the world, and the FED
Speaker 3: in particular, did not face trade offs. Inflation was non existent,
Speaker 3: and they could cut rates when they wanted to stimulate growth.
Speaker 1: They could raise rates if.
Speaker 3: They felt like if they felt like it, I have
Speaker 3: no other better reason for that. They clearly face even
Speaker 3: with inflation abating. I think it's gonna be a long
Speaker 3: time to the central banks of the world face the
Speaker 3: world with no trade offs, and the spread between cheap
Speaker 3: and expensive kind of my north star. I'm sad to
Speaker 3: tell people it is no longer wider than the dot
Speaker 3: com bubble, so it's about eighty five percent of it though,
Speaker 3: so we've had a massive comeback book. This is the
Speaker 3: saltiest thing I will tell this audience. I have laughed
Speaker 3: at people on Wall Street since I was twenty six
Speaker 3: for the following phrase.
Speaker 1: But I think we're in the third ending of this thing.
Speaker 4: So in the last minute, we have where do you
Speaker 4: see people currently?
Speaker 2: I'm asking you this as a quant not a psychologist quantitative.
Speaker 2: Where are you looking out at the world and seeing
Speaker 2: people still going crazy?
Speaker 3: Is it?
Speaker 1: AI?
Speaker 4: Is it tell us what the next bubble to avoid is.
Speaker 3: I have been I'm a little if something bad happens
Speaker 3: to me and it's fishy, I think it's going to
Speaker 3: be the private equity industry that gets me. I've written
Speaker 3: a lot, and I've talked about this for years. This
Speaker 3: is a twenty eight year old argument. I've been having
Speaker 3: nothing wrong with private investing at all, but I think
Speaker 3: more and more people do it today because they don't
Speaker 3: have to show volatility, not for the opportunity. When David
Speaker 3: Swinson was doing it in the eighties, it was about
Speaker 3: the money making opportunity. It wasn't about the fact that
Speaker 3: he didn't have to report ups and downs. And I
Speaker 3: think it's become more like that. And I think long
Speaker 3: only markets are have kind of whistled past a bit
Speaker 3: of a graveyard real interest rates have gone up two
Speaker 3: hundred basis points on the thirty year, and stock markets
Speaker 3: they've shrugged it off and typically those.
Speaker 1: Have moved together.
Speaker 3: But the private world is even more extreme where the
Speaker 3: I'm not sure if they tried to sell it what
Speaker 3: they would get, but they're still marked pretty pretty crazy.
Speaker 3: So I've been picking on them for a while, and
Speaker 3: with zero time to go, I see no reason to
Speaker 3: pick a new victim.
Speaker 1: I love private investing.
Speaker 3: I live in Granwich, Connecticut, and my kids don't get
Speaker 3: picked for sports teams because I make fun of private investing.
Speaker 3: But I do think that world is dominated investing for
Speaker 3: a while, partly for good reasons because there are some
Speaker 3: opportunities and great investors, but partly for some terrible reasons
Speaker 3: because they take volatility and they just cover it up.
Speaker 3: And I think that those chickens may come home to
Speaker 3: roost at some point.
Speaker 2: Cliff, I could talk to you for hours, but the
Speaker 2: clock says zero, so we have to wrap it up.
Speaker 2: Let's hear it for Cliff Assness of AQR.
Speaker 4: Thank you so much.
Speaker 2: We have been speaking with Cliff Asnes. He is the
Speaker 2: co founder and chief investment office of AQR AE hundred
Speaker 2: billion dollar hedge fund specializing in quantitative analytics, statistical arbitrage,
Speaker 2: value investing, etc. If you enjoy this conversation, hey be
Speaker 2: sure and check out any of our previous five hundred discussions.
Speaker 4: You can find those.
Speaker 2: At iTunes, Spotify, YouTube, wherever you get your favorite podcasts from.
Speaker 2: I want to thank the team at Advisor Circle for
Speaker 2: making the audio available from this extra special live event.
Speaker 4: I'm Barry Ritolts.
Speaker 2: You've been listening to Masters in Business Special Live Edition
Speaker 2: on Bloomberg Radio