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The transcript from this week’s, MiB: Cliff Asness, AQR, is below.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, this will be my shortest introduction ever, Clifford Asness and I just go over the entire universe of quant factor and value investing. It is a masterclass. And if you don’t believe me, I’m just going to shut up and say, with no further ado, my conversation with AQR’s Cliff Asness.
Let’s start out a little bit going over some of your background. You get your PhD at the University of Chicago, where you are the teaching assistant for some obscure prof named Gene Fama. Tell us a little bit about that.
CLIFFORD ASNESS, CO-FOUNDER, AQR CAPITAL MANAGEMENT: Yeah, I basically discovered him. I ended up at the University of Chicago. I was an undergrad studying business and engineering. I decided I wanted to be a professor because I did a job just for money, coding up studies for three Wharton professors. I liked what they did. I said, how do I do what you’re doing? And they said, go get a PhD. I said, where should I go? And they said, close the door because we were at Wharton. And Wharton is a great school, but PhD program rankings can be different than —
ASNESS: And they and almost to a man because I went to about 10 professors, they said go to Chicago.
ASNESS: I mean, I got in, I went, and Gene Fama was the man.
RITHOLTZ: To say the very least. So your doctoral thesis asserted that consistently beating market averages was attainable by exploiting both value and momentum. In other words, you took Fama’s value factor and added your own twist which was momentum, which eventually became a Fama-French factor, right?
ASNESS: Yeah. Fama-French still don’t include it in their official five-factor model.
ASNESS: A lot of us think they should. I think that’s just a philosophical difference. The way I always describe it is one of the scariest moments of my life was going to Gene’s office. I was already his teaching assistant. He had kind of agreed to be my dissertation chair, even without a particular topic, and going in and saying, I want to write it. I wrote it. It was more than just this, but one of the main things I want to explore is the momentum strategy, and then mumbling. And by the way, it works very well. Because, you know, there’s this constant fight in academia, if you believe something works, does it work because markets are efficient in its compensation for risk, or for behavioral reasons?
And momentum, inherently, and I think we all knew this instinctively back then, it’s very hard to come up with a rational story, a risk-based story. And I was nervous because he’s Mister Efficient Markets and rational. And to his credit and my relief, he said, if it’s in the data, write the paper, and he was very supportive of the paper. He works very closely with Dimensional, a firm I admire greatly. They don’t give as much weight to momentum as we do, but they use it in their trading process. So I feel like I’ve won half the battle on that —
ASNESS: — over time. The only thing you said that I might take a small disagreement with is consistently. We think value plus momentum has a really good risk-adjusted return, makes money over the long term. But when you’ve gone through two-year periods like the tech bubble, and three-year periods like ‘18 through ‘20, I think myself, my family and some of my clients might take issue with the word consistently.
RITHOLTZ: So let’s put a little more meat on those bones. To define what we’re talking about, you want to identify the cheapest value stocks, but only own those that seem to have started on an upswing.
RITHOLTZ: That seems to make some sense?
ASNESS: Yeah. You’re accidentally waiting into yet another quant controversy, whether you need both these characteristics in every stock, or whether you can have some stocks that are great on one and simply average on the other and the portfolio comes out. But the intuition you’re saying is exactly right. Two things, at that point, the literature has advanced. This is like quant finance circa 1990. You may throw in the size effect, and that was about it.
RITHOLTZ: Which we’re going to talk about in a little while —
RITHOLTZ: — because I’ve read some papers that suggest —
ASNESS: Yeah, we’re —
RITHOLTZ: — it may not exist.
ASNESS: We’re cynics about it. But value, momentum and size, in the opposite order that I just said, time-wise, size was kind of first and then value, then momentum were the three biggies, and they’re still very big in the literature. Around 1990, value says in the original metrics, and I think they’ve advanced since then, price-to-book was the famous one Fama and French use.
ASNESS: They’ll be the first to tell you they do kind of like it, but it has no special standing. It’s basically price divided by any reasonable fundamental.
RITHOLTZ: So it can be price-to-sales —
ASNESS: — price-to-earnings, price to whatever.
ASNESS: You’ll get people disagreeing like crazy. At our firm, we don’t think we’re particularly great at saying which one is the exact right way to do this. But if you buy low multiples and sell high multiples, either in a long-only beat the benchmark sense, whether over and underweight, and you did the same thing everyone does and call me a hedge fund manager. It’s about half our assets.
ASNESS: About half our assets are really traditional, where money managers beat, you know, plenty of things, don’t let a short, or lever, or any of those hedge fund kind of things. But the principle is exactly the same. The overweight in a value strategy would be low multiples, the underweight would be high multiples. If you’re running a pure momentum strategy, the overweight, and this is also momentum circa 1990, would be who’s doing better over the last year? It’s that simple.
I used to dismissively call it the two newspaper strategy. You needed a newspaper, a recent one and one from a year ago. It’s better to have a computer because it’s a little faster than you, but you look up and you buy what’s going up. It turns out this part is surprising, both make money over any decent time horizon. Probably not surprising is they are in geekspeak negatively correlated. If you are a pure value person or I am a pure momentum person, occasionally we agree. We may get into this later, but right now we’re in more agreement than normal because value stocks kind of have the momentum.
But more often than not, the cheap stocks are cheap because one of the reasons they’re cheap is they’ve been losing. So they’re negatively correlated strategies. And this doesn’t create a 10 Sharpe ratio, but a holy grail of quant finance is to try to find two things that, on average, make money that hedge each other. And value and momentum do, whether it’s relative outperformance against a benchmark or absolute performance in a hedge fund.
RITHOLTZ: So let’s talk a little bit about how you ended up launching AQR. Following your PhD dissertation, you end up eventually heading out to Goldman Sachs to effectively establish their quantitative research group.
ASNESS: That’s it, though, I’m going to amend the story slightly because a few of those things happened more simultaneously. I left the PhD program in late ’91 to take a year off. I’m now on year 32 of that year off —
ASNESS: — so it appears to have taken hold.
RITHOLTZ: So you’re a PhD school dropout?
ASNESS: No. I did finish the PhD.
RITHOLTZ: Oh, okay.
ASNESS: I went to Goldman. I had started my dissertation. I think a lot of people leave intending to write a dissertation from a job, and I don’t think anyone, including me, succeeds at that. But if you’ve already produced like a first draft, it can be a couple of years in this process to finish it.
ASNESS: But it’s more Yeoman-like work after the first draft. You’re just responding to things, running in new tests. So I had finished the first draft, went to Goldman I think a year, with the concept that an option can only be worth zero. I intended to be a professor when I started out, but let me see if I like this. After about a year, maybe about a year and a half, I stayed a little longer, I was really feeling like I should get back to some of the academic roots.
I was a fixed income portfolio manager and trader, which is a ton of fun. I recommend anyone who does this stuff for a living, trade in OTC market for a while to learn the good, bad and the ugly of what happens there. But it wasn’t like whatever skills they taught me in the PhD. Program didn’t feel right. I then got just very lucky. PIMCO out on the West Coast, read the first thing I wrote in the Journal of Portfolio Management. The exciting title was Option-Adjusted Spreads and a Steep Yield Curve. There’s going to be a TV-movie, at some point.
RITHOLTZ: Who’s going to play you in the movie? That’s the big question.
ASNESS: I’m not going to be flattered whoever it is, let’s just say that. And they won’t have any hair, which will be annoying because when I wrote that paper, I had hair.
ASNESS: They liked the paper. They talked to me. They didn’t even know I was writing a dissertation on quant equities at night. And they basically offered me a job to start a research group from scratch. Ironically, given what happened later, long-term capital helped my life because circa that time, they were doing extremely well. And suddenly, you know, all businesses, not just Wall Street, are something’s doing great there, we need one of those.
ASNESS: So the notion that we should have some academics helping us out was greatly aided by them, and I actually think there’s some brilliant people, though, obviously didn’t end well there. So it’s a little bit of irony that they help, but PIMCO is looking to start a group. I went to Goldman Sachs and said, I think this is the perfect combination. I get to do academic work, but in the real world, both in the sense of seeing if it actually works, and you make more money. Anyone who tells you they do money management over being a professor and never considered that is probably not —
RITHOLTZ: Never enters your mind for a second.
ASNESS: — not telling the full truth. Goldman said, unbeknownst to you, we’re looking to start such a group. To this day, I think that’s probably true, but I don’t know if that was reactive to me. But they did say that and they offered me the job, and I decided the weather in New York City is way better than Laguna Beach Cal —
RITHOLTZ: Newport Beach.
ASNESS: — or Newport Beach, excuse me, California. I also chose Chicago over Stanford —
ASNESS: — for PhD.
RITHOLTZ: So you don’t care about weather, obviously.
ASNESS: No. Chicago versus Stanford, I got into both.
ASNESS: They offered a stipend. PhDs are very lucky. They actually pay you to go to school. Everything was the same except, Chicago had in its budget to give me money for airfare to go visit.
RITHOLTZ: That was it?
ASNESS: Stanford didn’t. And I had no money. So I visited Chicago, and not Stanford, and it was a beautiful spring day.
ASNESS: So I’m fond of telling people I’m the world’s only person to choose the University of Chicago over Stanford on the —
RITHOLTZ: Based on the weather. I’m more intrigued by the concept of you sort of Bruce Wayne in fixed income during the day, and at night, your equity work is your Batman.
ASNESS: Yeah, that was tied for the craziest time in my life. The other time, my wife and I were, you know, more her than me, we had two sets of twins, 18 months apart.
RITHOLTZ: Oh, my goodness.
ASNESS: And it was a ton of fun, but it was ridiculous.
ASNESS: Right? So the nocturnal activity was a little different than writing a dissertation. But working at Goldman, with four babies, was very similar to writing a dissertation which is kind of is your baby.
RITHOLTZ: I can imagine. So we started talking about AQR. In ‘98, you leave Goldman to launch it. This is your 25th anniversary.
ASNESS: Yeah. It’s amazing.
RITHOLTZ: So first, congratulations.
ASNESS: I like to say a quarter century, it has more ground of thought (ph).
RITHOLTZ: Okay. It definitely does. It’s amazing how quickly the quarter century goes by. That’s the truly shocking thing.
ASNESS: All the clichés, particularly about children, but about all of life, they’re clichés for a reason.
ASNESS: You wake up one day and you go, what did I do for the last 25 years?
RITHOLTZ: Right. How did this happen?
ASNESS: I remember about three of those years. I’m fond of telling people, I have a really good memory that extends to two periods.
ASNESS: The last two weeks in high school.
RITHOLTZ: I think that’s probably true for a lot of people. It just depends on where you peaked —
RITHOLTZ: — personally. If you peak in high school or you peak in college, that’s where all your memories are most vivid. So given AQR has been around for 25 years, how has your investing philosophy evolved over that period, assuming it’s changed at all?
RITHOLTZ: I imagine it has.
ASNESS: It has, but more stayed the same than has changed. Adding new factors, measuring factor is better. I don’t think that’s a change in philosophy. That’s just applying the philosophy and digging deeper. Our general belief starting out with value and momentum at Goldman in the very early ‘90s, expanding along with the literature, some of our people have helped create, to other factors, low risk investing, quality investing, fundamental, not just price momentum.
RITHOLTZ: So let’s define those. Like, I think we understand what quality investing is, but what is low risk investing?
ASNESS: Low risk investing, at its simplest, again, all of these, you get to 10 quants in a room which sounds like the beginning of a bad joke. They’ll all have different ways and different sets of ways to measure this. But at its simplest, it’s a paper by two of my colleagues, Lasse Pedersen and Andre Frazzini, Andrea Frazzini, excuse me, I left out the last syllable of your name, Andrea. I will never do that again, wrote a paper called Betting Against Beta. And I forgot how many years ago.
RITHOLTZ: BAB as it’s known.
ASNESS: BAB, everything is three letters because Fama and French —
ASNESS: — name their factors three letters.
ASNESS: So now we all copy them. And there’ll be the first to tell you, they were essentially extending work of Fischer Black’s from, I don’t know, 10, 20 years ago, where he found that in basic theory, the capital asset pricing model, you know, we all kind of learned third week of an MBA finance class.
RITHOLTZ: Bill Sharpe.
ASNESS: Bill Sharpe. High beta stocks are supposed to return more, on average, than low beta stocks. And in fact, nothing else is supposed to matter at all. So it’s a one-factor model, and it’s admittedly simplistic. Even the people who created it won’t tell you it’s the be all end all, but it’s a very useful way to think of things. It gets you down to a very important concept, that diversifiable risk you shouldn’t get paid for because you don’t have to bear. You get bear for risk you can’t diversify away. Beta, being a risk you can’t diversify away because a lot of your portfolio is already long beta —
ASNESS: — should be paid. So the problem, of course, is, in some sense, you can say beta is paid because stocks tend to be bonds over the long term. But within the market, the so-called security markets line is pretty much entirely flat and has been in sample and out of sample for a ridiculously long amount of time, in a ridiculously large amount of places. Meaning, low beta stocks have kept up with high beta stocks, which in the simplest theory, they’re not supposed to.
You can use this in a number of ways. You can make your portfolio at a low beta stocks, earn as much money with smaller swings; or if you’re a hedge fund kind of person, and you can use this in long-only portfolios too which is a little more complicated. You can go long low beta, short high beta, but you better apply a hedge ratio. If you’re long a dollar of high beta of low beta, I sometimes get the sign wrong in interviews. I promise in real life, when we’re trading, we get the sign right like 3 out of 4 times.
RITHOLTZ: Okay. And that’s a pretty good number.
ASNESS: Hopefully everyone knows that 3 out of 4 is a joke. But you go long low beta, short high beta. If you did that on a dollar long and a dollar short, you just massively short the market. Long low beta and short high beta, betas work.
ASNESS: So you apply a hedge ratio, you short less than you long, and you try to create something about zero beta. And that has created a very, you know, like all these things, imperfect, that goes through bad periods, but a very attractive risk-adjusted return in and out of sample, long term. And then you can get into theories as to why it works.
RITHOLTZ: So what I was going to ask you is if low beta returns just about the same or almost the same as high beta, why the complexity? Why not just own low beta, and it will give you, on a risk-adjusted basis, a better return in high beta?
ASNESS: Well, absolutely some do. But if you’re a hedge fund person, trying to create an alternative investment that’s truly uncorrelated, low beta stocks are still highly correlated to the market.
ASNESS: So by going long low beta and shorting a smaller amount of high beta, and this depends on your preferences and how aggressive you want to be —
RITHOLTZ: But you’re eliminating that correlation.
ASNESS: Yes, you can create, I’m always leery in saying uncorrelated worries. I just want to put in —
RITHOLTZ: That’s correlated?
ASNESS: Well, I was striving for uncorrelated, but then the compliance officer in my head is saying sometimes it doesn’t come out to zero all the time.
ASNESS: But it comes out close. So you can create a very diversifying stream of returns, where if you just want low beta stocks, you are creating a more attractive stream of returns but still extremely correlated to perhaps your other holdings. So it can be used in different ways.
RITHOLTZ: So I think when most people think of AQR, they think value shop. But as I’m doing my homework to prep for our conversation, and finding all my previous note —
ASNESS: You don’t just wing this?
RITHOLTZ: No, I try not to. I’ve done it on, you know, Ray Dalio, I just winged it. But with you, I feel like I have to come in loaded for bear.
ASNESS: That’s a good accidental Wall Street joke, right?
RITHOLTZ: On purpose. Not so as then.
ASNESS: Okay, good.
RITHOLTZ: You know, I have all this —
ASNESS: I got a million of them.
RITHOLTZ: Right. I got them all teed up waiting for you. So people tend to think of AQR as a value shop. But really, you’re a deep quantitative shop with a lot of different strategies. Let’s talk a little bit about the various ways you guys invest money.
ASNESS: Well, can I back up for a second —
ASNESS: — and talk about why people think of us as a value shop?
ASNESS: There are a few reasons. One is there was one point in the very distant past where it was much closer to truth.
ASNESS: Some of the things like betting against beta, quality or profitability, carry strategies were additions over time. So a lot of people follow us, but anyone who’s followed us from the beginning, that they started out thinking that. Also, I just wrote a piece maybe a few months ago on our website, with the highly defensive, worried title, We Are Not Just About Value, in parentheses, (Except Occasionally When We Are). Because you do get these periods and value seems to be the worst culprit, 99 —
RITHOLTZ: So even half of your headlines —
RITHOLTZ: — are hedge. So you’re a half hedge fund?
ASNESS: Well, you know, remind me where we work because I’ll go off on tangents like you do, but I do write a lot of hedge statements and I’m kind of famous for my footnotes both because I stick the humor there, but also, I put in all the ways I might be wrong. And it’s really not a compliance reason, I hope it’s more of an intellectual honesty reason. Anyone who’s sure they’re right is very, very dangerous.
RITHOLTZ: The footnotes allow you to get past that point.
RITHOLTZ: I love saying, first of all, we hate to kill our darlings —
RITHOLTZ: — anybody who writes. But, secondly, you could very easily get stuck somewhere. Let me just throw this in a footnote —
RITHOLTZ: — be done with it and keep going. And it allows that —
RITHOLTZ: — okay, I’ve —
RITHOLTZ: — cleared the road for the rest of my thought.
ASNESS: The footnotes have three purposes to me, where I stick the humor. They are the hedges. Here are the ways that what I just said might have been bold blank and I could be wrong. And finally, there are sentences I love that my editor did not love.
ASNESS: Where we can mutually agree that it’s worth a footnote. But this —
RITHOLTZ: By the way, your editor just yes as you, God, I got to deal with Cliff today. Just throw it in the footnote and keep going.
ASNESS: Yeah. It’s helpful to have a wastepaper basket like that.
RITHOLTZ: I used to use a separate doc, that I would, whatever it was, something, something, something, edit. So when I would get stuck, let me just move this sentence —
RITHOLTZ: — this paragraph here because it’s interfering with the narrative.
ASNESS: And almost anyone who writes will find, like, they want to make the argument seven different ways.
ASNESS: Because you want to both kill the counterargument and then jump on its grave for a while.
RITHOLTZ: Anticipate the clutter (ph) of that.
ASNESS: A good editor will say pick your one or maybe two best arguments and go with those.
ASNESS: And footnotes again are useful.
RITHOLTZ: So digression aside, let’s go back to the multiple strategies.
ASNESS: No, I’m not done. I got to finish on —
RITHOLTZ: More digression.
ASNESS: — why we’re not all value.
RITHOLTZ: All right, let’s go.
ASNESS: This could take the rest of the time.
RITHOLTZ: I cleared my schedule through dinner.
ASNESS: We are multi-strategy. We go through long periods, almost decade-long periods where we hardly talk about value. It’s a relatively important factor, frankly, but it’s not a majority of what we do. And we go through long periods, a good example would be post GFC through 2017 where values tough.
RITHOLTZ: Past decade. Yeah.
ASNESS: And we had a great almost a decade, because everything else we do work, profitability one; fundamental, momentum one; low risk one. We don’t need value to work. A lot of that is because value lost over that period for what I will call and Gene Fama will have to forgive me here, rational reasons.
ASNESS: The expensive companies, by and large, outperformed not on price, which they did also, but they out-executed. They grew more in terms of earnings, sales, cash flows. If you’re a pure value investor in a quant sense, just buying low multiples, you win on average because, on average, the price goes too far. And there’s a risk-based explanation.
ASNESS: Again, I’m pissing off Fama constantly on this. But a big part of why you win, we think, is the expensive stuff is a better company usually, but not that much better, not what’s priced in. That’s on average. Sometimes, thankfully, less often than not, but still quite often, the expensive stuff ends up being worth it or more than worth it. And when that happens, the value factor, the quant value factor, very different than how a Graham and Dodd investor and we can get into this later, we’ll use the term value, that will suffer at those times.
But pretty much the rest of the process, we do it all simultaneously. It’s not really like one first then the other. But you can think of it as trying to avoid a value trap. Is this thing high profitability, with things changing in the right direction and low risk, therefore someone should pay a high multiple? And you want to avoid value just shorting that. That works like a charm in a rational market, in a bubble. And here, again, I’ll try to make this the final time. I’m a Gene Fama heretic because I love the man.
RITHOLTZ: Right. Who specifically says what’s a bubble.
ASNESS: Yeah. I think I’m somewhere in between. I think I’ve seen a few in my career. I think they exist. I think they are far more rare than the way a lot of Wall Street refers to him. A lot of Wall Street will say a stock they think is expensive, is in a bubble.
ASNESS: Single stock can’t be in a bubble.
ASNESS: Though, I do think the tech bubble and certainly by mid COVID, we were in various kinds of bubbles. In a bubble, value loses. Of course, almost by definition, people want the darlings. But the darlings are not the ones who are outexecuting. They’re the ones with the greatest stories. So the rest of our process doesn’t protect us very much. That is incredibly painful period for our process that both this time, which I think we’re still in the midst of end ’99, 2000, we’ve more than recovered from the roundtrip. It’s been good, but has led to some really tough times to wait out.
My Holy Grail would be to come up with something to add to our process that will do really well in bubbles, but not cost us money long term because I don’t think we can time this.
RITHOLTZ: That’s interesting.
ASNESS: I don’t really think I’ll find that. And by the way, this is self-serving, but if your worst times are going to be when everyone else is partying in a bubble, and your best times are going to be when that bubble is killing everyone because it’s coming down —
ASNESS: — it’s not a terrible property you have.
RITHOLTZ: No. No, it is absolutely not. So we’re going to talk more about value and growth later. But since you brought this up, I want to just throw a couple of ideas at you —
RITHOLTZ: — about that decade that followed the financial crisis, where not only did growth outperform value, but really thoroughly trounced it.
RITHOLTZ: So there are a couple of theories I’ve heard that I think are worth discussing. First, the decade before, at least the eight, nine years before the financial crisis, value was winning —
RITHOLTZ: — and growth was getting killed. So you started from a relative uneven place. Maybe some of this was catch-up. But the theme I kind of find more interesting is that prior to the financial crisis, Wall Street and the markets had systematically undervalued intangibles —
RITHOLTZ: — like patents, copyright —
RITHOLTZ: — algorithms, et cetera. How much of that 2010s rally was a catch-up by intangibles?
ASNESS: It certainly could have been some of the early part. A lot of quants added adjustments for that along the way. Most of us are not purists saying we’re not going to change our model since 1990.
ASNESS: The notion, for instance, that R&D that’s viewed as an expense, maybe all of it, may be part of it should actually be capitalized —
ASNESS: — which would go into book value and make a firm look not as expensive.
RITHOLTZ: So a company that spends a lot of money doing R&D is investing in the future.
ASNESS: Exactly. So I think that may be part of it I think is overdone in a few ways. One, it applies to more than just price-to-book, but it applies most directly to price-to-book, where you’re not capitalizing things like R&D. It can apply to earnings. But plenty of valuation measures, it has no applicability for price-to-sales. Is —
RITHOLTZ: Shouldn’t make any difference.
ASNESS: I don’t see where you think about intangibles.
ASNESS: What’s the price in that? What revenue is it generating? And those type measures did just about as bad as the ones that were contaminatable. Is that a word? I’m not sure it’s a word.
RITHOLTZ: Sure. It is now.
ASNESS: But it is now. So I definitely think you want to account for that in places like price-to-book in earnings. And I think collectively, not just AQR, that has been an improvement to how we measure value and the world has changed a bit. And caring about price versus anything, even if it were immune to intangibles, was not a very good thing until late 2020, since the GFC, so about 11 years. You know, the real world is always more complicated. Everyone is always looking for single explanations —
RITHOLTZ: Right. It’s not that way.
ASNESS: — when a lot of things have multiple explanations. So I think this can definitely be part of it. But I don’t think it’s the main driver.
RITHOLTZ: Yeah. Nuance is wildly underrated in finance, to say the least. Let’s talk a little bit about your research and writing. And I want to quote, your favorite publication, the New York Times, who wrote about you, quote, “He built a public reputation for his willingness to write and say what’s on his mind. In academia, he’s known for witty biting papers he writes for such publications as the Financial Analysts Journal.” I know you don’t write to do branding, but what do you personally get out of a fairly steady stream of deep thoughtful academic papers?
ASNESS: Well, first, you’re being too kind. Of course, I write to do branding.
ASNESS: I run a real world business and I prefer people to think we’re good at this, and I think that’s legitimate.
RITHOLTZ: That’s fair.
ASNESS: If I write something that people think is lousy, or they disagree with, or misses the point, it’s going to hurt our business. So I won’t pretend part of it is not a business decision, but it’s really not most of it. A lot of it is the DNA. Three of our four founders met at the PhD program at the University of Chicago. We consider writing, academic or often that kind of area in between academia and applied. You know, we’ve written a lot of papers in the Journal of Finance, the JFE, and that’s true academia. A lot of our work shows up in great places like the Financial Analysts Journal, in The Journal Of Portfolio Management, which is kind of the nexus between those two. This will sound childish, but a fair amount of this is just personal consumption.
RITHOLTZ: Meaning what?
ASNESS: We enjoy being part of that world. We grew up thinking part of the way you measure success is whether you influence the intellectual debate and how you’re regarded in those circles, and it’s just part of our utility function. I do think a few things. First, I always point out, I don’t know the exact breakdown, but a fair amount of what we do is public. But there’s a fair amount that we think is proprietary. And there are things that I would have AQR researchers hunted down and killed if they publish.
RITHOLTZ: Oh, really?
ASNESS: Yes. My compliance area would like you to know that I’m speaking in hyperbole, I would like you to know that I’m not. But, you know, even if there are things we think the world will discover, where you think you’re somewhat ahead on, and we do try to walk that line on. But a lot of what we do is, you know, is the value strategy cheap? Someone will write a paper saying the betting against beta strategy is really all only small cap stocks, and we’ll respond to that. So it’s really not giving away some of the stuff, which I think does exist, that is really unique. It does go to our taste.
And I do think besides just the advertising aspect, I think one huge benefit to our business is we hire a lot of PhDs, including professors. We hire some full time, and we have very strong relations where they work kind of half time for us. Usually, they get to work full time for their school also to great deal.
RITHOLTZ: To say, I can imagine.
ASNESS: They get multiple jobs. And that’s because what they’re doing for us is also what they’re researching. It’s actually quite beautiful. I don’t think we get taken nearly as seriously in that world.
RITHOLTZ: Meaning it would be a recruitment challenge.
RITHOLTZ: You can say to a professor, you could write for whatever you’re working on. You can help us.
RITHOLTZ: And if you ever want to publish with us, we can play with that also.
ASNESS: Exactly. It’s absolutely twofold. They’re allowed, again, within the stricture of if it’s staggeringly proprietary, no. But broadly speaking, we’re helping their academic career also because we’re okay with them writing about a lot of this. And that’s very attractive versus a firm that says you can’t say a word.
Second, I don’t think we could have even access to these people to the same degree if we weren’t producers as well as consumers of this research. You get a different respect level when you’re publishing, at least occasionally, in some of the same journals they are.
RITHOLTZ: And you’ve become enough of an institution, that affiliation with AQR doesn’t look bad on anybody’s resume and vice versa. It allows you to have access to some of the top academics that are out there.
ASNESS: Absolutely. There are exceptions. I think, you know, kind of near the end of 2020, maybe people were being quiet about that affiliation for a while.
RITHOLTZ: That was a short-term performance.
ASNESS: Yeah. No, I’m kidding. I’m kidding.
RITHOLTZ: It has nothing to do with your research.
ASNESS: I’m kidding. I am proud of the fact that I do think AQR on an academic resume at least doesn’t hurt and maybe even helps.
RITHOLTZ: I would say you’re being humble beyond necessary.
ASNESS: I can fake that a ton.
RITHOLTZ: All right. Well, you know if you can fake sincerity, that’s all you need, right?
ASNESS: You got me.
RITHOLTZ: That’s right. So let’s talk about a couple of your publications that I was amused by. In late 2019, you wrote, bonds are freaking expensive. How do you invest around that thesis? Because going back to the bull market and bonds that began in 1981, it felt like bonds were expensive throughout the whole 2010s.
RITHOLTZ: What made you finally cry uncle in 2019 and say, all right, no mas?
ASNESS: Well, first of all, I’m going to somewhat disappoint you saying we do not take very big bets on views like timing asset classes based on valuation. Antti Ilmanen and I wrote a paper, I forget the exact title, I think one of them was called Sin a Little, where we say, timing the market, and this applies to the bond market as well as the stock market, is an investing sin. And ultimately, we recommend you sin occasionally and a little.
RITHOLTZ: Not that I’ve done all my homework, but that was November 7th, 2019.
ASNESS: You know so much better than me.
RITHOLTZ: Quote, “It’s time to sin.” Well, I’ve researched it recently and you wrote it three years ago.
ASNESS: I’m actually bad at keeping the catalogue of my own work. There’s a lot going on here. The one you’re referring to was about value timing.
RITHOLTZ: Okay. As opposed to?
ASNESS: And it’s really the same concept. We do believe that if you systematically follow a legit, meaning you’re not forward looking, you’re only looking at backward data, try to time the stock market, the bond market or even value based on how cheap or rich it looks, they usually have very, very modest positive, long-term risk-adjusted returns. As you said, you can go through long, long periods —
ASNESS: — where they’re overvalued and get more overvalued.
ASNESS: We do use valuation in concert with things like momentum and profitability and things where now it starts to be better because it’s negatively correlated to those and all else equal. If you have momentum and you’re not overvalued —
RITHOLTZ: Timing is relevant, right? If you’re using momentum, how much does timing really matters —
RITHOLTZ: — as long as they’re your way.
ASNESS: Because it’s been there with momentum.
ASNESS: That piece on bonds being freaking expensive, which is going to eventually be a technical term, I’m going to push it.
ASNESS: That I stressed in there, I don’t know how to time this. This is a 5 to 10-year view. I tried various methods of looking at bonds. This was well before the yield back up and well before the inflation spike.
ASNESS: Compared to any forecast or trailing version of inflation and doing that consistently through time, bonds were about tied with giving you the least they’ve ever given you. And tied for worst is I think expensive.
RITHOLTZ: That’s right.
ASNESS: How someone reflects that if they are taking a long horizon. Now we can get into the TNA, there is no alternative, equities didn’t look great either. I think a lot of why we publish these long-term forecasts and my colleague, Antti Ilmanen is really the master of this, is both we’re interested in it and our clients really seem to value it. But we don’t trade on a 10-year forecast.
ASNESS: Let me give you an example. A 10-year forecast, let’s say value has power and that’s even disputable, but we believe it does, to tell you is this going to be a better or worse than normal 10 years going forward. Very often, the answer will be we predict positive returns but considerably less than history. Okay. What do you do —
RITHOLTZ: Are you just hedging, or is that a general projection?
ASNESS: No, that’s genuinely often a prediction from a model.
RITHOLTZ: So like the 40 percent number, what are the odds of this happening? 40 percent.
RITHOLTZ: You can’t be wrong when you say that.
ASNESS: Yeah. This stuff is always wishy-washy. You know, statisticians never say we know this. They say the chance we’re wrong is small. But it’s also intellectually accurate. You don’t ever no saying. But imagine you have a forecast. Stocks usually make 10 percent a year, and don’t hold me to any of these numbers. We think they’re going to make 5 percent a year, but not negative. You know what? If someone who’s short for the next 10 years, or underweight against a benchmark, you know what happens if you short a positive, but smaller than historical return?
RITHOLTZ: You lose money.
ASNESS: You lose less than you would over history. And you get to go to your client after 10 years, well, I lost your money for a decade. But the good news is I lost you less than I would have lost over the average decade. And it’s a good example where forecasting the 10-year period can be interesting and can be vital, right? If you’re anywhere from an individual to a pension fund, saying how much do I have to save to retire? What you’re going to earn on that money is an important number. But it’s not necessarily timing actionable number.
For years, my dad, it was in spreadsheet. It was a little piece of paper and it was probably calculated all wrong because believe it or not, my dad was innumerate. My mom was a math teacher so —
ASNESS: — I got it from somewhere. But he had that little sheet, what do I need to retire, which I think everyone has in some extent, including institutions. So we think that number is really important. But I do not recommend trading on just valuation, except that sin a little. I like to joke to the 120th percentile. The joke, of course, is there’s no such thing as 120th percentile.
RITHOLTZ: Right. Meaning, this is beyond our lifetime experience of —
ASNESS: Yeah. It’s beyond anything we’ve seen before. I would have been 20 percent above the prior 100th percentile, the new 100th percentile. And we’ve really tried hard and we can’t find any rational reason for it. A small move, don’t be a hero because again these things can get crazier and crazier. That’s the sin a little. We recommend sinning a little and occasionally. I recommend that, Barry, in your personal life also in a very different context. You can apply that any way you would like.
And so, at that point in 2019, with bonds, I think we would have told people we probably want to drop less than normal on a really long horizon. But mostly we’re telling people assume you’re going to make less. Now, the late 2019, it’s time for a sin. I think I tried to use venial, a mild sin.
RITHOLTZ: Venial. Veniality.
ASNESS: You got two Jews here.
ASNESS: We need a Catholic.
ASNESS: When I basically said it’s time for, I’m going to say, venial value sin, a venial value timing sin, and I was looking at the spread between cheap and expensive. I want to say we created this. That is probably false. You never know who created things privately and didn’t share them. We were the first to publish on this and it was back in the tech bubble, the 24-year-old result from 1999, very similar period to particularly ‘19 and ’20. Value killed we think irrationally so the other parts of the process don’t help, extremely painful, huge recovery afterwards.
But during the teeth of the pain, we wanted a measure of how extreme it is. And you can’t always just look at returns. Returns tell you the pain you’re in, but if those returns were, say, justified by massive, you know, earnings growth, if your earnings double, your PE stays the same and your return is a 100 percent. And that didn’t make you more expensive, it just was a great result. And some of that can always be in there, so you want to be prospective.
So we built this measure that’s very simple. All the academic and applied work that was published at that time sorted stocks on valuation measures, generally went long or overweight the cheap and short or underweight the expensive, and really never addressed how cheap and how expensive. You always get a spread. I’m fond of saying otherwise your spreadsheet is broken, or every stock is coincidentally selling for the same price-to-sales.
ASNESS: But sometimes that spread is huge, and sometimes it’s very tight, and it does correspond to times that would intuitively strike you as frothy.
RITHOLTZ: So the wider the spread, the more attractive the valuation.
RITHOLTZ: The lower value stocks versus the growth stock.
ASNESS: Value looks better versus growth on a three to five-year horizon. Also, pure value is never a great timing tool. I think you do put yourself on the right side of so-called catalysts when valuations are that extreme. Bad catalysts for you will hurt a little and good catalyst will help a lot. But still, I wrote this in late 2019 because spreads were approaching something I never thought I’d see again.’
RITHOLTZ: Back to ’99, though.
ASNESS: They were approaching the tech bubble peaks.
RITHOLTZ: Really? That’s shocking. In ’99, what do we have off the pandemic lows? 68 percent gain in the S&P, and then the next year another 28 percent on top of that. So this is late ‘19.
ASNESS: This is late ’19. We were not there yet.
ASNESS: And I’m talking about the spread between cheap and expensive, not the whole market. The entire market, if you like, a Shiller CAPE or something was much worse in ’99, 2000. It hit about 45, where it hit the low to mid 30s at the peak in 2020.
RITHOLTZ: How do you use Shiller CAPE in your work?
ASNESS: Same way.
RITHOLTZ: Because I know a lot of people are kind of shrug emoji.
ASNESS: Some indicator that when the Shiller CAPE is very high, the PE is very high, the 10-year prospective returns are low. We don’t actually go short something because of the Shiller CAPE.
RITHOLTZ: Right. It seems like it’s been on the high side for decades.
ASNESS: Yeah. That’s one of the main Antti and I look at and saying it’s pretty hard to make your money actively timing based on only the Shiller CAPE. It’s much more reasonable to have a valuable 10-year modification to historical norms, because the Shiller CAPE is high or low. But in late 2019, I wrote this, it’s time for a venial value timing sin. I wrote that I’m ignoring momentum or trend here, which is against a lot of our philosophy and largely because I thought this was epically crazy and it could come back very, very quickly, just because on average, trend and momentum work on average.
You want to be able to do something that works on average, many, many times. You only had one shot at this, right? If this came back in a three-month melt-up for value stocks, you could miss a lot of it if you if you didn’t do this. So it turned out, if I listened to trend plus value, it has worked out well for us. It would have been even a little better. So there’s a little bit of a moral story. I give you my fault as well as my —
ASNESS: But I wrote this thing. And then about, I don’t know, four or five months later, I wrote a follow-up piece saying no sin has ever been punished this violently and this quickly.
RITHOLTZ: I recall that.
ASNESS: I will make an excuse. But I think as excuses go, it’s one of the better ones.
ASNESS: It’s called COVID.
ASNESS: Certainly, that was not in my predictive power. Also, I think the market reacted ex-post certainly crazy to COVID. Basically, you remember, all you needed to own was peloton and Tesla, and value stocks were going to cease to exist in the lockdown.
RITHOLTZ: Well, Tesla started running up in anticipation of being added to the S&P before COVID, and then just really went next level.
ASNESS: Though, value, as we or almost anyone else measures it, was destroyed over the first six months of COVID, and it turned out not to even be directionally true. The value stocks fundamentals, what I call them executing outside of what the market cares about, just executing in their companies —
ASNESS: — was actually strong, even including the pandemic. So the fear did not materialize. We thought those spreads got crazy. But as opposed to approaching tech bubble highs, never thought I’d see in my career again after the tech bubble, admit I got that wrong, they blew past it, well past it, when COVID hit. And we stuck to our guns and even added to that tilt a bit.
Basically, any explanation that someone from the outside, a strategist, a pundit, a client, a consultant, or internal that we could come up with, for why we might be wrong. You know, the way I think of these is you got to keep a really open mind, consider what you might be wrong, tests that story. And if at the end of the day, there’s something that’s unprecedentedly crazy-looking, and you have, after keeping that open mind, rejected those stories, then you got to plant both feet and say I will not be moved. And I think we’ve gotten pretty good at that over time. I never wanted that.
One thing you asked earlier about investment philosophy changing and we went off and 20 other fund tangents. One major way my investment philosophy has changed is at the beginning of my career, 30 years ago really, if you go back to the Goldman days, if you had asked me what will make a great investor, quantitative in my sake, but in general, I would have probably given you an arrogant answer that, oh, just being smarter than other people. You know, being smarter than other investors then the market as a whole. The arrogant part is the implicit assumption that kind of comes along that I’m one of those people.
I still think this is a bold statement. Smart is good. I haven’t changed the sign on smart. But I now think long-term success, half the battle is after keeping that open mind, you can’t skip that step. If you decide you’re right, having an extremely ornery stick-to-itiveness to you is an equal partner to being smart.
RITHOLTZ: All right. So I’m going to just edit what you just said for a moment because I understand exactly what you’re saying, but I want to rephrase it. So intelligence in the market, those are table stakes. You have to assume everybody you’re trading with and against —
RITHOLTZ: — is intelligent, even if it’s not true. You have to assume that that’s what’s on the other side, hey, I don’t know who’s on the other side of my trade, but I’m going to assume they know at least what I know, if not more. What you’re also sort of suggesting is you have to learn when your high conviction trades become I stick to my guns and ride this out, even if I’m wrong for a quarter or more or four, this will eventually work out.
ASNESS: Or 11.
ASNESS: Because I know these numbers precisely. Drawdowns have this amazing subjective, we borrow the term from physics, time dilation, even though we use it differently, where if you look at a back test, or even real life returns and you see a fairly horrible drawdown, but you know it ends well, you look at and go, of course, I’d stick with that. It’s a great process. Look at what it delivers.
Two, three years, as some of these can take, they are an eternity. Everyone wants quarterly numbers which means you’ve gone back to people 11 times, 12 times and said, we stink again. It becomes a proof statement and you show a partial anecdote to this. But the financial media does a great job of coming up with stories why whatever is working is the truth and whoever is losing is —
RITHOLTZ: Right. That shows what’s working right now.
ASNESS: So you’re defending yourself. I do think we’ve done a great job of sticking our guns at these times. But I do worry that some years at the end of my life have been used up.
RITHOLTZ: But what’s the quote? There are some days that lasts decades —
RITHOLTZ: — and some decades that go by in days.
ASNESS: When we talk about children, that’s an example of decades that go by in days. Drawdowns are an example of days that go by —
RITHOLTZ: Right. Days are long and decades are short.
ASNESS: It feels far longer than it really is and what I might call, I don’t think there’s a real term, but statistical time.
ASNESS: When can you actually say this is wrong?
RITHOLTZ: It’s pain time. When you’re in pain, time goes much more slowly. Time flies when you’re having a good time. And this the inverse.
ASNESS: And this is perhaps self-serving, but this raising of a rational, after being open-minded and cynical stick-to-itiveness to half the battle is also why I think some of these things last and don’t get arbitrage the way in the real. This latest 2017 which again was a bad period for value, but a very good period for us and our firm grew.
Most common question I get, particularly in public forums, would be, and it’s an intelligent question, if this is as good as it looks like, why isn’t arbitrage the way? And literally, I did not expect or want to be as right as I was over the following three years. But I would say particularly having lived through the tech bubble, you have no idea how hard this can be to stick with at times. It is not that easy. It seems easy now over full cycles. And I am schizophrenic about this, half of me hates it because these times are hell, but half of me realizes that if they didn’t exist —
ASNESS: Right? Every value manager on earth and this probably applies to non-value, but this is the people I talk —
RITHOLTZ: Every discipline on Earth —
RITHOLTZ: — in finance. anyway, I’m going to steal your line, you don’t get the full glory of the upside without suffering through the out of favor downside.
ASNESS: No. Wes Gray, someone you and I talked about before we started, I think it’s Wes’s term.
RITHOLTZ: It is Wes’s. I know exactly where you’re going to go.
ASNESS: No pain, no premium.
RITHOLTZ: Oh, no, I was going to say even God would get fired as an active manager —
ASNESS: Oh, okay.
RITHOLTZ: — is a line from Wes.
ASNESS: Maybe Corey Hoffstein said no pay, no premium. I’m good at offering attribution. I’m not always good at getting it right.
ASNESS: But they’re both awesome so —
ASNESS: But I do think there’s truth to that. My favorite story which I’m going to make you listen to now.
ASNESS: This is from the tech bubble. I am, probably late ‘99, early 2000, at home at night talking to my new wife, and I’m whining and worse than whining. I’m cursing up a blue streak about how stupid and crazy this world is, none of which I can repeat even with the laxer laws today on George Carlin’s seven words. I still wouldn’t go through —
ASNESS: — what I was screaming that night. And she said to me, she only said one sentence, the rest was implied. She said, I thought you make your money because people have some behavioral biases and the rest is implied. She’s saying, but when those biases get really ugly and they make really big mistakes, you whine like a stuck pig.
RITHOLTZ: So wait, you’re a quant and your wife is a behaviorist. Is that right?
ASNESS: My wife has master’s in social work, so I guess behaviorist is accurate. And anyone who’s been happily married, which I’m going to search she is and she can rebut if you invite her on, to me, for a quarter century, it has to be a bit of a behaviorist.
ASNESS: But what we all want, which we’ll never get, is a world where there are opportunities. We’re active investors. We think we make the market a more efficient place. We think we make capital markets better. That’s important for society. But we exist to a large extent to take the other side of errors and correct that. We don’t want a world with no errors because there’s nothing to do. We want a world where there are significant errors. And after barrier Cliff puts the position on, 11 minutes later, the market realizes we were right and hands us our money.
RITHOLTZ: That doesn’t work that way.
ASNESS: And it doesn’t work that way.
ASNESS: It is almost perfectly calibrated and make sure most people can’t do it.
RITHOLTZ: I like that phrase. I wouldn’t say it’s almost perfectly calibrated. The countryside is littered with people. By the way, I know you spend time on Twitter. We’ll talk about that. On investment TikTok, which has since shrunk dramatically, I love —
ASNESS: I never got on investment TikTok. Thank God.
RITHOLTZ: Well, I access it via Twitter. But —
ASNESS: Do you, like, wrap your stuff on investment TikTok?
RITHOLTZ: No, never. Never.
ASNESS: You may put it to a Sinatra melody, it might be more appropriate for you.
RITHOLTZ: No. What I love is what TikTok calls investing TikTok, I call it Dunning-Kruger TikTok. And my favorite is the young couple, both good-looking people.
ASNESS: But why wouldn’t you choose good-looking people?
RITHOLTZ: The way we make money is we only buy stocks that are going up. And once they stop going up, we sell them. And that’s how we subsidize our whole lifestyle. I am not paraphrasing. That is like a verbatim quote.
RITHOLTZ: As one of Jagadish and Tippmann are the two academics who really deserve probably to play some momentum, but as one of the very early discoverers of momentum. There’s a little truth to what they’re saying. But they tend to do it in a very disciplined way. And very often, individuals and institutions and professional investors tend to be what I call momentum investors at a value time horizon. They look at something that’s been strong —
ASNESS: — for three, five years, and they go, it’s got to keep going. And at that time horizon, you want to be a contrarian, not a momentum investor. So I feel obligated as a co-author of some of the momentum stuff to defend that a little bit. But this is not adding up well for these people, I promise.
One last thing about it, a running joke I’ve had for years, is people in describing this kind of thing, often subtly use the wrong tense. They talk about buying what has been going up, but the implication is —
RITHOLTZ: It is —
ASNESS: — it is going up. And you just got to watch your tense. It’s very easy to identify what has gone up and it’s part of our process.
ASNESS: By the way, I would not be a pure momentum trader. Momentum has what the geeks will call a very bad left tail. Some famous periods of reversals in market, the most famous spring of 2009 when we came off the GFC.
ASNESS: For multifactor, it was actually enough, and value did well enough. But if you were a pure momentum investor, that was a very, very ugly period. So in another way, I think this couple that I’ve never watched is probably getting it wrong.
RITHOLTZ: Yeah, to say the very least. So I could talk about your publications forever. Why don’t I throw three or four at you —
ASNESS: Go ahead.
RITHOLTZ: — and you tell me which ones you want to talk about. Stock options and the lying liars who don’t want them; stock buybacks, unmitigated good or incomprehensible evil. That’s a paraphrase.
RITHOLTZ: AQR zone research has disproven the size factor and undermines long-term investing; or four, what is volatility laundering. I mean —
ASNESS: Okay, I’m going to try.
RITHOLTZ: — that’s three hours’ worth of material right there.
ASNESS: I usually lie about this, but I’m going to try to be quick and just go through them. Stock options and the lying liars who don’t want to or won’t expense so much, to get the exact title —
ASNESS: — as a play in an Al Franken book back in the time. I think Rush Limbaugh was the villain in his title. This was particularly post tech bubble. This has been an issue forever, that stock-based compensation, be they options, particularly if they’re options are not considered an expense of the company. The paper I wrote does this beat to death, let’s look at the 22 ways you could argue this and why they’re all stupid.
ASNESS: The best argument is the simplest one. These people accept a lower salary and want these things. Obviously, they’re costly.
RITHOLTZ: They have that.
ASNESS: Ultimately, the shareholders, I won’t go through all the other subtleties, what’s a little sad is we kind of won the battle in that current accounting standards make you expense stock options and that was a change. But we also lost the battle because plenty of firms, particularly in the tech world, still issue kind of pro forma earnings that don’t expense them. And a lot of Wall Street analysts to their shame, in my opinion, let them get away with it and use those numbers. They’re just not real.
RITHOLTZ: Let’s go to one of your favorites, buybacks.
ASNESS: Buybacks, you gave this Manichean evil or good.
ASNESS: My position, actually, I don’t say it mildly, but much more mild than that. My position is they’re largely nothing.
ASNESS: They’re largely very close to a dividend. You can argue they’re —
RITHOLTZ: A more tax efficient than that?
ASNESS: More tax efficient dividend. And by the way, I don’t take a great stance on how they should be taxed. That’s a separate issue. I take a stance on the idea that they’re evil. And by the way, this is one of the fun ones today, because it’s horseshoe theory, both the left and the right hate buybacks.
RITHOLTZ: Yeah, it’s kind of interesting, isn’t it?
ASNESS: You know, for different levels of innumeracy and paranoia, they think this is just a scam. Again, there could be 40 arguments for why buybacks are neutral and are not the evil thing you think about.
RITHOLTZ: Let me give you one argument.
RITHOLTZ: In a world where some companies do buybacks and other companies don’t, the companies that do buybacks tend to perform better than the ones that don’t.
ASNESS: That’s been a very mild effect, but it has been true and it’s been a relatively short term.
RITHOLTZ: Now, whether it’s causation or correlation is a whole another conversation.
ASNESS: Yeah. If it is causation, the most likely estimate, which is not crazy as management has more information than you do about the stock. And by the way, if they do believe the stock is undervalued, and very often this is public information, they’re just saying we’re really undervalued.
ASNESS: They shouldn’t be buying things back. It’s voluntary whether you sell and those who don’t choose to sell will benefit from that. So I have no problem with that. It is a relatively small effect.
RITHOLTZ: That’s interesting. You and I have debated it on Twitter, and I’m not so far from your position. But I’ve watched you demolish people on Twitter as if it’s a giant, hey, this is like the value effect.
RITHOLTZ: It’s much smaller than that.
ASNESS: It’s much smaller. If I’ve done that, that is one of my many Twitter exaggerations. I will not claim that I always keep a calm head on Twitter. But the simplest way to explain it, now, let me give you two quick ones. One is most of it is a reallocation of the stocks. When most investors participate in a buyback, they put it back in the stock market —
ASNESS: — with another stock.
RITHOLTZ: It’s a diversifier, actually.
ASNESS: So you know, a company that has great investment opportunities is seeking more capital and a company that doesn’t should be giving capital back. So that’s how it’s supposed to work.
Second is even more basic, and this does not get enough play. The shareholders earn the money or they own the money. If there’s cash on the balance sheet or assets on the balance sheet, it’s the shareholders. There’s only one group that’s allowed to get upset at them. If they choose to move it from the company to their own balance sheet, which is not stealing because they owned it when it was in the company.
ASNESS: Corporate bonds can have covenants that say you can’t lever beyond a certain point. And if buybacks push past that point, then there’s a legitimate argument. But that’s contractual. The bondholders should fight that.
RITHOLTZ: There be a lawsuit that would stop that.
ASNESS: I think —
RITHOLTZ: That’s got to be a pretty a tiny —
ASNESS: I think it’s small.
ASNESS: Buybacks also get a little demonized and corporations do this. For some reason I do not understand, they often couple them with the executive stock option grants.
RITHOLTZ: What a coincidence.
ASNESS: We talked about it before. And I think there is a little subterfuge going on there. They don’t want the share count to change a whole lot because questions will be asked.
RITHOLTZ: I think that’s the most valid criticism is, hey, you’re really hiding all this exec compensation by doing expensive buybacks.
ASNESS: And it jives with the lying liars stuff.
ASNESS: But it is not the buyback per se that’s bad. The buyback is still a neutral. They’re paying a market price for the security.
ASNESS: So there I wish people would be more precise. So largely on buybacks, and again, maybe in contrast to some of my more aggressive things I’ve tweeted on occasion, I want you to find those tweets.
RITHOLTZ: I think you’ve deleted a bunch there. I don’t know if they’re around where anyone could find that.
ASNESS: Well, I challenge you to find them knowing I’ve deleted them. This is part of my strategy.
ASNESS: But regardless, if you look at what we wrote, the derangement we write about is how much people hate them.
RITHOLTZ: Buyback derangement syndrome.
ASNESS: Yeah, we titled both an academic paper in the Journal of Portfolio Management and at Wall Street Journal editorial.
RITHOLTZ: So you know from whence the derangement comes?
ASNESS: Yeah, I know Trump derangement syndrome.
RITHOLTZ: No. Well, no, no, no, I mean that.
ASNESS: That’s what we’re playing.
RITHOLTZ: By the way, it used to go back to Bush derangement syndrome, not just Trump.
ASNESS: Oh, I don’t remember.
RITHOLTZ: Yeah. No. So you know, when you get older, the memory stuff —
ASNESS: Was there a Millard Fillmore derangement syndrome?
RITHOLTZ: I’m not that old. I’m not that much older than you. My two favorites back in the day, Dell was notorious for top ticking the market when announcing their stock buybacks. But now, you have the train derailments —
RITHOLTZ: — and they had a buyback last year. So of course, the buyback is the reason why they didn’t upgrade their brakes. And that example sort of colors everybody’s perspective.
ASNESS: Here, you go back to Modigliani and Miller. I’m not saying the theory is perfect, but as a starting point, firms should pursue all positive net present value projects, and I do think most management tries. I think the short termism can be exaggerated. So if they need the money, they should be investing. They can raise money in debt. A lot of the buybacks, by the way, and you could argue leverage has its own problems, but corporate treasurer is thinking that bonds were more overvalued than stocks. So they should buy back stock and sell bonds.
RITHOLTZ: In other words, during the 2010s, it’s very rational to borrow cheap and buy back stock.
ASNESS: Yes, essentially. And we show this in our more formal paper, there wasn’t room to do it in Wall Street Journal, that investment has really not suffered on that. You can always pick and choose. And in an argument, every side picks and chooses their favorite examples. This is a company that bought back, that then did great.
ASNESS: And you know, Apple has bought back a ton and sometimes they’re criticized for that. And I’m like, it’s worked out fairly well.
RITHOLTZ: It’s well priced, right? Yeah.
ASNESS: It worked out fairly well for them. They don’t —
RITHOLTZ: Same with Buffett.
ASNESS: They also have a ridiculous amount of cash, Apple, on the books. So it’s not like they needed the money. Buffett is a huge defender of buybacks. So I think I’m mainly yelling into a void, saying this is just not that big a deal. But it’s politically too good for populace of both stripes to yell about, to go away.
RITHOLTZ: Really, really interesting. Last week, actually, I interviewed Maria Vassalou from Goldman Sachs Asset Management, who pointed out that within the small-cap effect really is a micro-cap effect.
RITHOLTZ: Well, first let’s talk about your research. Was there ever truly a small-cap effect?
ASNESS: Yeah. I’ll start out saying I don’t think I’ve met Maria, but she’s right. Was there ever is the right question. There’s a little bit of a Keanu Reeves Matrix thing going on here. Is there really a spoon?
RITHOLTZ: Red pill us.
RITHOLTZ: Tell us what —
RITHOLTZ: Our view is there never really was one. Our view is not that there was one and it got arbitraged away, which is a different way to view it. Essentially, in the early ‘80s, the original capital asset pricing studies looked pretty good, seemed like beta was rewarded and that later got revised also. But then hole started appearing in that pure one factor world. The first major one was that even after accounting for beta, small caps generally have higher betas. They move more. The market goes up 5 percent on average. They might go up 7 percent as a group.
RITHOLTZ: So you’re suggesting it’s just more risk, more return?
ASNESS: They’re more volatile as a rule. And beta is composed of correlation and volatility. I think it’s more of the volatility than the correlation driving, but they’re higher beta. The CAPM are all theory. It says you should make more money if you’re higher beta, but not more than that. And the findings were not that small cap makes more money. That’s not that interesting. The findings were small cap makes more money than implied by their higher beta, so even more.
That over the years, a lot of the work being ours, but not all of it has been revised. Two big revisions, the second one we really were a big part of. The first was simply revisions to the databases, small cap stocks delist more often than large cap stocks. In any study, you need to make an assumption about what people actually got out of that delisting whatnot.
RITHOLTZ: So are you suggesting this whole thing is just survivorship bias?
ASNESS: A little bit, though, with well-intentioned. People had assumptions for delisting returns. The general consensus and my expertise does not lie here, but the general consensus is they underestimated the negativity of those delisting returns. All else equal, making small cap a little less attractive because your data has not accounted for enough. Where we jumped in is again, remember, we’re not talking about the small beat large. We’re talking about does it beat it beyond its beta. And we’re not the only ones to do this too, Scholes and Williams looked at it a while ago.
Those betas are generally underestimated by conventional techniques. If you do a quant geek’s favorite thing, regressed the monthly returns on small versus large on the market, you get a positive beta, small, has a higher beta than large. So if you go long small and short large, you have a positive beta leftover. A lot of small doesn’t trade every day.
ASNESS: If you look over a few months, those betas increase. If you do statistical work, we include the response of small not just to this month’s cap-weighted market, but to the last few, it tends to get into the small cap prices slowly. But that’s still real. So we’ve underestimated their betas. If their betas are underestimated, meaning we thought they were too low, we’ve overestimated their alphas. Their betas should have been higher. More of their return should be just attributed to the market going up. And basically, between those two things, there’s nothing going on. And this is not a bad thing. Small caps should be priced reasonably efficiently —
ASNESS: — versus large caps. So one thing I will —
RITHOLTZ: By the way, that’s kind of surprising given how much more coverage there is on the better known big caps, and how often these are orphans.
ASNESS: Well, I think that does show up in something you anticipated me, I’m about to say. These get confused occasionally. I do think many of the factors, anomalies, effects that quants and academics believe in, value being again maybe the poster child, but not the only one, do work better among small caps. So long, cheap, short, expensive and small caps, certainly has a higher gross risk-adjusted return. Net, they’re more expensive to trade. I still think that’s going to be the truth, the case net, but it’s a little more arguable. But I have no problem with someone saying I love small value because I think value probably does work better in small.
RITHOLTZ: That’s very interesting.
ASNESS: But the so-called small-cap effect, it often gets conflated with that. It is not small value. It’s that small is better than large. And just —
RITHOLTZ: And that we’re finding is no longer quantitative being supportive.
ASNESS: We don’t think it’s supported. At least if only adjust for beta, just to make everyone’s head hurt, we have an additional paper showing that using the more modern factors that weren’t even around in the ‘80s when guys like Rolf Banz and a few others we’re looking at the small-cap effects, so I can’t say they should have used them. Small caps tend to be bad on some of the newer factors, betting against beta. Profitability, they tend to be fairly unprofitable.
ASNESS: If you adjust for that, they should do even worse in a modern sense. And ironically, you get back to a small-cap effect, but only if you adjust for kind of the full panoply of modern factors. Small cap against the market is not a bargain.
RITHOLTZ: What about the micro-cap against the small-cap, why does that seem to have some —
ASNESS: Well, again, even including that, I think we see most of the small-cap effect go away when you adjust for the delisting again and the higher betas from illiquidity. But whatever, if there’s something left, it is disproportionately coming from micro-cap. That’s true.
RITHOLTZ: Let’s talk a little bit about one of the things we haven’t discussed, which is macro. And 2022 was kind of a good year for macro, at least if you’re on the right side of the trade. Why was last year so unique?
ASNESS: Well, it’s interesting. We haven’t talked. We’ve focused largely on stock selection and value. A big part of our business is actually macro. I often say we do less than people think. They think we do all these different things. But a lot of what we do in macro, and an early insight of ours, frankly, about 1995 at Goldman Sachs, was if you look at the factors, again, it was really value, momentum and size at that point, and apply them to macro decisions, what country to be in, what currency to be in.
They had similar efficacy. They worked in a statistical sense. I always say statistical sense. If your car worked like this, you’d fire your mechanic. Right? If your car works 6 out of 10 days, that would be pretty bad, but it’s pretty great as as a strategy. So we’ve been using value momentum, even for market direction trend has become increasingly. It’s probably the most important part of what we do in the macro side, with economic trends, not just price trends, being a relatively recent innovation and super important.
And last year, trend following in particular, which is a subset of macro, I will tell you we also run some, where we consider relative value and carry and other things. But we run some really focused on both economic and price trend factors that we’ve always described as having kind of a dual mandate. Long term, it’s supposed to make money. It’s not a crazy thing for an investment to do.
ASNESS: But it’s supposed to do particularly well in really bad times. This is a managed futures industry, the CTA industry. Trend following has had that property over time.
RITHOLTZ: Meaning commodities, currencies, anything that you’re buying with futures.
ASNESS: Commodities, currencies, equities, bond futures. And we’ve actually expanded that to what we call alternative trends, more esoteric commodities, yield curve shape, trades, even the equity factors themselves, even though we’re talking macro.
RITHOLTZ: So some derivative.
ASNESS: Yeah, so some tendency to trend. But that dual mandate is a little bit different than most. Most investments, you’d like a low correlation to other things. Sometimes you accept a medium or high correlation, but it’s mostly about the risk-adjusted return of the asset itself. Trend following has always, I think forever, people are looking for both. And it’s not free, you can create a higher risk-adjusted return if you don’t want to hedge giant drawdowns in the equity market. But this combination has always been a nice addition to portfolios and attractive to people. It got very loved after the GFC, when it really did what it was supposed to.
RITHOLTZ: And you had a giant trend that lasted, it felt like forever.
ASNESS: Yeah. And I should say trend following is not a panacea. You have bolts from the blue. Neither of these were very bad for trend following, but it didn’t make a lot of money either. October 19th of ‘87, which we saw a small trend start in about August, but not that much. And obviously, COVID, trend following was not how to protect yourself. There was no trend to follow.
ASNESS: Out of the blue, a pandemic hit.
RITHOLTZ: Extra genius shots will do that.
ASNESS: Yeah. But most serious bear markets we’ve seen aren’t a day. They are a few years of pent-up crazy or an economic event that leads to a few years the other way, and that’s where trend following really shines. The decade after, ironically, pretty similar to value, well, not as bad. Trend following simply didn’t make a lot of money in the decade after the GFC, unlike value lost money versus growth. Value lost versus growth. But still people started to lose interest in it.
They got excited after the GFC, and then if there is an insurance-like aspect, which I think there is to trend following, 10 years of a wild bull market, a lot of people start going why have I been wasting this money on insurance?
ASNESS: And I think it started in in parts of 2021 and it’s still continuing a little bit this year. But last year was a blowout year for both trend following and even the more general macro investing that considers relative value. And it’s exactly the year it’s supposed to help in. Consider a rival insurance strategy always owning puts.
RITHOLTZ: It sounds expensive.
ASNESS: It is expensive.
RITHOLTZ: And it sounds like it doesn’t work most of the time.
ASNESS: I’ve had huge Twitter fights with Nassim Taleb about this.
RITHOLTZ: By the way, you and Boaz Weinstein both seem to go at him politely, and you both have the (inaudible) to do it.
ASNESS: I did what I would I always do. I started out politely. It didn’t necessarily end there. And I will say I think Nassim is absolutely brilliant. He’s just also insufferable at times.
RITHOLTZ: It’s a dangerous combination.
ASNESS: You know, I may be less brilliant and less insufferable, but I might have some of the same characteristics which a dangerous mix when you —
RITHOLTZ: The difference is you bring a certain degree of personal humor and charm, with perhaps.
ASNESS: Well, he does not make fun of himself. That is fair.
RITHOLTZ: Right. So, you know, we all exist on a continuum —
RITHOLTZ: — and everybody sort of slots in in different places.
RITHOLTZ: I find you much more accessible and warm and fuzzy. Listen, his books are groundbreaking.
RITHOLTZ: No one is going to argue that he’s not brilliant. You are more accessible on Twitter than he is.
ASNESS: I do try to be. So a strategy he’s been involved for a long time that kind of corresponds to his Black Swan book.
ASNESS: It’s a very good book.
ASNESS: It’s basically a one liner, giant things happen more often than —
RITHOLTZ: Than we expect.
ASNESS: — quote, “normal model,” normal distribution say. But it’s important message. He got very lucky that he wrote a timeless message about an hour and a half before the GFC. Right? But my colleague Antti Ilmanen is getting very lucky and that same, he wrote a book called Investing in a Low Expected Return Environment —
ASNESS: — before 2022. So you can write something that’s absolutely right and correct, but timing luck.
RITHOLTZ: Dow 36,000, we’re almost there. When did that come out likely? ’99?
ASNESS: At least one of the co-authors —
RITHOLTZ: The difference between Antti and Nassim’s books, they’re actually real and meaningful.
RITHOLTZ: And that book was just nothing but non —
ASNESS: For pure fun at the end, you can ask me about that again. But the strategy Nassim favors is buying insurance through the options market. Tests of the simplest form as my colleague Antti has done, say that loses a boatload of money, including its huge victories in crashes. I have no problem with someone like Nassim saying actually, whoever he works with does this much smarter.
ASNESS: If you’re rolling puts —
RITHOLTZ: It’s not equal size every year.
ASNESS: — that’s a form of alpha.
RITHOLTZ: I bet there’s a million other ways to spin that.
ASNESS: But he doesn’t like the basic finding. He wants both and I won’t give him both. Puts work really well in crashes.
ASNESS: Right? March of 2020, October 19th of ’87, huge. There are leakages in terms of premium over the long haul that doesn’t have crashes is larger than what they make. And there are some bear markets that they failed to help with. They did not particularly help in 2022. There was no crash.
RITHOLTZ: Too quick.
ASNESS: Well, no, too slow for the puts. In 2020 —
RITHOLTZ: Down 34 percent, and then you snapped right back.
ASNESS: Oh, that was March of ‘20.
RITHOLTZ: Of ’20, I’m sorry.
ASNESS: No. You had it right given your time period.
ASNESS: The puts help like crazy then and managed futures didn’t. In 2022, managed futures helped like crazy because it was a long —
RITHOLTZ: Yeah, six months to the low in June about.
ASNESS: And puts I don’t think really helped at all. The premiums got very high —
ASNESS: — and there was no big crash. And that’s not an environment. If you like puts more than I do, you think the cost is lower, a portfolio of the two as an insurance product could make a lot of sense because they hedge different things, puts hedge both from the blue crashes and trend following hedges long slow crashes. I will make the self-serving claim that long slow crashes tend to be more deleterious to your wealth long term. A lot of short-term crashes reversed soon afterwards. They’re really about surviving.
ASNESS: So I will make a small commercial for how we do it. But if someone a little bit more reasonable than Nassim, wanted to go, all right, it is costly, but it’s less costly than you think and maybe we should combine these two.
ASNESS: I’m wide open to that. But in 2022, and frankly, you know, going forward, I’m mildly, I don’t do a lot of timing of our own strategies. I said it’s a sin. Most of what I recommend is always having some allocation to trend following. There’ll be long boring periods where I hopefully won’t lose you a ton, but won’t make you a ton. That’s usually a pretty good time for the rest of your portfolio. Over time, it should add up to a positive which it has, and it should help a lot in these one, two-year gigantic events.
If I had to time it, I’m a little more bullish than normal. It tends to do better when there’s great macro vol, when people don’t know what’s going to happen. Boring times where nothing is really going on, it’s not your time for puts. You know, I’m a little leery of saying this because I laugh when people are always saying now is special. So it’s dangerous to go. We have more uncertainty now than normal, but I do think I’m going to do it. I do think we have more macro uncertainty now than normal. So I like it a little more than normal.
But mostly, our argument is you don’t know when this is going to happen. You don’t know if we’re going to have another two years of this. And by the way, if we don’t have another two years of disaster, you’re pretty happy everywhere else.
RITHOLTZ: So let me push back on the more uncertainty —
RITHOLTZ: — because I cringe every time I see someone on TV say that.
ASNESS: Me too.
RITHOLTZ: When —
ASNESS: I gave you a long caveat saying —
RITHOLTZ: You did. You did. And yet you still jumped right in the hole you dug —
ASNESS: I did go there.
RITHOLTZ: — which is, you know, when do we ever know what’s going to happen in the future? When do we have a high degree of confidence? I take the behavioral side, which is when people are talking about uncertainty, what they’re really saying is, hey, we’re having a hard time lying to ourselves about how little we know what’s going to happen and we’re starting to get nervous. So macro vol might be the good descriptor for that, where you can pretend you know what’s going to happen because it’s so, I want to say uncertain, but that’s the wrong word. You just lose yourself confidence in knowing what might happen.
ASNESS: Yeah. We’re directionally the same. And I did also, as part of my caveat, said I still wouldn’t time this —
ASNESS: — very much. I do and I admit, I explicitly want to counter the belief that people might think we’ve missed it. Manage futures is one in a decade, huge positive, it adds up to good over the whole decade. But it may revert now. We see no tendency for that —
ASNESS: — historically. No, it’s a trend following strategy. If it starts to get it wrong, it’ll switch its mind pretty quickly, actually. The fundamental trends that we’ve added in the last five to getting closer to seven or eight years, we think have made the strategy materially better. It’s no longer just your grandfather’s trend following strategy.
ASNESS: We follow price. We think that always has a role in a portfolio. We don’t know if crazy stuff will continue or we’ll go back to normal. Again, if things do go back to normal, yeah, maybe your managed futures don’t help you very much. But everything else goes back to helping you.
ASNESS: So we think the case is, at least let me just be more mild, at least as strong as it normally is, and we think it’s pretty strong.
RITHOLTZ: That’s really —
ASNESS: I will back slightly off my sin there of forecasting.
ASNESS: So given the fact that you’ve been investing now for 35 years, something along those lines, in your lifetime, have you ever seen a 10 percent spike in inflation or a 5 percent rise in rates as an investor?
ASNESS: 5 percent rise in rates over long periods, we’ve seen that, but not anything like the recent period, and maybe not even. It’s been a downtrend in rates over my career.
ASNESS: I’m trying to do this in my head.
RITHOLTZ: Since ‘81.
ASNESS: I know for a fact, because I looked at it recently that I’ve not seen, you know, 5, 6 percent inflation in my career. Now, I do think, you know, I’d be happy to share with you, quants have some disadvantages. There’s less we can know about any one individual situation than a more discretionary manager. But we do have one advantage. Sometimes they’re maligned correctly, but sometimes they’re overmaligned. Back tests can be really helpful because just because I haven’t lived through inflationary periods doesn’t mean we can’t look at inflationary periods.
ASNESS: And that is a quant advantage. And frankly, with the exception of the trend following strategy, which I think when giants stuff happens, it does tend to do better. The core stock selection strategies and Antti, again, I keep quoting Antti. You should have him on instead of —
RITHOLTZ: I did.
ASNESS: I know you did. I know you did. But if I’m going to quote him all the time, why not just go to him. He has done a lot of our work on showing the environments that factor investing tends to do better or worse by factor and as a group. This is for stock selection. If you want to make it a tautology, yeah, when the spreads between cheap and expensive go way wider, value does lousy. But that’s a tautology.
Macrowise, there’s very little relation. There’s very little consistency to it. That’s actually I think a good thing. It means if you do this for asset classes, there’s obviously correlations. Higher growth and lower inflation is good for stocks and good for bonds. As they mix up, you can get different results. Low growth, low inflation is dynamite for bonds. How it comes out for stocks is a little bit more iffy. But when it comes to factors, it doesn’t mean there aren’t some big factor events, but they occur in all environments without a great pattern. So again, we do think we’re pretty good diversifier to a lot of the rest of the world that is much more linked to the macro cycle.
RITHOLTZ: So when you’re looking at back tests and you’re heading into ‘21 and ‘22, how are you thinking about the risks? And do you make changes? Did you just suffer through ‘20 and ’21, waiting for ‘22? Or are you gradually shifting the portfolio mix before you make it to the Promised Land?
ASNESS: Again, you and I have been bouncing back in a great way between quantitative stock selection and the more macro trend following, and the stories aren’t precisely the same.
RITHOLTZ: I mean, it’s the six blind men —
RITHOLTZ: — describing the elephant, which is my favorite parable. But we’re really just talking about different aspects of what takes place in risk markets.
ASNESS: For value, yeah, to be honest, when it does look unexplainably after the keeping that open mind attractive and we do that sin a little, we do just wait. Now, Barry, of course, we didn’t sit there in 2020 and say we’re going to have to wait. And in fact —
RITHOLTZ: We’re waiting till March 2022, mark your calendar. I saw that tweet from you.
ASNESS: Well, the funny thing is value actually started turning around in late 2020. Everyone calls it 2022. That value has been coming back since COVID started to ease.
RITHOLTZ: Well, once everything got way crazy by the end of ’20, there’s a little hindsight bias. But it makes sense for people, all right, let’s peel a little off here and rotate it then.
ASNESS: Oh, absolutely. But if you go back a couple years earlier, value spreads were very wide. And yeah, we were saying we don’t know when this will turn around, but it will and importantly on net from here. Saying, you know, one day, it’ll go up again doesn’t really help you. If it’s going to go down more than it’s going to go up in the future, it has to be on net.
RITHOLTZ: No broken clocks at AQR, is that right?
ASNESS: Not this time. I won’t say it didn’t break other things, but that’s just between me and whatever is strewn around my office. So value on its own, yeah, well, sometimes we do wait. Catalysts, famously, people look for catalysts, obviously, momentum, both price and fundamental. You could lump into the catalyst camp. So we do look for some of that.
But some of the things, when the absolute peak occurs, which is a timing level that I think is beyond any of our ability. Somebody always nails that ex post, but only anyone can consistently do that. You look at the peak of the tech bubble in March of 2000. You look at the peak of the valuation bubble in stocks, which was kind of October of 2020. Why it peaked there, not three months earlier, or six months later? Even with the benefit of hindsight, I don’t think we have great stories. I think when things get egregiously valued, the odds get more and more on your side. Again, good catalysts will help you more and bad will help you less. And sometimes our job is to plant our feet and say we will not move.
Now, on the macro trend following strategy, it was a better timing story. Again, it didn’t make money for a long time, but didn’t lose a lot. And both from some price trends, but I think even more from fundamental trends, we started to see the fundamental trends that could lead to a more inflationary environment. Again, it’s not us sitting around making inflation forecasts. We’re not macro economists.
ASNESS: Fundamental trends are things like those actual economists revising up their inflation forecasts. Growth trends are things like GDP surprises aggregated for the whole world, if you’re doing that all of equities country by country. Those did a really good job of getting ahead of the inflation that came. So there I’ll say on the value side, I’ll say we didn’t do a very good job on the catalysts, but we did a really good job on sticking with it and it has paid off. On the trend following and macro side, I will say I’ll give us higher grades on the catalyst side as to the timing. But that’s naturally what it’s trying to do.
RITHOLTZ: Right, by definition, really fascinating. So the past couple of years, we’ve seen a huge outperformance of value over growth. What does that mean looking forward? How much persistency does that value advantage have, especially following a decade of growth advantage?
ASNESS: It’s funny. It takes a much longer time for excesses to get squeezed out of the market than people think. Particularly if you’re on the wrong side of it, like, if you’re a growth stock investor, the last two years I’m in such pain. This has to be extreme. No, again, we start with measures that don’t look at returns, that look at the actual valuation ratios of stocks.
And at the peak of the bubble in 2020, a few months after COVID, it got to by far the widest ever, north of the tech bubble. After two-plus phenomenal years, the last time I looked just a couple days ago, it was at the 89th percentile.
RITHOLTZ: So still wildly —
ASNESS: Yeah. Also, tactically, I said I tilt it a little too early because I went on just value not on trend. The trend is now at its back. You know, nothing is a certainty. That can be huge reversals in any trend interim. I don’t want to predict the next quarter, but we are still very excited. We’re seeing still a mispricing that prior to COVID, I would have considered almost close to tied with the most extreme ever.
ASNESS: And we’re seeing the wind at its back. So again, I don’t want to overpromise, the short term can always make anyone look silly. But on a few year horizon, we are super excited about value.
RITHOLTZ: So the Goldman Sachs non-profitable tech basket, and there’s another basket of low quality stocks, they’ve crushed it in 2023. Is this just a dead cat bounce? What does this mean? Is the cycle changing, or what’s happening in your least favorite part of the market?
ASNESS: This is going to be a hard one because it’s confusing.
ASNESS: I’ll tell you that in advance. But it’s confusing in a different way I think even than you’re thinking. Breakup, what’s going on into pure measures of junk, no valuation here, low profitability as Goldman does against high profitability. And Goldman is not wrong about that. They’re not surprisingly, the results are right. Low beta against high beta, that we often consider part of quality. All else equal, you’d prefer a low beta. All else is not always equal, but if you can have less vol and less sensitivity, it’s a good thing.
Profitability, choosing more profitable and underweighting or selling low profitable. And beta, choosing low beta and underweighting or selling high beta. Together as a group and individually have had a really bad start to this year, for the exact reasons you’re talking about. It has been a junk rally. Now here, I’m hoping to blow your mind a little bit.
RITHOLTZ: Go ahead.
ASNESS: The way we measure value, and keep in mind, everybody does it a little different.
ASNESS: You can have 10 great people here, and they’re all going to have their own favorite ways. One thing we do since 1995, when we wrote a paper on this, we don’t allow value to take an industry bet. We tried to make it apples to apples.
ASNESS: Everyone talks about value in terms of like tech versus textiles. You can’t fully remove it in a bubble. These are all correlated. But we think value can be hard to compare. Valuation ratios can mean very different things in different industries. But broadly speaking, compliance gets nervous when I talk about performance to the public. But I will tell you value alone has had a very strong start to this year, which you would not guess if I told you it’s a junk rally.
RITHOLTZ: Now, they can happen simultaneously —
RITHOLTZ: — and perhaps for different reasons.
ASNESS: Now, this is actually much more normal.
RITHOLTZ: Oh, really?
ASNESS: Historically, when profitability and value are often negatively correlated, because the cheap stocks are often unprofitable. So when the profitability factor, if you will, is doing well, it has at least a decent negative correlation. It’s been stronger in the U.S. than globally, but it’s negatively correlated value. So what’s going on this year is more normal. But that is not what was going on for the prior few years.
Value and profitability, in particular, were highly correlated, because in a bubble, remember, in a rational loss for value, we can do well. Profitability does well. In a bubble, it’s not the profitable stocks that are soaring to the moon. It’s the story stocks.
RITHOLTZ: So let me take the other side —
RITHOLTZ: — of the bubble claim and say, hey, stocks got overvalued in 2021. But was it really a bubble? We’re down what? 20 percent on the S&P, 30 percent on the Nasdaq. That seems like a run of the mill drawdown —
RITHOLTZ: — and are not a full-on crash.
ASNESS: One of the hard parts is in a fun way, because they’re all relevant, we’re mixing a few different things. There is the level of the overall stock market and the overall bond market, and then there’s internal to the stock market. How cheap stocks did against expensive stocks —
ASNESS: — how profitable stocks did against unprofitable stocks, hedged without a market exposure.
ASNESS: People have used the term everything bubble —
RITHOLTZ: Right. Which is really wrong.
ASNESS: Everything can’t be in a bubble at once. By definition, by the way, the opposite, you can short the values. And we were in a depression, not a bubble. But there were some correlated things going on. For the market as a whole, the move in the stock market in one year was big, not something we don’t see occasionally. This is not a —
RITHOLTZ: 28 percent is not —
ASNESS: This is not on Nassim Taleb’s Black Swan —
ASNESS: — moment. The move in the bond market was very big, closer, but still not a black swan. The move in 60/40 maybe not still black swan, but was far more extreme than either alone because they happen at the same time.
RITHOLTZ: Forty years. ‘81 was the last time you saw that.
ASNESS: Yeah. Again, Antti will be the first to admit, he looks like his timing is better than it really was because he’s been saying this for a while. But that was the core of his work. He does a 10-year forecast on the outlook for 60/40. What current valuations, it’s more complicated than this. We called it the Shiller CAPE for stocks. Lower expected real returns when the Shiller CAPE is high, and just really yields on bond. Yields versus economists’ forecast of inflation.
Antti takes 60 percent. He’s the genius in math. To get the 60/40, he takes 60 percent of the stock forecasts, adds the 40 percent of the bond forecasts. That number hit the low ever, at least as we can monitor it. I won’t say the wrong —
RITHOLTZ: In ’21?
ASNESS: Yeah, at the end of ’21, call it.
RITHOLTZ: Yeah. That’s pretty good time.
ASNESS: Well, I always feel guilty when I say ever. Maybe in the Roman Empire, it was worse, but we can’t measure it.
RITHOLTZ: Right. Just towards the end.
ASNESS: In the measurable universe that we have, and 60/40, I’m going to try to get this right. Sometimes we talk global. Sometimes we talk U.S. Call it, it’s made about four and a half percent real. Meaning over inflation —
ASNESS: — over the long term. That’s actually quite a nice real return. We’re used to talking about nominal returns and almost half bonds. So four and a half percent real is very —
RITHOLTZ: Low risk, that’s a good number.
ASNESS: It’s very nice. Antti’s forecast, which I think is quite useful, obviously, got down to below 2. It was in the high 1s at the end of 2021. Just looking at current valuations, and saying how does that usually play out over 10 years? By the end of 2022, after all the pain, I think it got into just about 3.
RITHOLTZ: Really? Which is surprising given that we’re now looking at rates in the 4 to 5 percent range.
ASNESS: Well, remember, this is real.
RITHOLTZ: But inflation is (inaudible).
ASNESS: Right now, it just gets back to you challenging me on there’s more uncertainty. It’s pretty hard to come up with a really good 10-year forecast of inflation right now. But certainly positive is forecasted. So cash is interesting again. I’ll say that.
RITHOLTZ: That’s really interesting.
ASNESS: But how interesting it is, depends a lot on what your actual inflation outlook. Bonds are interesting again. So basically, the fairly massive trade-off was still only one-year trade-off. After a 13-year bull market and not all that bull market was bubbly. A lot of that was fundamentals. But a lot of that was repricing, things getting more expensive. You don’t fix 13 years of getting more expensive, in general, in one year. I’m not sure you want to because you got to go down a lot more than we did.
So Antti’s numbers, which I agree with, instead of four and a half, he’d probably use in the low threes. Now, if you’re sitting there saying, what do I need to retire? What’s that number? By no means are we certain that 3 is irrational, that we need to get four and a half. Four and a half, and I know you’ve heard these arguments, may have been just too good of a deal, historically. For instance, for much of the —
RITHOLTZ: Are you saying 60/40 has been arbitraged away, or is it just the environment we’re in?
ASNESS: It may have been repriced —
RITHOLTZ: That’s better.
ASNESS: — higher price to a lower expected return. Here’s my favorite argument for that and it’s not a complicated one. Very few people actually got the four and a half percent.
RITHOLTZ: That’s always true.
ASNESS: The costs of investing in various ways were far higher today. And almost all portfolios were not like index funds today. You know, you had a broker who bought —
ASNESS: — 10 stocks.
RITHOLTZ: There’s a lot of friction.
ASNESS: So a lot of friction and the effect of volatility of your portfolio was double the markets because you owned a handful of stocks. So both the top line was lower because you didn’t really get it. And second, you are facing higher risks by choice. But the index fund concept didn’t exist for much of this time.
ASNESS: So —
RITHOLTZ: And even when the concept existed, you couldn’t execute on it.
ASNESS: Yeah. So basically, I think the 3 today, this is very arguable, but maybe it’s good as the four and a half historically in terms of what you get to keep and what risks you have to take to get it. At below 2 and this is art, not science. Nobody can tell you what this number should be.
ASNESS: At below 2, I and Antti, and a lot of people did think that’s too low.
RITHOLTZ: Yeah, doesn’t make any sense.
ASNESS: But above 3, maybe I think PIMCO is a super firm, but I hate to give competitors any credit anytime.
ASNESS: But we may have a new normal of lower than normal, lower than historically normal.
RITHOLTZ: That’s really, really interesting. All right. So now I have you for five minutes which means this is our speed round and these answers have to be less than 60 seconds. Are you ready?
ASNESS: I am.
RITHOLTZ: All right. So first, we’ll do a quick three-part curveball, one minute. How early do you pull a goalie when you’re down one, two or three goals?
ASNESS: When you pull a goalie, if you’re down one at about five and a half, six minutes —
RITHOLTZ: In the last period.
ASNESS: — in the last period, all this can be situational. Our model is simple, right?
ASNESS: If it’s in your own zone, you put the goalie back in for a while.
ASNESS: Well, the two goal result is the one that always shocks people. You pull about 11 minutes to go.
RITHOLTZ: You’re essentially playing the last period.
ASNESS: Yeah. You’re playing half, more than the last period.
ASNESS: And the idea is you’re not at the money option. Losing by 3, 4, or 5 —
RITHOLTZ: It’s the same.
ASNESS: — it may have pride issues, which is not in our model, but it doesn’t have standings issues. And three, I actually forget the number, but I think it may be before the third period.
RITHOLTZ: Got it. MfA Poker Tournament in April, are you participating this year?
ASNESS: Since the GFC —
ASNESS: — which really had nothing to do with it, it’s just coincidental timing, I have only played poker in every third year in that charitable tournament. My skills to the extent I ever (inaudible).
RITHOLTZ: The atrophy.
ASNESS: I was never a great poker player because I have a short attention span.
ASNESS: And a lot of poker is —
RITHOLTZ: Being patient and —
ASNESS: — willing to stare at somebody for seven hours so you can remember what they did six hours ago.
ASNESS: I had fun with poker. I think I was pretty intuitive. I didn’t lose a ton, but I probably lost money in my poker career. First time I learned poker to play in this Math for America Tournament, I didn’t know a whole of them. I didn’t know how to play.
RITHOLTZ: Arguably —
ASNESS: And my second year I played and I came in second.
RITHOLTZ: Right. I’m going to say there’s so much random chance in it.
ASNESS: Oh, yeah. In one tournament, over time, poker is pure skill.
ASNESS: Over anything, it’s very similar to investing.
RITHOLTZ: Of course.
ASNESS: On short horizons, it’s really not —
RITHOLTZ: Anything can happen.
ASNESS: But one of the worst things that can happen to you as an investor or a gambler is to get lucky early.
RITHOLTZ: Yup. Yup, absolutely. The best thing for you is to walk into a casino and lose.
ASNESS: Then no matter how smart you think you are, you think you’re smarter than you really are.
RITHOLTZ: You’re always looking for that hit of dopamine.
RITHOLTZ: I don’t know if I’ll be able to get you to answer this in under a minute. Marvel or DC and what’s your favorite Marvel film?
ASNESS: I do like both. I’m a comic book fan. It’s how I learned to read. I’m more of a Marvel guy. Though, sometimes DC is great. It varies who the current right or crop is better.
ASNESS: Favorite movie is hard and what I’m saying is if you go find other people have asked me this, I’m not claiming full consistency. It varies over time.
ASNESS: I think the original first Ironman that kicked off the MCU —
ASNESS: — is an underrated movie. It’s a damn good movie.
RITHOLTZ: No, it’s a great movie.
ASNESS: And not in the MCU, before the MCU, the first X-Men movie. I don’t remember even how great it was.
RITHOLTZ: It was great.
ASNESS: But it was the first time we saw maybe Michael Keaton is Batman in ’89.
ASNESS: But for me, certainly with Marvel, it was the first time I saw a superhero movie or TV show that didn’t look ridiculous. The CGI and the effects caught up.
ASNESS: That was good. So I think that was a milestone. So those two.
RITHOLTZ: I’m going to throw it to you because I think they both have a —
ASNESS: Such a lightning round, but you’re disagreeing.
RITHOLTZ: Oh, no, I’m not disagreeing with you.
ASNESS: It’s not a lightning round. Okay.
RITHOLTZ: I’m appending.
ASNESS: All right.
RITHOLTZ: Deadpool and Guardians of the Galaxy both have a certain sense of humor. Always —
ASNESS: Thor: Ragnarok too.
RITHOLTZ: That’s right. Always seem to be missing from the rest of the Marvel world.
ASNESS: I love those. Some people want to be purist and say, that’s not how the comic books were. They’re wrong. If you’re really —
RITHOLTZ: They make sense to you.
ASNESS: They were wisecracking during every fight. So I do love those for the combination of humor. X-Men didn’t have much humor, I’ll admit that. Ironman 1 did mainly because Robert Downey Jr. is just hilarious.
RITHOLTZ: He’s great. Right. He was so good.
ASNESS: So I do like the ones with humor.
RITHOLTZ: So let’s talk about favorite books. What are you reading and what are some of your old time faves?
ASNESS: Can I rant one more second about Marvel movie?
ASNESS: You didn’t ask me what my least favorites are.
RITHOLTZ: Oh, go ahead.
ASNESS: They should find every copy which is hard digitally these days of Doctor Strange in the Multiverse of Madness.
ASNESS: And they should bury it in the sun. Let’s move on. That’s all I want to say about that one.
RITHOLTZ: All right. So you’re not a fan of Doctor Strange.
ASNESS: Terrible. I’m a big fan of the character, it makes me even angrier.
RITHOLTZ: Let’s talk about favorite books. What are you reading now? What are some of your favorites?
ASNESS: My all-time favorites tend to be in the sci-fi fantasy world, not surprising, given our comic discussion.
RITHOLTZ: Are you a big Dickhead?
ASNESS: I’ve read a bunch by him. That’s one of the (inaudible) questions I’ll get.
RITHOLTZ: By the way. I am a self-professed Dickhead. When I say that, people who don’t know Philip K. Dick —
ASNESS: In my career of going to comic book conventions, I’ve not heard that term.
RITHOLTZ: Oh, really? It’s very common on the Internet and it’s really —
ASNESS: The one thing fun about him is he’s written a lot of things that became like famous movies, but no one knows him.
RITHOLTZ: Blade Runner, Minority Report.
ASNESS: And no one knows that guy.
RITHOLTZ: The Schwarzenegger movie, they did two of them.
ASNESS: Yeah. Total Recall.
RITHOLTZ: Total Recall. Right. We Can Remember It for You Wholesale was the short story.
ASNESS: My all-time choice, one is very cliché.
RITHOLTZ: Go ahead.
ASNESS: Dune. I loved Dune. I read it.
RITHOLTZ: There are a couple of Frank Herbert books that are just amazing beyond the Dune. It’s amazing.
ASNESS: Yeah. The first two Dune books I thought were great. The first one much better than the second one. Then they got totally weird.
ASNESS: Very messianic, religious —
ASNESS: — odd.
RITHOLTZ: That was always the thread throughout.
ASNESS: Yeah, there was a thread.
RITHOLTZ: It could be crazy.
ASNESS: But it became all that. But I love Dune, complex —
RITHOLTZ: Yeah. Amazing.
ASNESS: — rich book. You know, sci-fi or fantasy sometimes gets a simplistic childish label. Dune —
ASNESS: — blows that away. The last movie was the first time I’ve seen Dune reasonable —
ASNESS: — on TV. Don’t even start me on Sting dueling with these —
RITHOLTZ: Got it. Got that.
ASNESS: — made-up swords that were in the book. Also, I’m a big fan of some of the old pulps like the original Conan stories by Robert E. Howard —
RITHOLTZ: How far is that? Oh, okay.
ASNESS: — in the ‘30s. I’m not against him. I’m not talking about Arnold Schwarzenegger’s Conan. I’m talking about —
RITHOLTZ: Right. The book.
ASNESS: — stuff that appeared in like weird tales —
ASNESS: — serialized and then became books. I think Robert E. Howard, he unfortunately killed himself very young and no one remembers him. But he created —
RITHOLTZ: And he didn’t see his own success.
ASNESS: No, he didn’t. He created Conan. And his writing was so rich, like dripped with feeling and color. So I was a big fan of that. This actually segues nicely into what I’m reading now.
RITHOLTZ: Go on.
ASNESS: Because I am rereading the original basic Lord of the Rings, which you use the term table stakes before.
ASNESS: That’s table stakes for a fantasy, right?
RITHOLTZ: I read it like every other summer, The Hobbit, anyway.
ASNESS: I liked The Hobbit. I never liked the full Lord of the Rings.
RITHOLTZ: And now?
ASNESS: I’m liking it more.
ASNESS: I have found historically, I have a small tolerance for 12 pages of Elven poetry, which I think Tom Bombadil, for some reason, the character scared me as a kid, even though he’s not very scary.
RITHOLTZ: Really? So let me ask you this question.
ASNESS: But I like him more now.
RITHOLTZ: So I love both The Hobbit and The Lord of the Rings. And while everybody loved Peter Jackson’s —
RITHOLTZ: — I thought it was way too dark. Within The Lord of the Rings, within the original, there’s a balance —
RITHOLTZ: — between the hope and the fear.
ASNESS: I think that’s fair and ultimately hope wins. So —
ASNESS: — it is a positive choice.
RITHOLTZ: So they take you to this really dark place. It’s almost like the ending is tucked on.
ASNESS: By the way, going over a minute is completely your fault. So —
RITHOLTZ: I own it.
ASNESS: — if you go through Tolkien’s experience of World War I and then writing in World War II, he really had that light and dark —
ASNESS: — going on.
RITHOLTZ: But it was balanced.
ASNESS: But I did enjoy the movies because part of it is —
RITHOLTZ: The same.
ASNESS: — even a fan your whole life, seen it come to life.
RITHOLTZ: In such a glorious way.
ASNESS: I do not recommend the extended versions —
RITHOLTZ: I’ve steered clear of that for the same reason.
ASNESS: — because they were already a little too long and the extended versions basically like Bilbo says goodbye 11 times. You have like 11 elegiac, I’m not sure I pronounced that right, but he’s going away. So I don’t recommend that. But I do love those movies. I’m reading that now. I’m reading David Rubenstein’s book on investing, largely because in May, April, or May, he’s going to interview me —
RITHOLTZ: Oh, great.
ASNESS: — which I’m terrified of because he may have seen some of the things I’ve said about private equity over time. I’m kidding. He knows about those. He still wants to interview me. But I got to be prepared for that one.
RITHOLTZ: He could care less what you think about private equity.
ASNESS: That’s true.
RITHOLTZ: Can I say that? I mean —
ASNESS: Yeah. There are people who are, you know —
RITHOLTZ: And I used the phrase wrong, it’s actually could not care less. But everybody says could care less.
ASNESS: Yeah. No, you’re right.
RITHOLTZ: All right. Our two adult questions we say for the very end, what sort of advice would you give to a recent college grad interested in a career in value investing, quantitative finance, or even academia?
ASNESS: In broad, general, financial career, I’ll go with, I don’t like either and if someone tries to only steer you to lucrative careers, that’s not a happy life. If people only steer you to find your bliss, well, if you’re not the best in the world that your bliss, and the bliss doesn’t actually pay you anything, it’s not such a great thing. I got into finance because I liked it. Because I worked for these professors, I found it interesting, thought I’d be a professor. Not everyone has to follow that route. But you want to blend those two things.
The only concrete advice I’ll give people, young people and I say this all the time, is try very hard not to chase what’s currently hot. Particularly starting out your career, don’t try to be suicidal. But going into what’s currently hot, you’re going to be five years off every time.
ASNESS: So I would back off that. And if someone is really considering a career in value investing, I recommend investing, as I said earlier, at least half your time in building up your psychological endurance level.
RITHOLTZ: Because you’re going to need it.
ASNESS: You think it’s all about balance sheet and income statement analysis? No. About half of it is the right personality and the right emotional makeup, and the right partners.
RITHOLTZ: Our final question, what do you know about the world of investing today you wish you knew 40 years ago when you were first getting your feet wet?
ASNESS: Going back, there’s always been this tension in academic finance and in applied quantitative finance, in why these things worked and we talked about it very briefly earlier. If someone shows you a great back test, there are really three possibilities. One is it’s diverse data mining. And let’s assume it’s not that, they’ve just tortured the data, let’s assume you think it’s real. It can work because you’re taking an actual rational risk and being compensated for it, or it’s often called behavioral finance, some people are making errors.
I often take two Nobel laureates, my Gene Fama as one end, and Dick Thaler, also in Chicago, as the behavioral guy. There are a lot of other great people in this field. I don’t mean to make it to these two. But I would —
RITHOLTZ: Yeah, you could do worse than those two.
ASNESS: Yeah, absolutely, and I’m a fan of both. If you ask me who I think is more right, now, like, I think Gene’s contributions are actually the biggest in the entire world of finance because a lot of the field wouldn’t exist without him. But that’s a different question of who’s right. I think I would have been 75/25 in the Gene camp, when I left Chicago, even finding momentum.
RITHOLTZ: And now, you flipped?
ASNESS: And now, I think it’d be 75/25. And all that means is more of why our stuff works I think is taking the other side of behavioral biases than a rational risk premium, than I used to. And we’re all a prisoner of our lived experience, right? Living through both the tech bubble and those last five years; two and change, terrible; two and change, very good. All that may have over-influenced me. And you know, sometimes you see more crazy events in a career than the average.
ASNESS: But I’ve definitely moved. I still vote Gene, the MVP of academic finance. Again, I’m impugning the Roman Empire throughout all of history. But I probably have moved more towards the behavioral side.
RITHOLTZ: But someone got to be on the wrong side of the trade and a few quantitatively identify who that is. They seem to work very well in harmony.
RITHOLTZ: Cliff, thank you for being so generous with your time. We have been speaking with Cliff Asness. He is the co-founder, and just general all about town managing principal at AQR Capital Management.
If you enjoy this conversation, well, check out any of the previous ones we’ve done over the past nine years. We’re coming up on almost 500 and you can find those at YouTube, iTunes, Spotify, wherever you find your favorite podcasts. Sign up for my daily reading list at results.com. Follow me on Twitter @ritholtz. Follow Clifford Asness on Twitter @cliffordasness, and you could check out all of the Bloomberg podcasts @podcasts.
I would be remiss if I did not thank the crack team that helps put these conversations together each week. Justin Milner is my audio engineer. Atika Valbrun is our project manager. Paris Wald is my producer. Sean Russo is my head of Research.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
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