CONSUELO MACK: This week on WEALTHTRACK, prepare
to be entertained and enlightened.
Financial thought leader Cliff Asness sets
the quant and hedge fund record straight,
next on Consuelo Mack WEALTHTRACK.
Hello and 
welcome to this edition of WEALTHTRACK.
I’m Consuelo Mack.
We are celebrating the launch of our fifteenth
season this week!
Talk about long term investing.
We are so delighted you can share it with
us.
One of the hallmarks of a Great Investor and
Financial Thought Leader is independent thinking.
In order to beat the market you have to do
unconventional things.
This week’s guest is a prime example he
is known for his rigorous research and ability
to create strategies that are either non-correlated
with market behavior , i.e., they zig when
the market zags, or add alpha, a performance
edge over the market using more conventional
strategies.
He is Cliff Asness, Co-Founder, Managing Principal
and Chief Investment Officer of AQR Capital
Management, a global money management firm
he launched in 1998.
It now has $225 billion dollars under management
in hedge funds as well as other alternative
and more traditional strategies for clients
and its family of mutual funds which it started
in 2009.
One of the oldest, the AQR Managed Futures
Strategy Fund, successfully designed to be
non-correlated to the market is co managed
by Asness and has a Morningstar Bronze analyst
rating.
AQR stands for Applied Quantitative Research.
The firm uses proprietary computer models
to forecast returns for a wide variety of
assets and geographies using a heavy application
of old fashioned human brainpower which it
has in abundance.
Asness is a PhD in Finance from the University
of Chicago where he was Nobel Laureate Eugene
Fama’s teaching assistant for two years.
Asness has won numerous prestigious awards
for his own research including the James R.
Vertin award in recognition of his lifetime
contribution to financial research.
At last count 11 of the firm’s 26 principals
have doctorate degrees and 5 are current or
former professors.
AQR is known for its value orientation but
Asness is quick to point out there are other
key strategies employed.
CLIFF ASNESS: It’s a big part of what we
do, but it’s not all of what we do.
This is ancient news from now.
This is the early 1990s.
I’m dating myself, but I wrote my dissertation
on kind of the opposite of value, the momentum
strategy.
I didn’t say it should be done instead of
value.
I said it is a nice complement to it.
Let me back up.
A value strategy tries to come up with some
reasonable metric for value: price to book,
price to cash flow, price to sales.
Then you can debate all kinds of how to make
those measures better, and we do.
The quant world gets very worked up about
that, and you go long or overweight depending
on the investment mandate, cheap, low price
and shorter or underweight expensive.
On average over the very long term, the cheap
tends to beat the expensive.
Momentum is almost the exact opposite in spirit.
It looks over the last six to 12 months.
There are both price and fundamental momentum
strategies, just the actual things like earnings
and profitability getting better and buy what’s
doing well and sells what’s doing poorly.
These are not the only two things in quantitative
finance, but they’re kind of two of the
biggies.
They both work on average.
You’ve heard me say it before, but I try
to be very accurate and cowardly in my use
of the word “work.”
I mean it as a statistician, a little more
often then it doesn’t work.
If you call ...
CONSUELO MACK: Two out of three years?
CLIFF ASNESS: Two out of three years would
be great.
That is a typical number we throw out.
If your car worked like that, you’d fire
your mechanic, but markets are harder than
... I don’t if they’re harder than building
a car, but ...
CONSUELO MACK: Let’s say they are.
CLIFF ASNESS: ... it’s harder to be reliably
right in markets, so two out of three is ...
CONSUELO MACK: Two out of three means that
you’re making money or you’re doing better
than the market in two out of three years.
What’s the definition of it…?
CLIFF ASNESS: It depends really on what a
client’s asked us to do because we do both
kinds of portfolios.
We do portfolios that for a long time we’ve
called absolute return portfolios.
That term sometimes means very low risk portfolios.
That’s not how we mean it.
We just mean a return that’s not correlated
to the market.
Again, value and momentum is an oversimplification,
but it’s a useful one.
Imagine that is your entire process.
That’s what you believe in.
So, you’ve identified stocks, and this by
the way extends to a lot more than stocks:
countries, bond markets, commodity markets,
where to be on a yield curve.
They’re all amenable in our view to some
value and momentum measures, but let’s talk
about stocks because that’s I think the
easiest language to discuss.
You’ve identified stocks that are attractive
on these measures and that are unattractive.
Client A has asked you to build something
that’s not correlated to markets and is
allowing you to use some of the scarier things
in finance.
When I say scary, I don’t think they’re
that scary but the ability to short sell,
to use some modest amount of leverage.
These become necessary if you’re trying
to create something uncorrelated.
It’s very hard to only buy things and be
uncorrelated to the stock market, but if you
buy and you sell in very similar amounts,
you can ... and then if the value and momentum
factors on average work, what your long beats
what you’re short on average, and it’s
not too related to the direction of the market.
I say on average.
It doesn’t always win, but when it wins
and loses is not when the market wins and
loses.
Now a different client comes along and says,
“Well, I think what you’re doing makes
some sense.”
Some of them think it makes no sense at all
by the way.
I’m leaving them out of this story but says,
“This idea makes sense, but I’m not looking
for an uncorrelated asset.
I’m a market person.
I’m just simply looking to do a little better
than the market, and I’m not comfortable
with nontraditional investing techniques.”
Then you can use these same measures to say,
well, I’m going to buy a subset of the market.
I’m not allowed to short.
I’m not going to really use that side of
the opinions, but you buy a subset of the
market.
Then again, the model is deeper than this
value and momentum.
It also extends to ideas like quality, carry,
low risk, but sticking with just value and
momentum, you buy stocks that fit that criteria.
Then if those measures work, you do better
than the market on average, so-called beat
the market, famous kind of goal, but you are
now running something that is very correlated
to the market.
You’re long only stocks.
You’re rising and falling with the market
and hoping to have an edge over time.
CONSUELO MACK: So, is that considered to be
an alternative investment?
CLIFF ASNESS: I don’t think so.
CONSUELO MACK: It doesn’t sound like it
is at all.
CLIFF ASNESS: I don’t think so.
I think of an alternative investment as one
that should be very low correlation to traditional
markets.
That is actually a controversial statement.
The hedge fund world for instance – and
we’ve written a ton about this – has been
a topic we’ve been obsessed with for almost
20 years.
Our first paper ...
CONSUELO MACK: Well, you run hedge funds too.
CLIFF ASNESS: We do.
We arrogantly say we actually hedge.
When we run a hedge fund, we’re attempting
to run a very low, often a zero-correlation
strategy.
All that means it’s not that hard to do.
You’re short about as much as you’re long.
The actual hedge fund world runs about 40
to 50 percent net long, and their returns
are about 0.8 correlated to the stock market.
So, they’re still trying to win and they’re
still harshly hedging.
There is some alternative going on, but we
would call those kind of half alternatives.
CONSUELO MACK: Point eight is high.
I mean they’re pretty correlated to the
stock market.
CLIFF ASNESS: Yes.
In specific geek terms, it’s pretty freaking
high.
CONSUELO MACK: Let me ask you about the value
orientation that you’ve got at AQR, and
in a previous WEALTHTRACK you told us that
a quant from like AQR combines value which
wins over the long term and with trend-following
strategies, and it will keep you safer than
pure value.
So, is there proof that value does win over
the long term?
I say that in the context of over the last
11 years for instance that value, has underperformed
growth for 11 plus years, and the spread of
performance is getting larger.
So, my question to you is, does value in fact
win over the long term?
CLIFF ASNESS: My answer is a very firm, “I
think so.”
The reason for that is you asked a great question.
Is there a proof of this?
There’s never a proof of anything that’s
statistical.
CONSUELO MACK: Really?
CLIFF ASNESS: No.
Unfortunately, in statistics, statisticians
if you watch carefully actually never say,
“We believe this.”
They say something more like, “If this is
true, the chance we’d see this result is
very, very small.”
All they’re doing ...
CONSUELO MACK: Wait.
If this is true, the chance we’d see this
result is very small?
CLIFF ASNESS: Let me put it this way.
If value did not have an expected larger return
than growth, the chance we’d see it win
for the 90 years we’ve tested back to the
1920s is very small, is one out of 100, one
out of 200.
I’m making ...
CONSUELO MACK: Oh my goodness.
CLIFF ASNESS: But the amount of time something
can happen from luck, there’s always some
level of luck it could be.
You might get that chance down, and unfortunately,
we don’t get it this low, but you could
get it down to one in a million, but you can’t
get any chance down to zero from purely observing
statistics.
You can just say we’re more and more sure.
CONSUELO MACK: So AQR, $225 billion under
management at this point, and I can remember
having you on in 2009 when you had $20 billion
under management.
In 2008 you had had 40 billion under management.
So, this is ...
CLIFF ASNESS: It’s a wild business.
Isn’t it?
CONSUELO MACK: Yes, it’s a wild business.
You’ve got 40 strategies, and I was going
through the list.
Risk Parity which you and I have talked about
in the past which appealed to me the way you
described it.
I don’t know if you’d describe it the
same way now.
The Single Sell Defensive, Momentum, Multi
Style, Relaxed Constraint Equity.
I have no idea what that is.
Three alpha.
CLIFF ASNESS: It’s a constraint we just
kind of ... no, I’m kidding.
CONSUELO MACK: Core plus bond fund which is
new in 2018, and there are a lot of firms,
competitors of yours that are coming in with
a whole slew of these products.
But as an individual investor, help us.
Which ones should we pay attention to?
CLIFF ASNESS: First, I would say we do way
less than it looks like we do.
We believe in a few core ideas.
We’ve already talked about them.
Cheap beats expensive.
What’s going on tends to keep going on.
CONSUELO MACK: Momentum.
That’s momentum.
CLIFF ASNESS: Value.
CONSUELO MACK: Value.
CLIFF ASNESS: Carry.
All else equal for the same cheapness, for
the same momentum, it’s better to get paid
than to pay in terms of yield.
CONSUELO MACK: So, carry is if prices don’t
move, it’s what you get.
So, for instance your dividend yields.
CLIFF ASNESS: You paid some attention to things
I’ve said before.
CONSUELO MACK: I did.
So, these are the four investment pillars,
and honestly, I look at you and your team,
and you’ve got 11 doctoral degrees or whatever
among your team, your principals, so you guys
are doing research all the time.
You’ve won every financial prize in the
book, and yet there are still four investment
pillars that you consistently ...
CLIFF ASNESS: And there were two 25 years
ago.
It grows slowly.
CONSUELO MACK: So, there isn’t a lot new
going on that we can bring to the table.
Is that right?
That’s going to give me an edge.
CLIFF ASNESS: I think that’s actually fair.
I think we are doing relatively timeless things
that are actually not even that different
than what good traditional stock pickers do.
Colleagues of mine wrote a paper called Buffett’s
Alpha on Warren Buffett’s returns.
Let me say for the record we are not claiming
Warren as a closet quant by any means.
We’re simply taking his record and saying,
statistically what quant factors does it look
like?
It turns out he doesn’t do momentum.
That’s not surprising for someone whose
preferred holding period is forever.
Momentum is not exactly a forever strategy,
but he’s very positively correlated to a
systematic quantitative value strategy, a
systematic quantitative profitability strategy
where after value you’d still like companies
that are doing better.
CONSUELO MACK: High quality is better than
low quality.
CLIFF ASNESS: Finally, what’s called the
low risk strategy, the fact that low volatility,
low beta companies don’t necessarily outperform
their counterparts but keep up much more than
you would imagine.
Financial theory, kind of the famous CAPM
says if you have a low beta, you should have
a lower average return.
The truth in a tremendous ...
CONSUELO MACK: Again, low beta is compared
to the market that you’re not much more
volatile than the market is.
CLIFF ASNESS: If you move on average half
of what the market moves, you’re a less
risky stock, and you should have a lower average
return, and if you move double the market,
you should compensate investors for that risk.
CONSUELO MACK: So not necessarily true.
CLIFF ASNESS: It turns out to be dramatically
false.
It’s not quite backwards, and this is a
little bit in dispute.
Some find an even stronger result, but we
don’t think high beta securities actually
underperform, but they don’t outperform,
and that’s a worse risk-adjusted return,
because you are a scarier security, and you’re
not offering a higher average return.
We use different terms.
Sometimes we call that part of the quality
effect.
Quality includes profitable companies, but
all else equal we like low risk, particularly
if we don’t have to pay in terms of expected
return.
It turns out Warren Buffett does too.
So again, Buffett is not a quant.
CONSUELO MACK: I was going to say.
He’s a closet quant.
CLIFF ASNESS: No.
It’s funny, but if someone has a style to
what they do and are disciplined about it,
they will end up, even if they pick none of
the same stocks and are using dramatically
different techniques, they will end up with
some correlation, a time period that’s good
for that style.
The result is also good for Warren Buffett.
CONSUELO MACK: So, for an individual then,
I mean your four investment pillars like cheap
beats expensive, momentum still works – I’m
not sure about that one – high quality beats
low quality, so are those kind of what we
should take as an individual investor and…
CLIFF ASNESS: I think when it comes to navigating
us for an individual investor, we greatly
prefer and actually try to structure what
we do on the individual side through mutual
funds to work through advisors.
Then we spend a ton of time.
It’s a bit of a copout answer I know for
right here.
CONSUELO MACK: No, and you do.
CLIFF ASNESS: But a lot of the existence of
these different strategies is to let an advisor
or an institution on their own build exposure
to the strategies they either have the most
confidence in that complement things they’re’
doing elsewhere.
For instance, this is hard for us to admit,
but we’re not the only game in town.
If someone thinks they have a great value
strategy somewhere else, maybe they’re looking
for us to do the other parts we believe in.
If somebody is extremely net long the markets,
maybe they’re coming to us for an uncorrelated.
If somebody is looking to build a portfolio
from scratch, maybe they’re looking for
basic exposure to stocks and bonds and looking
for managers to try to beat that.
So, either through an advisor or working directly
with institutions, we know we’re not a simple
beast to navigate.
We don’t recommend someone go to the website
and try to pick their three favorites.
CONSUELO MACK: . Let me ask you about a couple
of your mutual funds to understand kind of
the role they should play in a portfolio.
One of your early AQR mutual funds – you
entered the business in 2009 – was the Managed
Futures Strategy Fund.
You’re a manager on it.
It was from 2010.
It’s got $9.8 billion in it right now.
But I’m looking.
It’s like 0.16 percent annualized returns
over the five years.
So, I’m looking at that, and I think since
2010 you’ve beaten your category which is
the Managed Futures category.
You’re not supposed to be correlated to
equities and you’re not, but still that’s
a really ...
CLIFF ASNESS: It’s anemic.
CONSUELO MACK: It’s anemic.
CLIFF ASNESS: Absolutely.
CONSUELO MACK: So why bother?
What does this do for me in a portfolio?
Why should I be looking at Managed Futures
category for instance?
CLIFF ASNESS: It’s a great question, and
it applies to any strategy that’s been anemic
for some reasonable period.
Why bother?
You bother because you don’t think that’s
a representative period, and forecasting the
future, especially using only the recent past,
is hard.
I’ll tell you over the last five years,
maybe even back to anything post the financial
crisis has been a poor period for trend-following.
It’s been a pretty decent period for momentum
when it comes to stock picking.
It’s been a bad period for value investing.
It’s been a very good period for low-risk
investing.
On net it’s been a pretty good period for
us, but different things have worked at different
times.
Just like I look at Managed Futures and I
go we have well more than 100 years of data,
and it gets a little comical, but people have
gone back to Imperial Russia and analyzed
it, because one of the nice things about trend-following,
all you need is price to test it.
Value is harder to test.
You need fundamentals, and maybe you don’t
have that data, but if you look across five,
six different asset classes, geographies,
the tendency to trend is very, very strong.
If someone said to you, “We can create an
asset that’s about as good as the stock
market and completely uncorrelated to it,”
you might not believe that, but imagine you
fully believe that.
You bought it hook, line and sinker.
You’d say, “Why don’t I diversify about
half my money into that and half into the
stock market?
I get the same average return and they cancel
each other nicely.”
CONSUELO MACK: So is there such a strategy
that you could do as well as the stock market
but with half the ... ?
CLIFF ASNESS: We would never recommend half
someone’s assets in an alternative.
That was for pure illustrative purposes.
CONSUELO MACK: All right, all right.
CLIFF ASNESS: But the short answer is yes.
We do think something like a managed futures
long term will have fairly similar returns
to the stock market.
CONSUELO MACK: What is long term?
I think that’s what the problem is.
CLIFF ASNESS: It’s funny.
It’s almost always considerably longer than
anyone thinks.
What’s long term for the stock market?
It’s not three years.
It’s not five years because we have bad
periods over that.
CONSUELO MACK: Absolutely.
Is it seven years?
Is it ... ?
CLIFF ASNESS: If you get out to seven, ten,
20 years, and one of the nice things is using
history.
We can say Managed Futures is not working
for some period.
That’s happens a lot, but on average trends
tend to work.
They also have this nice property we haven’t
discussed that they tend to work in extended
painful time for traditional markets.
CONSUELO MACK: This is the great fear, and
that’s what I’m trying to think ahead
for all of us is this too will pass, this
bull market, and at some point, we will be
in a more painful financial period and, therefore,
that’s when I’m going to need protection,
probably when I’ve taken all the protection
off.
CLIFF ASNESS: Well, this pattern does repeat
again and again.
Post financial crisis, the cry is we need
uncorrelated assets that protect us from a
downturn.
Then you have a nine-year bull market.
Why do we have these stupid assets that are
around to protect us from a downturn?
You got to fight that tendency.
That’s what good investing is, is finding
something you believe in and stick with it
like grim death.
CONSUELO MACK: One investment for a long-term
diversified portfolio.
What would you all have each individual do
in a long-term diversified portfolio?
CLIFF ASNESS: I think that last time I stressed
bonds.
CONSUELO MACK: You did.
CLIFF ASNESS: Not in a tactical sense again
but just they’re underappreciated from the
diversification, particular if you’re amenable
to even the most mild use of leverage to restore
the risk.
That diversification is important.
I’m going to keep that answer, but I’m
going to hone it a little more.
CONSUELO MACK: Good.
CLIFF ASNESS: We have in the last couple years
one major line of research we’ve done is,
can we use these same ideas – value, momentum,
quality, carry – in a long-only bond portfolio?
It’s a little too self-serving, but we find
yet again they don’t work all the time by
any means, but those same forces help you
outperform a Barclay Bloomberg Aggregate Index,
Global or U.S.
Small edges, not magic, but the same ideas
boringly repeat.
But one thing we found, I want to tell people
to be careful about my prior recommendation
of bonds because we’ve also spent a lot
of time looking at the universe of active
bond managers, and they do something we don’t
love.
Even at the individual manager level it shows
up for almost all of them, and as a group
they have a very, very big bias towards lower
credit.
They are attempting to out-yield the index.
This is not a stupid strategy viewed alone.
On average you get paid for risk.
It is again not really an active strategy
you should pay a lot of money for.
You can simply choose a higher yield passive
portfolio if that’s what you want, so you
may be overpaying for it, but you’re also
... and we show this.
It’s so severe, you seriously eat into some
of the diversification aspects of bonds.
If bonds ...
CONSUELO MACK: They have so much in lower
credit quality bonds that you’re overweight.
CLIFF ASNESS: Lower credit.
It’s not precisely the same, but looks a
lot like equity.
A terrible equity market is usually a pretty
terrible market for lower credit versus higher
credit and vice versa.
They’re not precisely the same.
You could have a flat equity market where
lower credit, the yield effect dominates,
but they’re correlated, and you can see
that.
You can see that in downturns.
So, the typical ... and there are going to
be exceptions.
I always hate talking about the typical because
I’m being unfair to somebody, but we do
feel strongly that the typical active bond
manager has this almost passive, constant
overweight of lower credit.
That does get him a higher expected return,
but it’s not one you should pay him a lot
of money for, not pay active fees for it,
and they’re ruining some of the diversification
aspects.
CONSUELO MACK: So, they’re higher risk than
you’d think that a bond fund would be.
CLIFF ASNESS: They’re higher risk and less
diversification than you would think.
So, my new recommendation is a slight amending
of my old recommendation.
We still think it’s not a tactical view.
I’m not a screaming bond bull, but we think
bonds are an underappreciated asset in a long-term
portfolio, but I will amend that we think
people have to be more careful than we even
realized a few years ago; that they’re not
going to undo some of those diversification
aspects by investing with a manager who just
then goes and tries to out-yield the index
through low credit.
CONSUELO MACK: Cliff Asness, a treat to have
you on WEALTHTRACK.
Thank you so much.
CLIFF ASNESS: Oh, thank you.
It’s always fun.
CONSUELO MACK: Great.
At the close of every WEALTHTRACK we try to
give you one suggestion to help you build
and protect your wealth over the long term.
This week’s Action Point is: Take Cliff
Asness’ advice and Choose an investment
approach suitable for you and stick with it.
As Asness said, all in
vestment styles ebb and flow but the secret
to making them work is consistency.
AQR’s analysis of Warren Buffett’s approach
found that the secret to his success is his
“…preference for cheap, safe high-quality
stocks combined with his consistent use of
leverage to magnify returns while surviving
the inevitable large absolute and relative
drawdowns this entails.
Indeed, we find that stocks with the characteristics
favored by Buffett have done well in general...”
Most of us don’t have the ability to use
leverage, but we will all experience market
declines.
How we handle them over the years, staying
with them, or bailing out can make all of
the difference in performance.
Next week investing in the Trump Era.
How much do politics now matter?
Perspective and advice from influential global
economist John Lipsky and veteran strategist
Nick Sargen…
On this week’s exclusive extra feature on
our website Cliff Asness compares an unconventional
ice hockey strategy to investing.
Why what works doesn’t always get used.
Please feel free to reach out to us on Facebook
and Twitter.
Thank you for watching.
Have a great weekend and make the week ahead
a profitable and a productive one.
