Antti Ilmanen on Expected Returns

markets offer the least. He has an incredible CV full of all sorts of awards and has worked at all sorts of places like Salomon Brothers and Brevin Howard before ending up at a q R. If you're at all interested in value investing, factor investing, understanding how you're starting condition leads to future returns that might be better or worse than historical averages, you're gonna find this to absolutely be a master class in investing. I found it absolutely fascinating,

and I think you will as well. With no further ado, my conversation with a u RS Auntie Elmanen. Welcome to Bloomberg. Thanks, Perry. I'm really looking forward to this same here. So so first, I found the book to be quite fascinating, very in depth, and you managed to take some of the more technical arcana and make it very understandable. Will circle back with that. Let's let's start just by talking about your career. You you began as a sang Central Bank portfolio manager in Finland.

So yeah, my really first stroke of luck, I think, was getting that job. Before that, I had been nerdy kid with interesting esoteric things like royal family trees or or track and field statistic, not trading, and when I was studying in university economics, I did not really get the passion. The passion came when I went to invest the country's foreign exchange reserves there and it was it was very much global government bond markets, so thinking about

macro picture. I never never then then or later had I don't know much much interested on a single stock picking, so so think thinking of the big picture. And there were some lovely, lovely things like I was there in the October eighty seven crash and saw two year yields falling in one one overnight from nine and a half percent to seven and a half percent. You don't see those movements, yeah absolutely, Yeah. So so anyway, so that was that was That was a great, great learning experience.

And and then my second related stroke of luckworse that Professor ten French came there. Yeah, he came to educate nine and sort of what we were doing, what we should be doing, and and I was an enthusiastic kid there. Well by that time, I was already almost twenty eight and and he when I was expressing some interest about studying in the US, he was only, you should do it soon. You have yourself old enough to do that. And and and a few months later I was. I

was in the US. And it was so lucky in my life because because that year I met then H. Cliff Asnest and John lou who later founded uh a q R so as my fellow students. I met my wife there. She was NBA student from Germany. And it would have left a few months later University of Chicago, Chicago. So all of this, all of this luck sort of was related to my wonderful first jobs. And Gean Farmer

teachers there and his research partners Can French. Yeah, both both Cliff, actually all three, Cliff, John and I. We we had Farmer and French as our dissertation chairman. And and that's a small source of pride, a little little intimidating. So so you go from Chicago, is that how you ended up at Salmon Brothers? Yeah? So that that relationship actually already started when I was a portfolio manager, right funnily, in effectually like one of these Michael Lewis's la spoke

as good guys was one of my sales sales context. Yeah, he didn't have many good guys, but one was anyway. So so and and and I got to know people like Marty Leebovitz before I went to Chicago, and I think he helped. He may have again had a hand hand somewhere there. And so when I finished my studies, it was pretty clear that I wasn't sort of academic enough. I wanted to go to either by side or sales side. I even talked to them ge some Ware, Cliff and

John Ware didn't go there. Uh sort of thought from my eighties experience ad by side, this dust the wrong choice anyway. So so I then went to Salomon Brothers, did bond research for a couple of years on yield curve strategies, then moved to Europe. That was always a deal with my wife to um to be a bond strategist at Salomon for for many years, initially very discretionary,

but gradually becoming more and more systematic. And uh, and eventually turned from this customer oriented role to prop trading

for a while and then her gender up Brevan Howard. Yes, so I think that from from these times when I was strategist, I was talking to my two great people, but like you know, earlier on some LTCM and then various other people and including Alan who came actually from Salomon and so somewhere all three he sort of invited me to try to be a mini cliff Uh systematic systematic trader with a small team there at Brevan Howard, which was in some sense great, but it is sort

of a misfit because it's a very discretionary place, and so trying to do systematic in that environment was harder, and I think none of us were doing extremely well, none of us were doing extremely badly, but it just it just didn't become a um it's not a great third yeah yeah, yeah, but it was. It was. On the other hand, it was just a great place well

first to try it. But the second thing is that when two thousand and eight came along, it was one of the few places that we're making money, so it was a very comfortable vantage point for for that environment. How did you go from being a Mini clif firstness to a Maxi Cliff first. Yeah, so so, um, I had stopped that systematic trading, but I had been talking

with those guys often possibly um. Joining It was a matter also of them opening European office because that's where I was physically and so so so that that was a coaching. It also helped that I was I basically decided to write this book expected returns, and when I when I wrote it, I asked Cliff to write the foreword for it. And and by the way, like if you if you looked like check some time the first words he has there, like it was, I was sweating

when I read read that. Um, it's just by telling that first time I met Anti, I thought he was insane and I was right so so so that that that was a little stressful, but it turns it out very nice. But anyway, so that experience reminded I think both of us how aligned our thinking is based on this common common background, and that's somehow I think motivated them to I think them to offer, and me to me to say yes yes to uh to the idea

of joining them. Really, what I would think is getting to my natural home, and it happened in twenty eleven, so you've been there for more than a decade. You're now cohord of Portfolio Solutions. What is that role like? What's your what's your day to day work like at a QR Capital. Yeah, so the Portfolio Solutions group advice is mainly institutional clients on all kinds of challenges that they haven't thinking about expect it, returns, portfolio construction, risk management, etcetera.

And then in addition, we write lots of papers, I speak in many conferences. And then in addition to that, I've had a hand in designing and improving some of our strategies, especially related to style premium. That was something I was quite passionate about when I joined. And and by now i'm co head. The guy who has collaborated very closely with me, Dan Bill alone has taken more and more over the day to day running of the thing. And I, you know, I took time to write a

second book recently and now I'm talking about it. And I think, with with with my age, I'm happy to sort of moved part time status. I think so. In the book, Cliff Fastness again does the introduction and he says, you overshare a great characteristic for someone research, but he sometimes says he's afraid you're gonna feel the secret sauce.

So what explain over sharing of financial research? Yeah, so this is this is related to all of us having this University of Chicago experience where where we were really taught the value of being open and and putting your research out there for public scrutiny too, to improve it and to educate. But of course there are possible downsides to that, and and and that has been always always

a question. So so I'm not and we are not writing about all the proprietary proprietary strategies that we have, but we are talking quite openly about some things like against styles, factory investing, alternatively premium things that are relatively widely known. And I have this I don't know, Yeah, I'm sort of leaning that way of being too transparent and and and then somebody may have to control me a little. So so let's just talk a little bit about um. Two of the key themes in the book.

The first is alpha. It's the holy grail but also allusive and costly explain. Alpha is something we all aspire for, but in reality the evidence is very limited that that most investors can deliver alpha. Moreover, there's there's a lot of good research by others and us showing that much what people think is alpha can be explained by either you know, heads funds running, taking on lots of equity correlation or then correlation to these various styles that are

not quite quite market better. But it's it's certainly not pure alpha either. So somehow this type of demystifying, I think is helpful. But it's it's clear that investors tend to be managers and investors tend to be over confident in their ability to find that. So I'm glad you brought that up, because there's another bullet points in the last chapter the book which strikes me. Let me let me read it. Quote discipline, humility and patience UM as a key to invest in success. That sounds more like

behavioral finance than factor investment. Yeah. Yeah. So one other founder, David Cabilt, he's he's always had this very good point that good investment results require good investment strategies and good investors and and so we wrote the paper together almost a decade to go on bad habits and good practices and and really think thinking about those things, and it does definitely get to behavior our advices in general, I think behavioral finance literature focus is way too much on

how you can exploit other people's mistakes as opposed to looking in the mirror and reducing your your own own mistakes. So really, really quite interesting. So so let's talk a little bit about UM. Some of the concepts about expected returns UM you mentioned in the beginning of the book, lower asset yields and richer asset prices have pulled forward

future returns. In other words, a lot of the games we've seen in the twenty tens and our guess twenty one and twenty two weren't so much based on that multiple and of earnings, but future multiples that were pulled forward. And so that time period explain that it's always good to think of starting deals and valuations sort of as two sides of the same coin. So starting deals of all major assets were coming down in last decade and

last decades actually several decades. So something that I try to make investors see that, Uh, they naturally think of this way this way also of expected returns with bonds, but when they think of equities or housing they sort look at the rear view mirror and think of historical libraries returns that can be distorted by this returning or

cheapening quite a lot. So I think it's helpful to think that all of these long only investments are priced by thinking of expected cast flows discounted by a common discount right to risk less part and some varius as a specific premier. And now when this common discount rate has been at all time lows and was coming down for a decades, so that was making everything expensive. At the same time, whatever happened to the expected cast flows and other premium and so that that situation has gotten

us to this sort of everything bubble less. Some some saying I think it's a bubble is a bit wrong word there in the sense that there is a fundamental story behind it. The low real yields that were influencing all kinds of investments makes a lot of sense. You wrote this book in one or at least finished it in and you describe in the book what you see

as an unquote investment winter ahead. I have to say that seems pretty president considering since you handed the book in to be published last year, markets have pretty much done nothing but roll over and head south in two. Was this just lucky timing or were you a little president? I'll put it largely too lucky timing. But so the story, I was always saying that we know that we've got

these low expected returns given those low starting deals. And and by the way, related to what you're saying, I really like another statement, we borrowed returns from the future when we were when we were capitalizing everything at those expensive levels, and so that locked in low future returns. We just didn't know whether that's gonna materialized through slow pain staying in this low expected return world, or fast

pain cheapening. And so then in the in the book I was I was saying that I don't really have a strong view on this one. But but in conclusions I did put there that that it just seems that stars are aligning for some fast pain. And it wasn't just the high valuations, but there was a catalyst. There was this basically inflation problem was seemingly getting as close to the day when FED finally has to make some hard choices, and so so so that I got got right.

But but I would say that I was really lucky because I could have written in six months earlier, and in general I've had other market timing calls. I'm not famous for being good at market. I mean I don't know anybody who is. There are no old gold market timers in France Billionaire list. There's there's old in this bowl,

but there's not both. Um, let's let's talk a little bit about the pushback to low expected returns, you know, following the financial crisis and the FED cutting rates economy and the market starts recovering late two thousand nine and then two thousand and ten, and we kept hearing from a lot of different value corners. Hey, everything is richly priced. Bonds are the most expensive they've been in thirty years.

Stocks are pricy, lower your return expectations. But yet the tens sore returns and equities and bonds close to double historical averages. How do we explain why that advice took so long before it started to work. So I think there is a fair risk that we anybody who was talking like that, he's thought that's the boy who cried wolf and Lucy losing credibility then by this time, and I think that would be said because I think sometimes it's going to really work, and this year really looks

like it can be can be that sometime. And I felt always somewhat good that we were at least we were not pushing for we were not predicting me and reverting valuations that we have made things work. We were saying it, let's be really humble about any market timing use of this stuff. But low starting heels do anchor expected returns lower. But it's true that and and what we saw then in that in that decade, that rich things can get richer, and that doesn't take quite a

long time. And so actually my favorite quote is to think about what happened to SMP five shielder p that went from mildly above historical average too empty to double and wildly above average forty in ten years time. And that type of thing gives you well, basically seven percent annual returns pro rated then and so so that's the key reason. And something similar happened. Real yels on bonds

were already low, they went even lower. Um rental heels on equities, credit spread, anything you look at had basically tail winds from from these following years, and that repricing then gave high returns. And that there's a danger that people then look at the rear view mirror and become complacent just at the wrong time. So so let's talk

a little bit about that. How significant was the ultra low rates of the Fell reserve to making all of these different asset classes richly valued and continuing to generate strong returns right up until the FED started raising rates. So I think so short term what happened this year was really there was a catalyst of inflation and FED tightening. But the long term story was always always about valuations and and the important thing, as I said, is related

to this common part low real deals. And should we blame FED for that or should be blaming somehow greedy investors. I buy more the stories that there was this fundamental fundamental effects, most importantly proper probably savings glad excess savings coming from pension savers. Also another story is that that when when the wealthy we're getting a bigger share of

the pie, their savings rates are higher. There are there are research on both fronts which which sort of explain why we've gotten this exceptional savings clot which was then pushing all assets yields lower and and creating this and fed them. Investors were basically then responding to that situation rather than driving it. Now, we heard a lot about the savings clout from then chairman Ben Bernanke in the early two thousand's. Is this savings clot qualitatively different than

what we saw two decades ago? Yeah, it's it's it's it's the same idea. So always when you think of real years, you think that, okay, there's a there's either an issue with investments or savings, and it's it's a balance between those two. And he was highlighting that this probably is more coming from the savings side, and then he was symphasized this is the this is a China and and often often emerging market foreign reserves, those those types of excess savings where sort the culprit for the

conundrum in two thousand five or whatever it was. And and I think that that story still has some legs, but sort of the key culprit then became demographics and retirement savers And the latest story now we center in the sort of one percent. So so the flip side of that, if there's a savings glut, meaning a big uptick in demand for that paper, does that also suggest we have a dearth of high quality sovereign paper of bonds issued by countries like the US or the UK,

or is it just whatever. The existing supply of paper is what, Liz, And it's the demand that has spiked. Yeah, I think the demand has been driving things and and and well, the supply has been there like there's there's there's been plenty of plenty of supply as well to to cater for it, and and really really given the need for the to to cover public deficits and so on.

But again, I think I think if one thinks of what what sort of started this among fundamental forces, I choose to go with that savings plat That's my best reading of the literaty and it makes some sense. So you wrote the prior book a decade ago, two thousand and eleven, just expected returns in the decade between that book in this book, What have we all learned? What what has the markets taught us? And how did you work that into the new book? Well? I like that.

I like the basic framework still still in the book. But I think certainly it was a terrible decade for all kinds of contrarian strategies and and I have become even more humble. It's sort of funny that I I wrote my dissertation four the years ago in duration timing, and I've thought about all kinds of market time. Every decade I become more humble about about the endeavor. And yet even as I told at the end of this latest book, I'm still mentioning star start aligning. And it

might be so, so the temptation is there. But I think the main point I want to say is I think what we should really try to think of investing as a strategic effort good diversification and so as opposed to some great tactical timing, because that doesn't do too well. So I think I think that would be and part partly, you know, relearned through the difficulty of contrarian timing strategies.

Then then another thing, which which was very important in this decade, was there was a growing interest in these diversifying return sources. But I think by now the most popular one is related to a liquid investments, whereas my favorites where then and are still now more liquid strategies Vario style, premium value investing, trend following, and so on

and so so. One of the interesting things to talk about in the book is that we continue to find more data, and not just the decade of data that went by, but historical data, old data going back to the eighteen hundreds. I have to ask, where is this do we call it ancient? Where is this nineteenth century data coming from? And how can you apply it to

investing in the twenty one cent Yeah. So the first point is that we accrue out of sample new experience so slowly that that that it's sort of pain painful to do to do that waiting, and and therefore it

is helpful supplementary source to get some old data. Most really studies were done with datas in nineteen sixties to nineties, and then it was extended to beginning of CRISP data six and now we've had people going further back and and I am so I haven't been one of those in the archives, but but I'm one of those looking at that that data and studying it critically and and seeing what what we can learn from there, mainly whether

you whether you get similar patterns. I do love it when I find that some strategies have worked persistently over different centuries, pervasively across different countries and asset classes and robust with different specifications. So that makes me more confident. But I do I have recognized And that's something I say in the book as well, that that when people see my hundred and two hundred years of data there some just roll their eyes and and and why is that? Why?

Why do why do I care about two hundred years of data? I really care about last three years with my old portfolio. Well, obviously that's a very specific example set. You want to go away beyond that. But it raises people rolling their eyes, raise the question how reliable is that data? How accurate is it? Can we have confidence that it's been cleanly assembled because the technology of the

eighteen hundreds a little more manual than today. All fair, So I'll just I'll just say, well, first I said, you just do the best you can, and I think so there's some value in the data. But the problem there are data problems, There are investability questions. Even if the data verified, maybe you couldn't do for in diversification or something like well, actually before first maybe you could.

That was pretty international era. Um, and then there's a whole criticism that the world has structurally changed and that creating sim has more bite the further back you go. So, I think for all these reasons we should be skeptical, but I still like it as a supplementary evidence, not as main motivation for anything. So you mentioned the versification earlier. In the last section of the book, you write an

owed to diversification. Tell us about that. Sure, I do think you know it's a cliche, but diversification is pretty close to a free lunch, and it is a wonderful, wonderful aid to improving portfolios. I think it's much easier to improve your risk ad justed returns through good risk diversification than by getting somehow greater insights in one particular strategy. So and and so I write, I write about it

both both. I don't know that the simple maths about it how you can double double sharp ratios with foreign uncorrelated strategies, and then remind us it's really difficult to find for uncorrelated strategies in long only world. You may have to get too long short world to take advance at each of those types of opportunities. And then I'm the flip side of that. I am saying that diversification

has got some critics. Of course, there's diversification or the or or that diversification fails when most needed and so, and I think I can counter those to some extent, but I think there are challenges that good frisk diversification often then requires you to use some shorting and leverage, and there are limits to how much people want to

do that. There's unconventionality issues. And then this's this what what we've highlighted in reacent Yes, that you sort of inherently you lack stories and and so it's it's it's very sort of math oriented or or algebra oriental type of thing as opposed to great stories, which which drive most investment passions. Right, that makes a lot of sense. You mentioned free launch. You talk about rebalancing arguably another

free launch. Tell us your thoughts on rebalancing. Yeah, So rebalancing, I think is a way of ensuring that you can retain your risk targets and you can retain your diversification. So I think of it primarily has that there's a follow up question whether you whether you can get better returns and then how you do it and so and I talk a little lightly. I think I wouldn't be too strict and rebalancing I think like one one good

idea is to be somewhat lazy with rebalancing strategy. So let me hear something like that or or maybe four times a year, but part of the portfolio, so you're everything, you don't you you don't get so um dependent on when you did it your year, So that that type of thing. But but basically, if you if you are a little lazy or patient with rebalancing, you let the near to momentum play out and you might get closer

to the time when there's mean reversion advantages. So so you're trying to play a little bit these advantages that tend to be in financial markets with momentum mean reversion. So let's talk a little bit about low expected returns. We we already talked about the impacts on FED rates. What else goes into driving valuation factors that can lower future expected returns. It really depends on what rise on

we talk about. So monetary policy macro conditions are very important for short term but I think I I'd like to focus in my focused in the book mainly on long term expected returns and then its terms being five, five, five to ten years something like that. And yeah, it's interesting if you go even further than sort of valuations even don't matter, so everything is gets diluted, and then you have to think about what's some theoretical long grand return.

But so so for for ten years ahead, then starting ITAs and valuations are essential and and again so I think those those are very helpful anchor for thinking about those returns. Even though you can get this very ugly uh forecast. There ares like what happened in the last last decade. But when such setting happens, then it pretty much stores problems for the future. So like last decade, as it's rich and it's just ment at all, you are going to have even more problems in in in

those future returns. And I think the only way you can sort of solve the low expected return problem here is at least for risky assets, is that there would be this much faster growth, this techno optimism that you some quarters and there there could be, but we've had we've had wonderful technological advance this last hundred years and and two per cent reial growth is pretty much as

good as it gets. And that's the interesting thing because you're talk in the book about very often mom and pop investors individual investors tend to confuse uh GDP growth with expected returns. Academically, we know there's almost no correlation between the two, is there. It's surprising that whether you look at our time in one country or you look

at across countries, the relation is very modest. And my my favorite poster boy on that one is China, which had this thirty years of very fast for equity investors, it was a really sorry story. Yeah no, it was a lost opportunity. If you piled into China, you missed a lot of opportunity elsewhere in the world. It's quite quite amazing, and there are some stories why that's why that's the case, Like basically, one on one logic is a GDP growth doesn't capture how the pie is shared

between corporates and so on. And there's there's a different sector compositions. There's there's public versus an unlisted sectors, all all kinds of questions like this that can then mechanically explain why this happens. But it is. It's it's a it's a weird result and it's understandable, and I think it commonly motivates people to look for those fast growing countries and taking it for granted that that's a good investment. So when we're thinking about various asset classes, how does

cash work into that allocation strategy? Is that a legitimate as at class or is it just a drug on future returns except for years like well even in two Again, in relative sense, cash is of course doing fine, but real real returning cashes whatever minus pipers and it just happens to be better than even more rice various results. And so so I think one one interesting uh thing is that you sort of you need to have some market timing ability, I think, to make cash useful and

use it almost as an option. And and then it matters whether you have got um some interesting yield levels. Twenty years ago you had that three or four percent three or return. Cash not not around in this situation. So I do think that the main story with cash c is, like you said, there's there's there's something about the dragon. It dilutes. It's not a great diversify or dilutesive performance. It would be good if you have got some great market timing skills, but let's be humble about it.

Often I'd even say that cash may be best used as a basically on on the other side, like you want to use it for leverage for some long shot strategies, and so that may be a helpful answer what you do with that In the book, I like the way you describe certain investor types based on their future liabilities. So pensions endow minds to find benefit plans. You point out that they're particularly sensitive to low expected returns. Tell us what makes them so susceptible? Is it the future

liability as they have? Why is merely the concept of lower expected returns so problematic for them? Yeah? Well, I think it is. It is for any investor, But if you have made some commitments for the future, then it is maybe more legally binding, and and that that makes it tougher than for somebody who can who can basically adjust expectations um or or try to just live through these things without without recognizing the low expected return until

until somewhere far into the future. So so let's talk about for into the future, how long should we expect lower returns for? Is this a question of quarters or or years and decades? Is the cyclical? Does it eventually turn out? And tell us a little bit about duration of expected returns? Sure? So the main story of the book is about those low starting years, and therefore we

are talking of long run story. Then I'll sort of turn into more speculative pandit here by thinking about the current situation soon where I do think that we are now in this fast pain situation where we will probably get more where we will surely get more monetary policy tightening. And I suspect that the latest latest market positive positive is on yels is maybe way too optimistic. I think I think you will need you will need more tightening to control inflation. And again this is this is a

speculative talk here. So I think fast pain will be with us for various risky assets, but I think there will be a limit to it because of the structural forces. I refer to the savings. But but but I think that's not going away anytime soon, and therefore there's going to be a lead on how far heels can rise, and that and basically those bond deals they have been underwriting high valuations and all other on stocks and real estates and so on and and and those rising yields have

been very important in cheapening those other asset classes. And so I think there's going to be more pain on that front, but not too much. I don't think we will get so much higher yields and cheaper asset valuations that we would sort of solve the long run problem of low expected It turns we will. We will still get some pain, but but well, I think the slow pain will be with us quite a long time. So

so let me see if I can explain that. If I if I understand that we've had a savings glot that has put a cap on interest rates, which means that the cost of capital has been very low, and therefore that allowed us to speculate in real estate inequity, and that allowed valuations to go high. And what's going to determine how much those multiples compress is how high rates end up going up? Am I oversimplifying that? I

know that? Is? That is right? And again we have got now the cyclical situation where where basically the inflation problem forced finally central banks to to act quite aggressively then on well anyway, on on the interest right front. And and then how much more they have to do is going to be important in the near term. But I just don't see your scenario where they would race rate so much that we would get back to the kind of four or five uh expected real return from

sixty portfolios which used to be there. We are about half of that nowadays. We've come from the lows, but we are still like, let's say sixty two percent three yels roughly the number as opposed to the four plus long run. So so we're recording this the first week of July. The FED has already raised seventy five basis points on top of their previous fifty basis points for a while. The consensus is that the end of July, I think it's the seven meeting seemed to be seventy

five basis points. Uh. It sounds like fears of recession might drive that down to fifty basis points. But clearly there's no consensus there yet. How far do you think the Fed's going to go in tightening and do we run the risk there were behind the curve in one all running the risk that they're getting ahead of themselves. And two yeah, First, just a qualifier here that that nobody knows. Nobody knows and and and we don't trade on my views. We don't like this is this is uh,

that's that's important, and it is it's incredibly difficult. But but yeah, we we certainly do think about those those social attempts. And my I'm pretty much in a letty Larry Summers came there thinking that it's very hard to get immaculate disinflation here and and and you will need FED. FED needs to do more to get that inflation into control. And if it does, either if it acts more or financial markets dropping up, then then there's going to be

some pretty bad outcomes too risky assets. Without that, I think we are we are going to continue to have that inflation problem. There's a there's a narrow path how it could go in a more benign way, and market seems to be clutching that straw right now. So what would make you change your mind? Mine? What would lead you to say, oh, I've been too cautious about future expected returns, and because A, B and C happened, I

think we could get a little more confident. Yeah, so, I think the long horizon estimates are very difficult to change. The starting yields are are heavy anchor, so I think it would be it would really require the growth environment to change. Again, I mentioned earlier technological progress, those types

of things, So short term anything can happen. But but but somehow you have to have this type of idea of the greater internet usage globally and all all kinds of technological progresses moving us from the two percent to three or four, which is hard to do, hard to do, has not happened, right, And then you mentioned earlier the cheapening. If stocks got much cheaper, that could potentially change the

starting valuation. But do we really think that's a likely Probably, yeah, I I would be surprised that we would get that

much cheaper. And again, the economic logic I have is there the savings somehow that that basically really ills are not going to allow that we have to I don't know, fragile economy, too, fragile financial markets to to allow that much step in we would we might be talking of further further market force and that and that that seems pretty unlikely from at least with the state of the world today. Obviously that can change any any time. That

that's really that's really quite interesting. So let's talk about some things that seem relatively cheap. Cliff Fastness in the forward of the book wrote quote value premium seems record cheap today, that was the end of one. Is value premiums still cheap today? Value premium is still very cheap. And it's been a lovely year in the sense that we have had positive returns, and yet the value spread, this forward looking measure of how cheap value stocks have

versus growth stocks, has remained wide. And part partly it is that you get some pullbacks like we have recently recently gotten, but also we are basically rotating into new value stocks and growth stocks, and and and the fundamentals have actually further had sort of favorable um developments favoring

values stocks versus growth stocks. So for all these reasons, we see that value stocks the way we tend to trade them are as cheap or even cheaper than they were at the worst times during the dot com bubble. And it is important to just distinct with sen Cree wrote about this in a in a blog recently that that dot com bubble was very much about tech versus others and and across sectors. We haven't got into the new heighst but we tend to focus on within industry

um stock selection in our value strategies. And with that, the key story of this recent bubble was really markets favoring these disruptive, profitless growth companies within every sector, and that opportunity remains still very wide. And we we love seeing like pretty good performing behind us and then then very good runway because those values spreads remained quite right. And in the US, I've noticed that small cap value has done much better than the larger cap companies and

then emerging market small cap value. Last I looked, it might have even been green for the year, might have been positive returns for the year. Why are small cap doing so well on the value spaces here? Well, it often happens, like you just you just get bigger movements in good and bad on the small caps than large caps. So so I mentioned the quote from Cliff he's a

big character. What what's it like working with him? It's mainly it's great though if you had him with us here on the studio, I think you wouldn't hear much of me. And and that's just as well, because he is he's uh, he's faster on his feet than he's he's with here. So so that's that's in everybody's benefit. But it so seriously, it does help that our investment thinking, investment beliefs are so similar. So I I really rarely have got any any any wish to second guess anything

he says or does, so so that's great. And then most importantly, I do love his ethical antenna and this kind of truth telling obsession that he has. I mean sometimes there's there are overshoots there, but it's really it's it's it's a reason for me why I love it to work in a q R more than in any

other place in financially because of Cliff. You know, usually you get a guy who's quantitatively oriented, you tend not to get that sort of articulate nous and you also tend not to get that sort of um sense of humor, which is very very specific to him. He's a very funny guy. He's yeah, and and and a bit mixed feelings because there's no way to beat him one of those things. But that's okay, that's very funny. Um. So so let's talk a little bit about the things that

have changed since you wrote this this book. Um, what's going on in the current market. Is it just confirming what your expectations were for for future returns? Tell us a little bit about how two has now that it's half over, How has this impacted um the general premise of of the book. Yeah, I think overall, I feel totally blessed that that we got The book came out at the time when when markets were roughly acting the way the title was saying, talking about low expected it

as we've got low realized returns of that. That sounds sounds great. And it also turns out that some of our strategies, value strategy trend following these types of strategies are doing very well. So so I'm getting like great, great response. But of course things have some some things have happened as expected related to inflation, central bank tightening.

But then I had no idea of what you know, the geopolitics Russia Russia, U train or or the greater split we have between us we are and China and so and so, and I don't have I don't have great insights to this for us. When I think of the longer unexpected returns, the key stories that assets have cheapened as one would one would have expected in this situation, and and the question is whether there's going to be more. I think it's it is interesting that we've had we've

seen the biggest moves in bonds smaller moves. When I think of yield heel space, not not price space, but in heal space, equity yields have written uh more, and then illiquidy heals have risen so far very little, And of course there is a smoothing effect, and so that's a but. But I do expect that there's going to

be an issue. I I saw in March when when equities didn't instantly respond to rising years, it reminded me of Wiley Coyoity running running over that Cliffland, sort of waiting for gravity to hit and and I think something like that maybe still happening with the private tesseets, that they are sort of waiting, waiting to price things. So so let's talk a little bit about that. There's been a lot of discussion about private markets and and the

illequidity premium they get. Um, what what are your thoughts on there? Should should now untraded assets get an eloquently premium? Yeah, so I've written a lot about it, Cliff of course, uh also, and and and more and more weatily on this, and I think it is it's dangerous that people I think too automatically that if I invest in a liquid investments, I'm going to earn an illiquidity premium. I think after

equity premium. That's probably the second most confident statement people would have on longer expectators, and data doesn't really support it. So we've done lots of empirical evidence on this, and so the logic why why the data is then so maybe disappointing is I think that that people somehow confused. They think that UM that the I liquidity is the only important feature. So so yes, I think it is fair to require liquidity premium for locking your money for

ten years. But then there's this other characteristics lack characteristic, lack of market market, the smoothing service service as I call it, and that may totally offset the amount of access return that you get. So if there's a two or three percent require liquidity premium for for looking money UM, we might accept the same return for public and private equities UM because with the private equities you don't get

the great que actility that you see. Now. You also show a chart in the book that that shows how the bottom third of um I liquid markets have you know, by definition, they're underperforming the top third, but that gap has just been widening and it seems like, in addition to whatever I liquidly premium are in private markets, there also seems to be a pre substantial I don't know if I want to call this quality factor, but the best of the liquid investments seem to really dramatically outperform

the bottom. That spread is much bigger than we might have anticipated otherwise. So so, apart from thinking about illiquids overall, one of these great selling points there is is why this person between our performers and under performers. And to me, that's such a lovely example of investor over confidence that when people see this this person, they think, oh, the upside is for me, the downside is for someone else. And so so clearly this opportunity involves some risk as well,

and and and it is. It's it's just somehow that that industry doesn't seem to have anybody getting that that downside. So sorry, I I do think that some investors have got a decent claim to expect to get those top quarter alright, let's say, top half half managers. But but for others, I think it's it's somehow it's better to just think that, okay, if we get the industry level returns that's that's reasonable. So Will Rogers used to always advise people only by staffs that go up. If they

don't go up, don't buy them. Does the same thing apply to private markets? Only invest in private markets that I'll perform. If they don't now perform, stay away from Yeah, it's only example. Hindsight is great, but but it is so I would say just positively there. Historically, in particularly if we look at private equity, it has a great thirty thirty five year history of outperforming smp I five foundered by by three percent or something like that. And

that's after five six percent fees. That gross alpha is just mind boggling in some sense. But but looking ahead, um, we should be much more com cautious because the gap has already been much narrower the last fifteen years, and it seems to be narrower because the money was flowing in because of the popularization of the Yale model. Since then, the forward looking opportunity has been much narrower, and realized opportunity has been much more, much more modest, and the

fees are the good old fees. So I think next decade will be more disappointed. And when we look back to the early days of that our performance there were a tiny fraction of the number of funds. Then what is it like ten thousand private equity funds there used to be there, used to be numbered in hundreds, not thousands. Yeah. Yeah, the same as as the HENE fund and the venture capital worlds. Success has attracted a lot of capital, which leads to other performance. Yeah. And one further thing is

that these questions were already relevant a few years ago. Um, but private equity did very well the last few years. And uh, and I saw Dan Rasmussen wrote quite nicely, so recognized. I mean, that's that's rare and probably when somebody does it sort of um post mortem on my mistake. That's what he did there, And he said he got it sort of wrong because, um, because they private equity, like hedge funds and especially venture capital, we're pushing a

lot into the growth sector. And that worked very well for a few years. And I think to the extent that we write about the value versus growth, that benefit will turn into disadvantage I think in the coming years. And so it's really interesting. We haven't talked about a couple of other um alternatives, credit spreads, commodities, what else are you thinking about in the old space. Yeah, I think commodities is the most most interesting case, and so

I bet a double positive story on that one. The first one is the obvious one that when we look for inflation hedging investments, they are pretty much the best. There is also most portfolios that invest most constituents of anybody's portfolio stock spons and so on day, they have got this inflationary deals that was helpful for a long time, but not recently. And so if you want to have a pretty neutral portfolio, you should have some some allocation

to commodities. Then the second point is that many investors things that you don't earn a positive long run reward and commodities, but the data says otherwise. Basically, really yeah, diversified combination of commodity futures has earned something like three four percent long run reward. And that's it's it's a weird thing, and I focused on it in the commodities sector telling that it's part of it is related to commodity role maybe, but but important part is related to

diversification returns. Basically, this is getting very big. But let me just try commodities on a single single commodity basis have got thirty percent molatility, which means that that that type of volatility hurts compound returns a lot. And and when you combine lowly correlated commodities together, you can reduce that volatility roughly half it, half it, and you can

get this volatility drag much smaller, and so forth. If if, as the evidence suggests that a single commodity has pretty much not outperformed cash in the long run, portfolio of them has done it because of this saving on this volatility drag thanks to diversification. So it's a basket of energy and industrial metals and precious metals and food stuff and lots of yes and lots of single ones of them,

and so again you get you commodities. You know, these types of effects happen in any investment on your equities, on your bonds and so on. It just doesn't matter so much with them because the correlations tend to be higher, or volatilities lower. Commodities have got this glorious combination of high high volatility and local relation that makes this really matter very very interesting. Let's talk about E. S g um. There have been some estimates that it's now over twenty

trillion dollars. You talk a little bit about UM E S G investing, tell us about your thoughts. Yeah, so it is clearly growing force and and I would argue also largely a force for good. But expected return impact is debatable. And so Cliff Roath already a blog a few years ago highlighting this simple logic that well, one

logic is that constraints always should have a cost. But another logic is it, if you want to be virtuous and you want to raise the discount rates for sinful companies, well you do that by maybe investing let's less in them, or even in some cases you could you could short them, and so um, if you do that and you raise their discount rate, you also raised that discount rate. This flip side of expected return makes the more charted. Yeah, so somebody else who is willing to basically buy the

sinful companies, then we'll earn higher return. So that is pretty much the long run story that should happen. UM when when investors really like something for non monetary reasons, and that includes E S G, then the I think the reasonable counter argument is that we may be in a transition phase here where where we are getting the repricing. How do we get to those higher these countries. Well, we get it basically by making those those companies cheaper.

And then we can debate now whether we are in early innings or late innings on on that that question. So so so in the long run, I think there will be some cost, and I think most investors who are sc on oriented should be willing to take some cost as a flip side of their virtuous investing. But but in between they might get sort of the win

win outcome that day. So now you weren't getting the win when outcome in the past six months, especially if you were low carb and low oil any of the energy stacks have just on spectacle in the past year. Is that going to be the long run trade off? Is that if you're staying away from some of these, you take a chance that there's a big move up

in a sector that you've reduced your exposure to. Yeah, I that that that possibility always exists, and now we now that we had it, I think it is gonna raise more discussions in some organizations than um how to deal with any financial trade of friends. I must say that in Europe, I think that investors will largely um stay with their E s G beliefs, and there's not going to be a question if they if they think

they there's there's some financial of course that's okay. In US there's more doubts, and it has become such a political issue that it's going to be I think harder. Just I I everything or anything I can say on this one, I think is that is that there was a sort of easy travel towards more E s C for the last few years, and now I think we are we are in a in a world where it's going to be harder. I think the trade the still the same, but it's going to be more jagged going ahead,

and maybe especially so in the US. And and before I get to my favorite questions, I gotta throw a curveball at you, Cliff, ask this mentioned you like to go in a hundred and twenty degree sauna and then jump out and roll around in the snow. Is this a Finland finish sort of thing? Tell us tell us about your heat and cold habits. That is, that is exactly what we do for cheap fun. And sadly there

are a few opportunities with the global warming. But but yeah, so so how hot does the sauna get I was thinking whether you're talking fire in you know, we are talking with centigrade. Now we do go go closet degrees. No, no, we go to degrees centigrade. Yeah. Yeah, so that's like a hundred sixty eight. You'll do the translation there. I think of you know, the I do my father and height and closing that. But still eighty degrees is very you're just that's very warm. It's it's it's nice, nice

to sweat that. And then when you jump into the snow, it's not a little bit of a shock to the system or or you go to um, you know, call out, you go into I see what that shows. That's that's even better. But that's that's that's hard. But yeah, no, it's it's uh, it's great fun when you can really do that. Quite interesting. All right, So let's jump to our favorite questions that we ask all of our guests,

starting with what have you been streaming these days? Tell us about your favorite whatever kept you entertained during the pandemic or whatever podcast you listened to. Sure, sure, yeah, I thought about these in recent months when I have heard you ask these questions. And by the way, I've gotten some good tips I got, I got the Leboro and called my agent the friends once and some Israeli

shows in from here. So yeah, that's why I ask it, because you know, I get to speak to people who have interesting sensibilit it is, I want to hear what they're seeing and here. Yeah, well so so as the first non obvious or non interesting answer, I think, like recently, I think we better call soul looking forward to the to the last few episodes. But so that's that's been great, but I thought that I'd rather highlight than some less

well known older theories. So my favorites I think in the last ten years where sort of slow burn, um, the Americans the Russian Spies that that that one or or rectify it was a story from southern US, and and just just I think I think lovely stories got

to take time for those. And likewise theny podcasts, um, I listen a lot to history and so beyond beyond investing, and I'll just leave well on near investing, I would say Tim Harford's um Cautionary Tales is fun, and and Zingalis and Bethany McLean Capitalism task got very thoughtful topics. So I think they are, they are good at but I love in his history area. I love Dan Carlin, Mike Duncan, Patrick Wiman and this British show called The Rest is History, which just always makes me laugh. So

so that's a good that's good. That's a very interesting list. Um, let's talk about some of the mentors who helped to shape your career. Sure, so obviously I told the dissertation chairman, Farmer and French. So they've been very influential in many ways. But but I would especially then highlight Marty lebe of it so before, during, and after Salomony yea so and he's he's such a such a mention that it's it is, it's wonderful to have known him for the case. Uh

what about books? What are some of your favorites and what are you reading right now? Yeah? So I am a voracious reader, lots of investing fiction, non fictional, all kinds of things. Um, I thought I will highlight from fiction. Um really big one, Hillary Mantell's trilogy on Thomas Cromwell Wolf Wolf Hall. I was thinking, I think maybe I heard in or You're so also the three Body problem very different to sci fi, the Chinese one so I

guess that was great, and then on on on nonfiction. Um, I think the most impressive book I read in the last couple of years was Joe Henrich is the Weirdest People in the World. So this is this is weird? Is uh? Western educated? Uh, it's rich, democratic, and it's basically telling telling how different the people who are most often studied in various psychological studies, the Western University students,

how different they are from most cultures. And then it's explaining why things went that way, and it's it's it's both parts of the story are very interesting. But but again a very long book, really really intriguing. Yeah, and currently, um, Zach Carter, I think, is your author of the book on Cain's Price Price Price of Peace. Good. That's a

good that's pretty good. Lust what sort of advice would you give to a recent college graduate who is interested in a career in either investing finance value quantitative investing. How would you advise them? I'll go with the old fashioned I think, don't sacrifice your ethics. That integrity matters. M hmm. But that's really good advice. And and our final question, what do you know about the world of investing today that you wish you knew thirty years so

years ago when you were first getting started. I thought, I'll say this lightly, that bond deals can go negative. You know, I didn't expect that to happen. But the funny thing is that I thought that, really I would have then expected that to coincide with barish equity markets, but into any tenls, it actually happened with with with a big bullmarket. So it wasn't that that equities um pushed equity weakness pushed bond deals down, but it was

that low bond deals pushed equities up. So courseality went that way, and and that's surprising. So I think that's that's that's one. And then another serious, serious point is is how important and how hard patience is. So so with all of these ideas I talk about these longer strategies, and you just it doesn't matter too much if you don't have the stickiness. So I think one has to really calibrate one's investment to the amount of patients one

one can reasonably expect to have. Huh, really really intriguing. We have been speaking with Auntie il Nannen, co head of Portfolio Solutions at a qu are. If you enjoy this conversation, well, check out any of our previous four hundred or so podcasts. You can find those at iTunes, Spotify, wherever you get your favorite podcasts. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. You can sign up for my

daily reading list at Rid Halts dot com. Follow me on Twitter at Rid Halts. I would be remiss if I did not thank the crack team that helps put these conversations together each week. Justin Milliner is my audio engineer. Atico val Bron is my project manager. Sean Russo is my head of research. Paris Ward is my producer. I'm Barry Ritolts. You've been listening to Masters in Business on Bloomberg Radio