Cliff Asness on Celebrating 25 Years With AQR

This is Master's in Business with very Rid Holds on Bloomberg Radio.

This week we have an additional extra special podcast live from future Proof, I sit down with AQR's Cliff Astness. He is the co founder and chief investment officer at AQR, one hundred billion dollar plus hedge fund that specializes in a run of strategies ranging from quantitative analytics to value investing, and a whole run of different things in between. I

Well, I never had. Maybe that feeling was implied, but I wouldn't say that even I know not to say that out loud. It's funny sitting here in Newport Beach.

We're in Newport Beach, right.

Huntington Beach, Newport Beach. Yeah, it's right up the road, all right.

My hotel I think was in Newport Beach. Can I say Newport Beach?

All right?

Because Newport Beach and Pimco actually features in my personal story. I was at the University of Chicago studying for a PhD in finance. I first went to Goldman Sachs for a summer. I had a professor from undergrad who worked there. One of my best friends worked there. Like you can name drop, feel free to oh John Biner. He was CEO of CIO of Fixed Income for about twenty years at g SAM.

Then I went for a year. I was still writing my dissertation.

I was writing my dissertation at night on value and momentum to choose individual stocks while working at Goldman during the day. It was It was the probably the second hardest time in my life. The heart artist was when my wife and I mainly her, but my wife and I had two sets of twins eighteen months apart.

Four kids in eighteen months.

Is she gets mad at me when I refer to our family planning as a gross failure of risk control.

But it was true.

So I was there about a year and I was actually just trying to decide do I want to stay at Goldman. I was having a good I was enjoying. It didn't feel like what I was supposed to do. I was a portfolio manager. I was trading. It was fun, but you know, I was studying academic finance.

Dumb luck.

I had written one paper in the Journal of Portfolio Management. It was called option adjusted Spreads and a Steep yield curve. You've seen the movie Chart Least then is in it.

It's really very good.

They read it and being fellow geeks, they liked it, asked to talk to me.

Ended up fly me out.

I met with with them. I remember one thing. I'm telling you too many stories. This is the first time I ever ate sushi. The guy from uh Pimpkoh I didn't eat fish at that point. I like fish now. But the guy from Pimco guy Nam, he's passed away now. But a guy named Frank Furbinovich is a great guy. Said to me, Hey, sushi okay for lunch? And this is something if there are any twenty somethings in the audience you think you're you gotta say fine to that.

You don't realize the person asking you will be totally.

Okay with you going. Actually, I don't love sushi. You feel like you're gonna blow the whole thing. So I'm like, yeah, no, sushi's wonderful. So on this interview, I chewed one piece of sushi for about fifteen minutes, and I did spit it into a napkin when he wasn't looking. And they still offered me a job to go out there and start a research group. It kind of light bulb went off. I'm like, wait, doing academic research, but an applied way.

And needs this weather look but cloudy overcast. Who wants to be in California?

Anyone who's happy where they ended up, who doesn't admit that there was a fair amount of luck. Now, you can make your own luck, and effort counts ability accounts, but luck counts too.

I got lucky at various stages.

In this I hear that on a regular basis from guests on Masters in Business.

It's terrible advice to give. By the way, what first get lucky? Well, not useful?

Well the table.

There are lots of people who are very smart and very hard working who don't achieve outstanding, amazing success, a top point one percent success.

What separates some of them? You've mentioned this repeatedly.

There's a little serendipity in everything. So, speaking of serendipity, you're at Goldman, you meet some folks tell us how AQR came about.

So I started this group. This was nineteen ninety four. I know, I look around, I look for the people who were born in ninety before nineteen ninety four, and I want to say hi, shout out to them. So we started this group was initially four people with a very general, scary general mandate. They had no idea why they wanted this group. They just knew other people were starting quant groups on Wall Street. Ironically, the then success of long term capital management.

Made get us.

Some of that made a lot of the firms think we need applied academics here. I don't think we've ever done anything particularly similar to long term capital management.

But they actually helped me out too. So we started this group with no mandate, just see if you can help.

We kind of went around like door to door, quants around g SAM saying does anyone need anything quantitative?

And the first job they asked us to do was to help.

They had an active global equity product, you know, concentrated stock picking, that had kind of a SOSO record, and if you analyze their record, it was really strong within each country, but they were always in the wrong countries.

So they'd have client meetings that would be well. The good news is are Norwegian stocks crushed the Norwegian index.

The bad news is there was a kup in Norway.

That doesn't mean in a kup in Norway since nineteen forty, but they approximated it. So they turned us and they said, can you guys help pick countries? And here's where you know, luck meets hutzba. At this point you don't go, well, I don't know, I've never really tested picking countries.

You go, hell, yes, we can help pick countries.

We went into a very tiny room, four of us and kind of it's embarrassing how simple it was. We spent about three days before we hit on the obvious solution, which was to pretend countries were individual stocks and treat them like what we had studied in academia, the early work on value, momentum, even size for predicting individual stocks. We ended up writing a paper on and it held up for countries, and we just kept growing it individual stocks, bonds, currencies,

Scared of doing that. It's scary to leave Goldman Sachs.

Goldman Sacks is really good at terrifying you too, by the way, when you say you're thinking about leaving, if you're honest, if you don't just give him a fade a company and say I'm considering this, which I did. You sit down with very senior people and they kind of say, you know, you only get to leave Goldman Sachs once.

Young man, and then you shrivel and you go, I'll stay.

So I did that a couple rounds till finally end of ninety seven, early ninety eight took the plunge.

And to Goldman's credit, they're very good at keeping hooks and people. They become your prime broker. They're selling you transactions, trades.

This is this is getting really into some nitty gritty details. But when you leave Goldman, the part you left is quite mad at you. The rest of Goldman is quite excited. Because the money we were managing at Goldman, I did not expect to get into this kind of stuff. But the money we were managing at Goldman, we could not trade with Goldman for rather obvious reasons.

Once we leave, suddenly we're.

A potential and that did help smooth the relationship over and Goldman is still certainly one of the alternates.

It bounces around a bit and one of the top two or three people we trade with these days.

So you leave Goldman, you set up your own own shop. At what point do you get a sense, hey, this can work. We're having clients come in. The numbers look pretty good. A performance doesn't stink. When does it dawn on you? This was a good decision to hang our own shin.

I don't know. I'm hoping it kicks in soon, one of these days. Soon. We had a very strong start prior to trading. We left.

It took us about nine months to We didn't take a thing out of Goldman. We were building and rebuilding. We had a road show, we made it. What I think is I've been saying for years was an era, and it was an era. When we were at Goldman,

Partly, I think it was an era. Partly I think we didn't have a tremendous amount of choice.

When you're thirty and starting your own firm and you say you want to run traditional long only assets, people, your potential clients kind of look and go come back when you've been doing it for five years and you look more like I look now than I looked. Then when you say we're launching an aggressive hedge fund then

It's been way bigger one since then. We've been eclipsed by that.

The next eighteen months of actually running money were very, very bad. We started running money in August of ninety eight. I'm gonna mention them again again. I didn't mean to mention them once, let alone twice. But August of ninety eight is when the LTCM kind of death spiral began. Russia defaulted, and it's always Russia and LTCM began a few months our initial you know, the stock market was

We did well during that crash.

Then something called the dot com bubble took off, and I have written a lot about this.

I think in the last five.

Years people think of us maybe too much as value investors. It's a big part of what we do, but it's far from all. We go through decade long periods where we hardly talk about it because many of the other things are dominating. In giant bubbles, the value portion of what we were doing suffers. And that happened in ninety nine, two thousand, and it happened in nineteen and twenty. So we were down in this account about thirty five percent

Now, if the.

Fellow quants in the room are saying, well, you were taking twenty three percent volatility, that's barely maybe two standard deviations. Whoever's thinking that as a moron, I was thinking it at the time because I'm thinking the world thinks about risk adjusted returns. Right we were We had up three triple digit years in this.

Kind of account at Goldman not a good way to start a business.

So let's talk about you mentioned you started with a long short. You've become known as value guys, but really you'll run a variety of different strategies and different different silos. Let's talk a little bit about how that developed. How did you go from hey, we're going to run and gun a long short and take an occasional thirty percent hit to adding diversified approaches to not just risk management, but where are you going to generate your alpha from?

Partly, that's just been always what we've been done, even in our time at Goldman Sachs.

As I just told you guys, we started out.

First models we built were about what equity countries looked more attractive. We quickly poured those two bond markets.

At that time.

The world has gotten deeper, the factor world has gotten deeper, but value and momentum were the two main factors.

When you go to a bond market, you go what's value.

Everybody who does this will claim, and I will too, that their models are much better and more subtleness. But if you just looked at prospective real bond yield across twenty countries, the ones would higher yields tend to be scarier like value things often are and tend to on average do better. Momentum is ridiculously easy. Everywhere you go,

I get annoyed.

They're about five to ten major things that most and I'm speaking in general of the exceptions that most quants probably believe in. Cheap tends to be expensive, good momentum both priced and then later on importantly, fundamentals, things getting better tend to keep getting better. Lower risk things measured both fundamentally and in terms of the quant measures bita

Measure it on.

Expanding the set of things beyond value and momentum, and then expanding the places we do it. We didn't do emerging markets at Goldman. When you add that, you get two wonderful things at once. Actually you could fail utterly. If it works, you get two wonderful things at once. You get another strategy to add, which is correlated.

You shouldn't pretend it's not.

But it's not perfectly correlated, so it's somewhat diversifying, and you get another little out of sample tests. Statisticians quants, we have very strange dreams. We don't dream about cars and houses and significant others. We dream about out of sample tests. It's kind of the gold standard. You often don't have enough. Sometimes you gotta wait thirty years to

I'm glad you reference that not geographically. But let's talk a little bit about one of the issues that seems to really have come into its own over the past decade, which is tax aware investing.

It's people talk about.

Asset location, and hey, I'm going to put my highest turnover, most active account into my tax deferred portfolio and the long term boring index stuff I'll keep in my taxable account. That seems to be the conventional wisdom. You seems to have moved in a direction opposite that tell us about that.

Well, first, the conventional wisdom isn't wrong if you're owning a traditional, say, actively managed long only stock portfolio with some decent turnover that doesn't have very attractive tax properties. Where we got into this starting the research about ten years ago, writing our first paper, we've been fairly public about this stuff. A first paper I think on this was in twenty fifteen. Were a few different sets, and

The long short is the over and the underweights that you had before.

Just that active separation makes something far more tax efficient. The index fund a cruise, like all index funds are fairly tax efficient, and the active part you only pay tax if you make money.

You have a bad year, you don't pay a tax on it.

In a traditional long only portfolio, imagine markets they do go up on average over time, and you want to sell something you actually haven't produced alfin you just don't like the stock anymore. You get a tax hit from that. So simply the separation gets far more efficient. Then you say, well, can I do any better about this? And here it's the last time I'll try to mention luck. Not again,

This is why it's luck. It's about a year. You know, you know what averages means.

Some things are fairly quick, some things be old for five years, but average is about a year.

A year is a magic number. In stock a year and a day.

Right, you know you have a big winner at eleven and a half months, you're kind of an idiot if you sell it, right and lets unless you have illegal inside information.

Wait two weeks in a day.

It turns out that in a long short portfolio with proxy, with not tremendous turnover but decent turnover and an average kind of one year holding period, there's a tremendous amount of optimization around that you can do.

So, so the optimization on holding something beyond the to get to the lower long term capital gains tax is pretty obvious.

What about the flip side of that?

What about tax lost harvesting to offset those some of those gains.

We're big fans of that. How do you approach this?

Yeah, essentially, what we do you can think of as a I hope this sounds arrogant, a more advanced form of tax loss harvesting.

We are certainly waiting to sell the winners.

By the way, if something's a winner in three months and we think the price has just gotten stupid, the alpha models will dominate the tax models. It's not a pure tax product. This is a decision when it's at the margin. But we also will rather savagely say, this thing's on the edge of where we want to sell it, and it's eleven and a half months, so let's take

This is the twelve month thing.

If you do that systematically, not even over aggressively, you generate more tax benefit that you can use in the standalone portfolio. The standalone portfolio is already turned into a long term gain, and you can use those extra losses elsewhere. And if you put that into a taxable account, you can't take those losses out of taxable account and use them elsewhere. So I do think the conventional wisdom. I won't I won't be mean about it. It is for

So let's let's pivot a little bit and talk about value, which.

You tenn one from the irs is here are they were?

But they're very comfortable with what we're doing.

But I don't don't want to push it.

They do a nice job with guns. They let you know what you can and can't get away. Just follow the rules. It's easy, yes, not that difficult. You got you have an accountant, right, No, I did it all myself.

All right, Well we'll talk afterwards. Return like this right manually? You thought at with a pencil.

Right.

So let's talk a little bit about value, which is how a lot of people traditionally think about you. Value had a horrific decade in the twenty tens, and anybody who was paying attention to mean reversion was waiting for it to come waiting for it to come. What made the twenty tens such an unusual period for value, and how long can the current run of value playing catchup?

Last four?

Right, Barry just asked me a twenty seven minute answer question. So I'll try not to I'll.

Try not to abuse it.

You got a let nine.

First, You are right.

I think we have been known to me in particular for value only because I've been screaming about it since about twenty nineteen. I also casally write things pointing out that I go through decades where I never mentioned value from about post GFC, he said twenty ten.

I think that's about right.

Through two thousand and maybe eighteen, most traditional forms of value had a pretty bad run. You can always find somebody with their own indicator that they won't tell you what it is, and it's proprietary, and it would have worked like a charm. But almost ubiquitous se value strategies did poorly. We actually, I'm not going to hide from a very bad period for us. I'm about to get to it, but we actually had a really good run from twenty ten through twenty seventeen while value was suffering.

I think a lot of the reason for this is values loss over that period.

Was because and I don't mean I hope, I don't mean this in a deep moral sense, but it deserved to lose. The companies underperformed, they under executed. The fundamentals were not good. And it turns out that if one runs a pure quantitative you know, the Gram and Dodd people think of value very differently, more holistically, but in the quant world, values generally price compared to fundamentals.

It's a pure bargain searching.

You use the phrase cheap for a reason.

Cheap cheap for a reason is what the Graham and Dodd people might say, and it's what our model as a whole would say.

I'm going to segue for a second.

I think the quants and academics messed up this conversation twenty five years ago by calling the famous farm and French farm and French with my dissertation advisors.

I love them.

I don't even think they called it value early on, but that became called the value factor price to a fundamental. Nobody just really disagrees with the Graham and Dodd world that that's not value. Value is what you're paying compared to fundamentals in context of is it a good company, is it executing well? What?

Or it's growth? How risky is it? In the quantitative academic world, you get there.

By this thing they call the value factor, which I think really should be called the low price or, if you want to be more long winded, the low price to fundamental factor.

I like that factor.

On average, it wins, it doesn't win nearly as much as if you combine it with some measures of is it does it deserve to be cheap? One simple way to think of twenty ten through about eighteen is the does it deserve to cheap?

Which is cheap which is more than half of what we do work like a charm.

So value can lose, and somebody who's has that as part of their process but doesn't dominate their process can do fine. Now and as late as late twenty seventeen, I was actually taking the opposite side of some famous a handful not just one of famous value managers who are saying, we've had eight terrible years. That's never happened before. It has to reverse, and we measure this thing called

From that kind of environment.

To win in that environment, you need to find a systematic, long term factor that makes money on average, that does really well.

In a crazy bubble.

Sounds like momentum.

Momentum is one of the few you have hopes on. Momentum is a flighty thing to put all your eggs on. For one thing, a momentum standalone has a horrific left tail when momentum reverses if you get it wrong. Also momentum, you can think you have a good environment on average. It works in a bubble. It did add value in this bubble, But if you get a few wiggles that are crazy.

Momentum is more sensitive.

So momentum is one of the few you have hopes on and it's interesting you raise it, because to find one that will help it has to be something that.

Works in a bubble but works on average over the long term.

I'm excluding massively perfect timing. I'm not obviously. If you can say do value all the time except nineteen and twenty, that's great.

So is it a coincidence that your dissertation was value and momentum together? And is that useful?

If it is as a happy coincidence, So how useful was that? It was certainly useful, though if I can admit to this crowd, I think I should have listened

So let's talk a little bit about this decade and last decade. Value didn't do well when capital was cheap, rates were low, inflation was practically non existent. Growth really dominated. Now it's a new regime. The ten year is foreign changed, the Fed funds rate is five and change. Even though inflation has rolled over, everything is still elevated in price. What does that mean looking at forward versus what we

Or how do you look at this regime change?

I think the macro world influences this, but maybe a little less than other people. I think the spread between cheap and expensive historically is only mildly related to interest rates, real or nominal.

The story is good.

When interest rates are really high, people prefer value because the cash flows are short term, and when they're really low, you prefer growth because cash flow is a very long term. One of the problems is when you actually look at expensive versus cheap companies, the realize growth differentials of broad diversified portfolios I'm not talking about picking in video or something are very small, so there really is not a very strong theoretical reason. I think occasionally hit manias and

Correlated to people going nuts write that down.

This is very quantitative academic people going nuts.

And I do think that era.

You know us, we don't try to make massive macroeconomic forecasts. But I think for ten years we lived in a world where maybe the most significant macroeconomic thing to me is the central banks around the world, and the FED in particular, did not face trade offs. Inflation was non existent, and they could cut rates when they wanted to stimulate growth.

They could raise rates if.

They felt like if they felt like it, I have no other better reason for that. They clearly face even with inflation abating. I think it's gonna be a long time to the central banks of the world face the world with no trade offs, and the spread between cheap and expensive kind of my north star. I'm sad to tell people it is no longer wider than the dot com bubble, so it's about eighty five percent of it though, so we've had a massive comeback book. This is the

But I think we're in the third ending of this thing.

So in the last minute, we have where do you see people currently?

I'm asking you this as a quant not a psychologist quantitative. Where are you looking out at the world and seeing people still going crazy?

Is it?

AI?

Is it tell us what the next bubble to avoid is.

I have been I'm a little if something bad happens to me and it's fishy, I think it's going to be the private equity industry that gets me. I've written a lot, and I've talked about this for years. This is a twenty eight year old argument. I've been having nothing wrong with private investing at all, but I think more and more people do it today because they don't have to show volatility, not for the opportunity. When David Swinson was doing it in the eighties, it was about

Have moved together.

But the private world is even more extreme where the I'm not sure if they tried to sell it what they would get, but they're still marked pretty pretty crazy. So I've been picking on them for a while, and with zero time to go, I see no reason to pick a new victim.

I love private investing.

I live in Granwich, Connecticut, and my kids don't get picked for sports teams because I make fun of private investing. But I do think that world is dominated investing for a while, partly for good reasons because there are some opportunities and great investors, but partly for some terrible reasons because they take volatility and they just cover it up. And I think that those chickens may come home to roost at some point.

Cliff, I could talk to you for hours, but the clock says zero, so we have to wrap it up. Let's hear it for Cliff Assness of AQR.

Thank you so much.

We have been speaking with Cliff Asnes. He is the co founder and chief investment office of AQR AE hundred billion dollar hedge fund specializing in quantitative analytics, statistical arbitrage, value investing, etc. If you enjoy this conversation, hey be sure and check out any of our previous five hundred discussions.

You can find those.

At iTunes, Spotify, YouTube, wherever you get your favorite podcasts from. I want to thank the team at Advisor Circle for making the audio available from this extra special live event.

I'm Barry Ritolts.

You've been listening to Masters in Business Special Live Edition on Bloomberg Radio