Masters in Business: AQR Scott Cliff Asness (Audio)

Fascinating gentleman, really really interesting background. Undergraduate University of Pennsylvania, Wharton Economics, you pen engineering degree a double engineer, double major. Goes to University of Chicago, ends up with an m b a slash PhD in the Chicago program. Um eventually takes a time off to go to Goldman Sachs, where, at age twenty nine, he's the head of the quant group. Just an absurd, absurd resume. Pull up the papers that he's written, dozens of award winning best and Best in Show,

Best of the Year. Just really a phenomenally interesting and insightful guy. A little background as to how we met and how he ended up doing the show because um, as he generally said during the interview, I stalked him for a while. So Cliff rights very frequently, which is

something that we do in our shop. And I really like people who take all their thoughts and put them down in an organized, structured fashion, and they have something interesting to say, and lots of lots of things that he writes are just fascinating and insightful and just a touch of humor, a dollarp of humor thrown in. You look at some of the headlines of his white papers or his blog post and you'll see some really clever amusing titles that with lots and lots of pop cultural references.

In addition, there ain't a whole lot of hedge fund managers running the sort of money he is that tweet on a regular basis, and so he published. He was one of the signatories to the letter to Ben Ben Bernanke worried about hyper inflation and the collapse of the dollar, and I called him in a number of people out on it. And while many of the people who who were on the wrong side of the hyper inflation debate kind of pretended they never said it, Cliff came right

back at me on Twitter. Well, you know there's still time, but so far it looks like I'm wrong and you're right. Hey, you don't get that sort of response from people. Usually you get a lot of arrogance and pushed back and we'll see, you know, it's only been five years, give it another decade. But he's not that way. He's like, well, so far, I've clearly been wrong. And you know, he's a real data guy and I respect that tremendously. Um,

you'll find he's not your typical billionaire hedge fund manager. Uh. Extremely Even though he doesn't do a lot of media, and even though I stalked him for a good year to get him on the show, he was really stunning Lee charming and self effacing and witty and not at all what you would imagine a lot of people in his position are like. And if you read some of his writings, they're very very you know, here's the data, here's the context, here's here's what the details are, and

that's pretty much it. They're very aggressive, they're a little in your face, but he's got the goods to back it. If he's in your face, it's because the numbers are there, and he's at heart a numbers guy. So we stopped just around the two hour mark. I'm not kidding when I say this could have gone another two hours. We absolutely would not have run out of questions. I find him to be one of the most fascinating people in finance.

Lots of what he writes is really really influential. It moves the debate forward, it moves the argument of finance forward. And um, I think this is one of the most interesting conversations we've had on the show. So without me babbling a whole lot further, I think you're really gonna enjoy our conversation with a qu Rs Cliff Astenus. This is Masters in Business with Barry Ridholts on Bloomberg Radio. My special guest today is someone who I've been chasing

for a while to have on the show. I'm gonna introduce him first and then give you his curriculum vitae, and that will be the first half hour of the show. Cliff Fastness, welcome to the program. Thank you, Barry. I'm excited to be here. Um, I'm I'm actually really excited to have you. Let me. For those of you who are not in the financial industry and may not be familiar with Cliff assness name. We have a little bit

of of financial royalty here. First, you're the founder and chief investment officer of a q u R, which runs about a hundred and twenty billion dollars in both hedge funds and traditional strategies. Have a few co founders, David Cambrella and John lou Those are the guys that you were working with at Goldman Sachs. Correct, When before we get to Goldman Sachs, you graduated you penn with a degree in economics from Wharton and a simultaneous degree Bachelors

of Science and Engineering. Yes, either one of those is a heck of a degree. To have a lot of a lot of effort, a lot of work, both of them at once. That's really an impressive. I didn't know any better and had no social life there you go. So you go from Wharton to Chicago at the Booth School. But may not it was, It wasn't, but it was just Chicago. I'm giving David as due was the Booths School just wasn't called it yet. And you the research assistant to Eugene Fama, known as the father of the

efficient market hypothesis. We'll get to that a little later. Because you're not exactly an E. M. H type of guy, and um, he chaired your doctoral dissertation. You got your PhD um which is not in any specific atis a PhD. And no people always ask me this. It's you get

it from the business school. You effectively major in whatever you wrote your dissertation in, but it's a generic business school PhD. And so you decide to write your dissertation on how you could use momentum and value to beat the market when your doctoral thesis advisor is the guy who says, no, you can't. Yes, that was with some trepidation. He and his co author was also one of my advisors. Ken French had already done a lot of work on value.

French from again More Financial Royalty. To say the least, they had already done a lot of the pioneering work on value investing and value investing. It's still a fight. It's still arguable whether it works because markets are irrational or whether it works because it's a risk premium of some kind. And we could spend a whole show talking about that momentum. I guess some people argue about it but I think the literature is far stronger on the irrational side. So yeah, it was scary to tell you.

I tell I've told the story for years, going up to Gane and saying I want to write a dissertation on on price momentum, the simplest of all momentum to dr Farm and and then I mumbled the second part. And it works really well because a dissertation saying momentum is terrible is a perfect Fama dissertation. You know, look at these fools following this to his credit, and this is actually I think a warm story. Um, he has his opinions, and he but he is brilliant and he's

open minded. Um, you don't change his mind. But he is very comfortable. He said, if it's in the data, write the paper. Wow, that's really interesting. So the weather in Pennsylvania is bad enough, what made you say I want to go to Chicago? It gets worse? So I had to choose between Chicago and Stanford. They had precisely the same scholarship program for Peach. Peach season has got a good deal, we don't actually pay. It was exactly the same, and UM, Chicago at that point probably still

UM was just an incredible program. I got advice from so many people saying, if you if you're serious about finance, and you can go to Chicago, go But it was pretty hard enough to go to Stanford. I can imagine. Did you know you would be working with Fama beforehand? No, he kind of chooses you, and I got lucky and he chose me. Um. He was one of the reasons I'd certainly heard of him, but less so than you can imagine. I was a little naive. Um. I just

walked around, said I want to study this more. Where should I go? I got the advice to go there, took jeans class. Uh. And then at the end of his the first year, he asked somebody to ta this class next year. And I got lucky. He gave me the tap. That's great. Now you leave, you graduate, you get your your doctor. And now I left without the doctorate for Goldman. I left to take a year off, to take a year off, that's to find myself. No, I I got it eventually. It's not doctor essence because

it's massively pretentious for finance. These were doctor and I'm afraid you'll ask me to check your hernia. Well, I did get the PhD along the way. So now you end up at Goldman you actually be eventually become director of Quantitative Research for asset management. At age twenty nine, you formed the Goldman Sacks Global Alpha Funds, which was a quant vehicle for deploying their capital using your quantitative metrics.

That's at age twenty nine. And then sixteen years ago you found a q R, which stands for applied quantitative research. Didn't know anyone knew that anymore. Yes, I guess that, but I guess that and punched it in when it came up thought about starting our own firm. We had a whole bunch of you know, three of us who were thinking about it. Should we do this? Should we not?

We ended up spending almost all the time talking about what we should name it, and we came up with the IBM of Firms, about the most boring name you can imagine, but if it's what we do exactly, and it's better because when you first see a q R, it's like, all right, it's as in this, and then ye, people are still looking for the you know they're looking for right, and I left out by the way, some of the awards top paper um from the Graham and Dot Award in two thousand three and two thousand eleven

best perspectives piece for the financial analyst general? Is that what that is? Two thousand four and then the Portfolio Management Best Paper Award O one oh three and that's all the time we have. Thanks for coming by, Cliff. So so really, the first question I gotta ask you in the last minute we have in this segment is what made you decide to go into not just finance but quantitative finance. First, there was total indecision. Um. I

took this. You mentioned my undergrad I was an engineer in a business school student because I had no idea what I wanted to do. I was fairly mathematical, and my father read about this program, this dual degree program, and said, why don't you do this? You can decide later. That was the total amount of planning. I like the finance. I liked I found it intellectually interesting, and to be honest, you know, you never know. You look back when you were twenty and you try to figure out if you

planned it or not. Um, but I think I was attracted to the idea of something that I found intellectually fascinating, that you could make an actual career out of that. Wasn't the archaeology. I just upset all the archaeologists out there. I'm Barry, what helps. You're listening to Masters in Business on Bloomberg Radio. My guest today is Cliff Assness. He's the founder and chief investment officer of a q R, which Fortune Magazine called one of the most important and

influential hedge funds in the world. Cliff, let's talk a little bit about the quant crisis of oh seven, and I'm just gonna quickly set the table. We had. We had the bear Sterns wobbling a bit, then the bear Sterns hedge funds around June of oh seven, right, they blew up and that was a whole another issue. And then we saw in August a lot of things hit the fan all at once. That was a really rough period.

That began a period where let's I don't want to talk about the entire financial crisis, but the quant crisis and oh seven, you guys saw a short period of time you lost of assets that that had to be a hellish period to live through. I um, we can't do this segment because I've blocked it all out. Okay, so it's just all suppressed so before we then, let me let me try and free that up just so, so just sscribe for listeners who may not be familiar with what quants are. What is a quant what is

the quantitative approach to invest? Sure? Um, there are some other people who will do quantitative techniques. I'll describe it very generally and as it applies to us. Quant investment managers are about I would say two words describing very well. They're about averages, and they're about diversification. They're not about kind of the sexy side of here's my best stock pick? Uh. Sometimes I respond if people ask me, you know, what's your favorite stock or what's your biggest holding, I look

at them and go, I don't know. Which is usually true, and they get very confused because we are on thousands of But let me give you some examples. If cheap stocks measured you have any of your favorite ways, price divided by earnings, cash flow, dividend sales tend to beat expensive stocks on average over time. On average, yes, on average over time, not always, not even close to always.

I wish it was always. If they tend to win, and that's all you knew and all you believed, you wouldn't bet on it by picking your three favorite cheap

stocks and shorting your three least favorite expensive stocks. You believe in the average, you would do it with a very diversified portfolio of cheap and you would sell or underweight, depending if it's a hedge fund or if it's a traditional portfolio, a very diverse side portfolio of expensive and you'd hope that your logic and your historical evidence repeated itself over the next long term. We have found, along

with others, this is not unique to us. A set of things that work like value is one of them. I didn't choose the random of the example randomly. You gotta be careful When I say work, I mean like a statistician two out of three years, three out of four years. If your car work like this, you'd fire your mechanic. You need an economic story why it works. I don't believe in just data. I believe in try

and understand why it works. And you need a lot of out of sample tests, for instance, in value and and all and all the things we do, we have found it's not just individual stocks. We always end up discussing individual stocks, but cheap countries measured at an analogous way at the country level, Cheap bond markets using real bond yield slope of the yield curve, cheap currencies using purchasing power parity, cheap commodities using just commodities to press

first day long term average. Anything we've looked at shows some tendency for cheap to beat expensive. Then other things exist momentum, which you mentioned. I wrote my dissertation on things that are getting better relatively recently tend to beat things that are getting worse. It feels like the opposite of value, but very different times. Say that again, things that are getting better relatively recently six to twelve months, um, be things that are still on a down slopes um.

And this, uh, this is a bit of a blow to the efficient market hypothesis. Maybe one day people will reconcile them. Um. But that kind of shouldn't be. It's it's a little too easy. I called the new to newspaper strategy. If you're only trading price momentum, we need a newspaper from today, in a newspaper from a year ago. I think I when I when I wrote this dissertation for gene Fama, who is both efficient markets and the value Guru. I didn't say this is better than value.

That would have been both wrong investing and bad graduation strategy. I said it complements value very well. They both make money. Value is a much slower turnover strategy. You often do find stocks, even though it doesn't sound common. You often find stocks that are still cheap, not as cheap as they were a year ago, but have good momentum. So both of those tend to work on average, so do

other things like high quality. High profitability tends to beat poor profitability, low beta, low wrist stocks tend to beat high risk stocks. To a quant You want to trade those very diversified in as many places, not just for individual I keep saying stocks, but I have to correct myself. Anything you can trade that's liquid and you have good data on which both makes it better investment because you can spread your bets more and makes you more confident.

It's not just random data mining. So I want to go back to what you said, an out of sample set, and you didn't use the words mean reversion, but essentially what you're describing is using mathematics to analyze is any place that you can put your money to work and look to take advantage of that eventual mean reversion, meaning cheap stocks will eventually get back to be fairly priced, as will expensive stocks will eventually come back down to fair If you put the two together, I would readily

agree that value investing is highly related to the idea of mean reversion. They're almost almost synonyms. Um. If you add momentum in there is just that. Again, there are more that we do. But if that's the second one, UM, we would say things without a doubt mean revert. But they get there eventually. They tend to keep going the same direction for at least a little while longer before they mean. Way to put that they overshoot. And just for the lay people listening, you mentioned out of sample

set um. So if we're looking at tech stocks um, or we're looking at recent data, describe how you would use an out of sample set to confirm that a sample refers to the following problem. If you give me enough data or anyone good with computers and statistics, I will find you something that has worked in the past. It might be total gibberish. One of the most famous ones, UH is butter prices in Bangladesh help predict the SNP fight.

I could be mangling that, but it's something like I recall that and the same thing with the decreased number of pirates and the the pirates decreased number of pirates and the increased in in measured temperatures. People say you could randomly find any two things. The Super Bowl effects another example by after the NFC, but not just the NFC or an old because they had adjusted for the Steelers who won annoyingly often. And if it's screwed up the rule. So there's no real cure for this, but

there's there's some there's something you can do. You can go look somewhere you haven't looked yet. One great out of sample test. It's time and it's now been twenty five years since my dissertation. That's frightening to say out loud, and and the stuff is held up and that's a wonderful out of sample test. But when I'm as you said twenty nine at Goldman Sachs, a good career strategy was not first, we wait twenty five years and if

it works, we pounce. We keep going right. So another thing you can do is say, well, if this logic works to pick stocks in the US, doesn't work in Europe, doesn't work in Japan. All right, If it works for stocks around the world, doesn't work for bond markets, doesn't work for commodities, doesn't work for currencies. So finding these things work for other things was both lucrative because you could do it in more places, but also very calming because it made you think that's a much smaller chance

that you're just lucky. It's not random. There's actually a theme underneath. I'm Barry Ridhults. You're listening to Masters and Business on Bloomberg Radio. My guest today is Cliff Assness. He's founder and c i O of the most influential hedge fund in the world. Am I giving you a promotion? What did they call you? One of the most influential hedgefund? Take that? And the irony is you've been fairly critical of the hedge fund industry in general. Let's let's talk

a little bit about that. What what's your beef with with hedge Well, first, I've been a schizophrenic on the hedge fund industry. You know, it's kind of like having a little brother, if other not that they're my little brother. But if they someone else picks on your little brother, you defend them, and if your little brothers having a good day, you punch him all. We started out in the year two thousand, this is fifteen years ago. We

wrote a paper called do hedge funds hedge? When I was a younger whipper snapper, and I got yelled at by half the big names in hedge funds. Was both fun and scary. Uh. And we said there to net long the word hedge implies their hedging, and they were about forty percent net long stocks, meaning if you went long a dollar in short sixty cents, you're still exposed. That that might be a good idea for total returns, but you shouldn't pay two and twenty for that because

you can get net long from Jack Bogel forty. They actually Vanguard, so you're referencing ran a big study after the o A crisis, and they found that a sixty forty unleveraged portfolio beat something like the hedge funds out there and once fees they want. Well on the little brother comment, I think that's mostly right, but I'm gonna take a little issue with that. Here's the criticism. I think hedge funds. UH do a lot of very good strategies that make economic sense and have evidence behind them.

Forgetting fees and forgetting hedging, merger arbitrage lending capital after a situation has occurred. You have a liquidity risk of a deal blow up risk, you get paid for that. Convertible arbitrage is largely I think a liquidity premium trend following and managed futures. I'm a momentum part of what we do. We think it works. There are others good strategies. They do them partially not fully hedged, which is weird and adds to the price because effectively you're getting a

party of return from an exposure. You should get more cheaply, and then they charge a ton for it. So this is self serving because it's kind of how we do it. But we think hedge fund should fully hedge and then charge less. We wrote this paper that's critical. Some of the criticisms of hedge funds. The worst ones are when they compare them to a stocks. Now their net long long term about forty of the stock market and geeks

speak a point for beta. Stock market goes up ten percent a day, you expect four percent on your hedge funds, but if it goes down ten percent, you expect to only lose. So stocks is a bad comparison. In general. That guy who bet against Warren Buffett is discovering this um. It wasn't my bet, so I'm allowed to It's not ex posts. It could have been bad for Warren too if we had a bear market. It's just a a bad comparison. And in five six years of bull markets,

it's a terrible comparison to hedge funds. Sixty forty is much better, but it's still about more long stocks than than hedge funds have been historically, even before the last few years. You can show this, and when the market goes up fifteen percent a year for five years, that's three percent a year of a drag. So I think it's a much better comparison. But if you do the actual dollar for dollar, you end up critical of a few things. They don't Actually this will sound weird, but

take enough risk. We don't want risk, we want turn But that's how you get return is from them taking more risks. So after you headge out that that market exposure, they're not quite doing enough to really move your portfolio that much. But there has historically been in our dad to some excess return. So I called this a tepid defense. First, I've criticized him as being too not long, not a

good enough deal. But then when others have made comparisons that UM one is not terrible, the stocks a terrible comparison, I think it's been too negative. I think the truth is there are good strategies UM they just don't do it at as a good enough deal, at at an aggressive enough way to make it a good deal for investing.

So in. In In other words, and I know you don't like to pat yourself on the back, but I will so you that I love You looked at this and basically said, well, when we look at the world of hedge funds, they're they're not embracing risk relative to what their mandate is, and they're not fully hedging, and they're charging too much. And you said, we can hit all three,

but check off all three boxes. We could really embrace appropriate measured risk in a way that makes sense, not kind of be a little bit pregnant, but really be fully in. We could fully hedge this position and instead of charging two plus of the profits, the Delta fund is one in ten um. By the way, could we have had this conversation a few years ago or would you have been prevented by uh the SEC rules back then.

I have no idea. I know they once sent me on TV where I had not passed my Series seven. I shouldn't take too much time here, but I had passed it and it passed it in at Goldman expired. We weren't a broken dealer, so I and then we started. I had to retake it, so they told me, don't talk about fees. It's one of the things you don't have to talk about if you haven't passed the test. The anchor, of course, immediately asking me about fees, which which he was told not to, and I had to

look like the most evasive guy the man. I I kind of said, we think the low versus the industry, and I kind of look down and prayed he didn't continue, which he didn't. It was not my high point of media. I'm Barry rid Helts. You're listening to Masters in Business

on Bloomberg Radio. My guest today is Cliff Assness. We were speaking earlier about hedge funds and in general, how they don't necessarily hedge and why they charged too much, and h u r S Delta Funds charges one in ten, which actually got of all people Vanguard founders Jack Bogel saying that seems like a pretty reasonable deal. I'm impressed, quote unquote, I'm impressed. Well, that's tough to do to impressed. Now, I've I've known Jack for a while. He's kind um.

The mutual fund version of this is called the multi strategy fund Jack. I actually asked him about this afterwards, because if Jack Bogel says something nice about your strategy, you want to be able to quote it, and we mutually agreed how I could quote him, and I'm I'm I'm very fond of this. UM. I did not convince Jack to invest and recommend hedge funds. Jack does like tilting away from market cap and long home. He doesn't like value. You know, he's straight down the line. That's

a separate issue. But he's straight down the line. So I'm not that persuasive. But I got him to say that what we do in hedge funds, because of the transparency and the fee structure, is the hedge fund he hates least I am quite proud of. That's a fantastic quote. So let's let's talk a little bit about hedge funds in general, because it seems to be a very bifurcated industry. Most hedge funds seem to be really significantly underperforming and

a handful of winners. Um not. I'm not just referring to some of your big firms funds that have done well, but a handful full of firms, not just Renaissance technologies. It's really a a it's not a Gaussian distribution, it's not a bell curved. It's it's a fat head and a long his seat is getting close in to my new It's a fat head with a long tail, and it's really just a handful of giant winners and everybody else are also runs also rans. Why is that the

industry has gotten more like that over over time? Uh? Part of it, Part of it is for good reasons, part of it is for bad reasons. I do think if the market is not perfectly efficient and some people can beat it, it's still a pretty narrow group. It's still pretty efficient and a pretty narrow group of people who can beat it, So still a handful in that sense, it's not that crazy. I think there's a negative reason to that, UM that investors of all types of all stripes, institutional,

high net worth, retail, chase performance too much. Um. You know, they chase short term performance and they chase multi year performance. And certainly that's indicative and all I'll sequel. I prefer it when mine is good. UM. I whine about this much more when it's going against me than when it's going for me. But I think people should spend a lot more time on the process. Whether it makes sense

if they have a very long term track record. But I think people chase too much, and particularly people seem to look at three to five year horizons and chase them. And one of the few things I'm that we actually know about three to five year horizons and finance is that's about the horizon. Things tend to mean revert, not continue. That's a full side. That's about a cycle. Where in the mutual fun world, that's about when somebody ends up

on the cover. Hedge funds aren't that different, and usually all the money plows into it just as they've peaked in a reverse. And there are some people who defy all the odds and just keep going. But some of the very large hedge funds are this effect doing well for a while, and then the money just pours in, and I'll say it, I'll say it, even when it's us, it's probably too much. So is there a dollar amount what you would say, Okay, No, we have done that

to various strategies. We are blessed and having fairly large capacity as quants. We trade very diverse side portfolios, big cap stocks, UH countries, currencies. But we have closed some arbitrage strategies and mergers and converts. We've opened and closed them. We've closed them whenever the market wasn't amenable to more capital.

We've traded. We've closed some I wouldn't call him high frequency, but but faster trading strategies because those end of hit capacity faster, and there is no strategy we wouldn't close at some point. Because there's no strategy is an obvious statement that's still upsets some people. There is no strategy that doesn't get worse past a certain minimum necessary point as it gets bigger. But we see that time and again.

We see the mutual funds. We see in hedge funds there's a dollar amount that the manager can handle successfully, can regularly make money and beyond that, it looks like they're just gathering assets for the sake of gathering assets, and the performance goes away. I think it's very strategy specific.

You've got to really grill your managers. If you are inclined to look for stock picking skill and you are thrilled with someone's track record, it's not that hard to figure out if it was mainly small cap and microcap

stocks and they're way too big for that. Now, if they were a currency trader of any kind, and you don't have to be a quant but they were a currency trader, um, maybe it's not that crazy that they can take and it requires some thought, but I think it's one of the key things that should be asked. How you pass the point where you can manage The answer is gonna be very different for different people, but it's always a good question. So let's talk I'm gonna

pivot a little bit. Let's talk about high frequency trading, because I know you use you You guys are not an h f T, but you certainly use a lot of um computer generated or algorithmically driven trading to be more productive, more efficient, lower cost for your execution. You're a pretty big defender of HFT. We're an s f T, a slothful frequency trader UM and and you know we've been I'll be honest, I've been trying to be very

clear and careful about this. We have been a public defender of of high frequency trading and and we are quantitative. So it's easy to confuse those two and not. We're defenders. We don't think there's anything wrong with it, but we don't want people to think we're doing something we're we're not. We're not high frequency traders. It is my belief that that there's there's nothing perfect. I'm not excusing all behavior and saying nothing wrong goes on UM, but that's true

of every industry, of every group. I'm not sure HFT is worse either. Most of what goes on in h f T, which also explains most of the behavior that scares people, is about making markets. They make most of their money. But if Barry wants to trade comes to the market, they will take the other side of Barry's trade. Uh, and then they will try to hedge that risk. And they will And and why do they have to trade

high frequency? Well, they put out a bid in an offer, they'll buy it for somewhat less than they'll sell it to Barry. I'm going to use you as my example the way. Now, let's say the market moves a little bit. They gotta change those bids and offers, or else you or I could sneak in and get too good of a deal on them. They got to move it with the market. So they are canceling, correcting constantly. Why do

they have to trade it near light speed? I still laughed at the speed of light has something to do with my industry. It shouldn't. We're not in. We're not in. Electrons can move down optic fiber cable from your office to the exchange. I geek equations, but that little c for the speed alike should not be in any finance equations.

Yet it does show up occasionally. But most of their need for speed, and I sound a little too top gun there, but most of their need for speed comes from having to beat other high frequency traders to Yes, it is an arms race, but to be the one to execute Barry's trade. So by and large, and I think everyone almost everyone agrees with this. I shouldn't say everyone, um, but from Vanguard, Jack Bogel, other people have looked at this agree, they've lowered costs for investors. Um, there's always

been market making has always been a middleman. We might all not love a middleman, but there's always been someone to do this. They do it cheaper than the more mob monopolistic specialists and old market makers used to do it. Um things that look like front running that scare people. Market makers used to do once someone starts to buy a lot. Unethical front running is you have some information

that someone's about to trade that you shouldn't have. But observing trades and saying where there's something, that's probably something else, so we're gonna start to move the price that's gone on forever. It's just rational. Anyone making a market's going to do that. So it's not a blanket defense. But we think most of what they do is provide trading liquidity cheaper. The two big complaints that I think are credible.

The first is what some people call packet sniffing. So it's not an order that's been executed, it's not a trade. It's cliff is sending an order to buy a hundred thousand x y z. They sniff that order out before it hits the exchange and jump in line in front of you and flip what you were about to buy to you anyway, but at half a sent higher. So

that's one complaint. The other complaint is, you know, it's like the old joke about a banker is happy to lend you money as long as you don't need any They provide liquidly until it's necessary, and then hey, this is getting a little too hairy for us, will close. Either of those are are jokes. Those are quite serious and accurate statements. Um. But I will agree with you um on the first one, and I'll take a little

issue with the second one about them running away. Um, when it comes to information they're not supposed to have. If anyone has private information that they're not supposed to have, that should be stopped. I think that's a relevantly tiny part of what goes on. And I think you know, traders have attempted to do stuff like this since time immemorial. There was probably someone on the outside of Rome, uh

during this two thousand years ago. But if we find a place someone's finding information that that's private, that's using them, they're jumping ahead of me or you, that should be stopped. Well, I think that it's private it's that the exchange has the information, they're providing it to people who are paying for it. You get into a gray area when people are paying for it. If it's disclosed and they're paying for it, you could make a caveat emptor article that

we all know we're being front run. And these these profits are are It's a competitive world. These guys are hyper competitive with each other, so they then try to undercut each other and providing more competitive liquidity, and you have dark pools and you have other things that it's no longer as profitable as it was. I am still perfectly fine. I would like to see it be volume terry, but if I were setting up in exchange, I probably would make that not allowed. I think the confidence would

be larger than the gained to that. So I think it's a bad idea, though I could make a more uh you know, geeky economic argument that if it's disclosed, it's okay. I'd like to see that stopped. The other the the other part in them running away, I think they do run away. I'm not taking issue with your facts.

I just think market makers have always run away. I think this fantasy that uh that in the old days they would take a loss for the team, ready willing and able to make a market and to provide stability regardless of market conditions. I don't think you will ever find a market maker in these kind of markets and these kind of trading who buys at a price they know is is above the equilibrium price, or sells at a price they know is the true price. Two out of duty, and I don't think it's any less than

was before. I think they used to run away before. So I'm not saying they're wonderful. I'm saying they're precisest, cowardly, and venal as they've always been, and we shouldn't expect different. They're the same as it ever was. It's just technology instead of you. You can hang around a little bit, we can keep talking. For the podcast portion. I've been speaking with Cliff Astness. He's the founder and c i O of a q R. If you enjoy these conversations,

be sure and check out our complete chat. This will go on for hours after this. You can find that on Bloomberg dot com, at SoundCloud, and of course at Apple iTunes. Be sure to check out my daily column on Bloomberg View. Follow me on Twitter. At rid Halts. Cliff, what's your Twitter handle? Uh? Sumarian? Uh. Someone go read old Conan comics and that's how it's how they spelled in the old cord. It's also just search for Cliff Astness and where you can find it. This is Barry Ridholts.

You're listening to Masters in Business the podcast. This is this is my favorite part where I don't have to worry about I'm taking the year piece off. I don't have to worry about um the radio, the times we just kicked back. Cliff, thank you so much for coming by. We were off air, we would des i ibing. I was chasing you for a while and I figured I would wear you down and get you here eventually. Yeah,

I am. I wasn't really avoiding you, but I must tell you having so many amazing people, many of which I consider people I study, wore me down and said I want to be part of this group. That that's the that was the trick, only sucking up I'm gonna be doing in this whole thing, and that I do. I enjoyed that the my rolodex is not bad, not

the greatest rolodex, but not too bad. And I knew enough people between Michael Mobison, Lasla Borrini and a handful of guys like that, I knew that there would be enough critical mass that I would eventually start honing in on guys like yourself and Bill Gross. So it's really and Bob Schiller and Ray Dally and triangulating and yeah, no,

since I just name drop Bob Schiller. You mentioned something in one of your papers, by the way, I've I've read and my head of research has read a lot of what you guys crank out and put out some

really interesting pagers. You talk about being somewhere between Fama and Schiller, And the funny thing is you and I both wrote something after the two of them won the Nobel the difference being mine was this fluffy, eight hundred word piece and you put out a three thousand word dissertation on why they're both right and that's why they both want the um. Well, it was it was fun.

I co wrote that with John lou Is, one of my founding partners, and I'm also both of us had Fama as uh co chairs of our dissertation, so we really we we had a similar um. You know, we've worked together forever, so our perspective is similar in that sense, but we also had a similar history, and I would say we started out as Fama's students and are incredibly schooled by him in that efficient markets way of of thinking. I wrote my dissertation early on on momentum trading, which

is already a bit heretical for the afficient markets hypothesis. UH. Today this is big fight about why certain things have worked historically, like like cheap beating expensive um. One camp, the efficient markets farmer camp, says, well, if cheap winds, it's because it's risk here, you're assuming more risk. You're buying these small cap or these value stocks that have fallen out of favor. You assume the risk and therefore

pays off with a better return over time. Another exactly right, another camp, and that would be consistent with an efficient market. You can make more if you take more risk. And that's not that's not inefficient. You're just right. You're you're at the hundred dollar table and the payout. The other camp, the inefficient, the irrational camp, as typified by Bob is sharing in the Nobel Prize. But it's certainly broader than than Bob is. And I'm just using an example of

value cheap each expensive because people make errors. If something is doing poorly, they think it'll go on forever, and it should be. You should pay less for it, but not as much. This would be a terrible English sense, but not as much. Less as the actual price. It goes too far, and vice versa. Things that are are going well. Um and we saw lots of examples of that in two thousands. We saw stocks trading for less than book value, less than cash on hand. Things like that.

I'll never forget along the small cap slash value thesis. There was a company I had traded earlier, micro Music. It run up to two hundred bucks. It collapsed. I want to say it about two forty three with three dollars cash on hand, debt free, profitable. How is this possible? You're waiting for this thing to go out of business eventually gets it goes up, gets taken up by IBM.

We UM. We launched a q R in late um after very good RONNERD Goldman, and the first thing we did, and we didn't quanto it's very diversified, but implicitly did was fight the tech bubble. Um value investing did not have a very good say the least it had. Five years of the nineties were pretty toil, but ninety nine was a crescendo of doom um. And I don't mean to be melodramatic phrase, but it certainly felt that way.

And again it's not all we do. For instance, momentum was good enough to offset value for much of the late nineties, not nine. Value was so bad. Um. So I I cut my teeth at least at my new firm, not not originally a goldman on fighting the tech bubble, and I still have the scars of that. A lot of battles since that. That was still the worst. So let's talk about the word bubble, because I could say, yeah, you you basically think everybody over you, well, no doubt

the tech bubble. That was a genuine bubble. But since then you you've said, people over use the term, almost to the point of making it meaningless. This is a great way to explain how I'm in the middle of Bob Schiller and Jean Fauma. Jean will tell you, and I've recently had this conversation with him again, there there's nothing he'll look back on and say that was definitely

a bubble. And he's very intellectually consistent. No matter how strong you you feel and how smart you think you are, you don't want argue with with with Gene He's it's pretty hard to beat. I still don't agree with him on this, but I would run from that and hide. But I do believe bubbles occur. Gene gene Um at least he might not go as far as say they don't recur. He'll say we can't really prove they've occurred. I think there was a definite bubble in tech stocks.

I think, and I want to accuse Bob Shulder directly of this. I love Bob. I don't know what he he does, but I think people on the irrational side use the word bubble too much, and certainly on the wall street side, there's a bubble and everything. I I had a presentation where I had with I threw up like twenty headlines from bubbles and markets to bubbles and individual stocks too. We have dumbed down the word bubble.

The definition I like a bubble is it's still subjective, but it's I can't come up with any plausible future scenario where this yields a return that's even remotely acceptable. It could be a low return. So the funny thing about that line of yours is, I you just did in a column headline the bubble in bubbles. Well, we're gonna be in coort over that um. But your definition of what a bubble is is there is just no rational, reasonable price in the future based on what you paid.

And this was real time, and we have the papers to show it. During the tech bubble, we tried very hard to say, could we be wrong about this? What if you assumed the high end of Woltere earning scores, which was insane assumptions at the time. They weren't gonna happen, But assume them. Assume people are willing to accept less on stocks than the past, because the less you'll accept

in return, the more you can pay in price. That was counterintuitive because everyone's assuming it would go on forever. Let's assume it's rational in a in a in a fish in markets world, we couldn't get close to the current price. I was willing to call that a bubble. I wrote, um, something I called a partial book draft that never you asked me earlier, why I've never in the book? I tried once? Uh, you don't want to write a book about something being a bubble and have

it start to crash around you. I kept revising the book for about six months, and then I decided I'd rather make money than finish the book. And no one wants a book. Hey, there was a bubble and I called it, but I forgot to tell you real time. Um, but I was, I was writing this thing. I wrote articles on it that thank god, we're we're out there, but that i'd call a bubble. Let me give you a current example of something that I think is a very expensive market, but people call a bubble all the time.

Is the bond market? Bond really yields using forecasts of inflation, talking about US bonds are perilously close to zero. They bounce around. They've been that is about as low as they've ever been several times in history. That's pretty bad. Zero is pretty bad. Can I come up with a scenario where these bonds do okay over the next ten years? Well, I don't call this a plausible scenario. Can I come up with is not my best guess, just just something

that's not wholly ridiculous. And you can come up with it with one word, and you know the word Japan. You knew it, and now you have harmony yielding almost briefly yielding lessons by no means. And and just to reiterate, am I predicting the US turns into Japan? From pretty much still now? Um? Maybe ninety to two thousand at the worst. Um, But is it possible? Yeah, So I am willing to say it's a quite expensive market versus history. That's a different statement. Bubble has a level of assurance,

it has a level of insanity. It is a level of you should go out and short this thing. The other problem with bubble is much more practical, and this applies even when they're real bubbles. To the tech bubble, timing is always an issue. People forget again. Bob Shill has done tremendous work, but he started saying it at least um a rational juberance was more or less his phrase that the Greenspan said it tanked the market and

then had to retreat from it. I think that was quietly Bob's fault, which I would find so much fun if I were Bob. Congressional testimony tanks the market. But and this is notrefore proving the market is completely around. This is not a knock on Bob, because he'd be the first to tell you not to use his stuff to time the market and actively trade. But if you did from when he first started saying it, I'm not I don't think you made money. I think round trip, we don't think we ever got back to so we

got lower returns than normal. Where his measures very good for forecasting, but to actually make money by being an active trade or you don't want to use the Schiller p with a ten year horizon. The Cape measure, yeah, which I love. If you look at the past thirty years, CAPE has been showing over valued market for something like the time, which you know that I think I'll trust your numbers. It's certainly something like that. I find that

to be a little less of a knock. These things can wander away from normal for so long that it does impress upon people. While you don't want to trade over this, even over a even perhaps over a third year horizon, I have if I ever find an investor will give me a fifty year lock up, maybe I'll use the CAPE to to try to forecast things. And if you've been thinking about it, because you mentioned something earlier about this um, if you look at modern society

and how much more productive and efficient. I'm trying to remember where I I'm pulling this from something you you wrote, but I'm I'm not remembering which paper this was. Uh, it might have been something more informal than a white paper. But look at at the lack of capital intensive heavy industries. Think about manufacturing and what used to go into stamping out locomotives versus hey, we're we're creating a software company. Look at uber with no hard costs other than some

code and some serverses. But that becomes you know, that becomes a small cost of business as opposed to having to build these giants, steel mills and these you know that that sort of stuff. So maybe to some small degree, how more productive and efficient and less capital intensive these companies are. Maybe that rationalizes somewhat of a higher return at at at a higher pe, but that's really just

a small part. It's certainly possible. The the argument I like best um is that that people required a much higher return prior to call the last thirty years because some behavioral and some structural structural as it was far costlier town stocks. You know, we all act like there was these Vanguard, Jack Bogel ten basis point index funds forever when they were the way to own stocks, and and this is the behavioral part, was generally far more

concentrated portfolios. I don't think many people before this called the seventies owned the index. We look at it as if they did, but they tend to on the tent stocks. They're brokers recommended a huge that was insane, but at large cost. Concentrated portfolio, so riskier, we're to lower average return because the costs are much bigger trading through a broker at the old Brockdge costs before they changed the feast. So we look at the old returns like people got

those from Bogel when they weren't. They were getting it from their stockbroker with more risk. So along the lines what you said, and I'd build on that, I'm not I'm not dismissing that. I'd say in the in the history we look at of stock returns, perhaps people required a much higher gross level because they didn't get all of it, They got much less of it, and it had to take on more risk to get it because

their portfolios were more concentrated. So there is a case that it's a little more pessimistic than your case, a case that justifies higher prices today, but it also comes with a lower expected return. The lower expected turn is not wrong when prices are higher, returns are lower in this world. But it's rational. So let's get paid too much.

You don't need to get paid that much. Let's talk about that, because you've said recently you're in the camp that anyone looking out ten years should rationally expect lower than average returns going far. Yeah, I'll be specific um without mean reversion in prices um. And because that's too much about forecasting some people. I mean, you know, I probably believe in a little mean reversion um in p s in real bond yields, but that's forecasting and guests work.

Just you're you're not a big fan of forecast. I try. I mean, you know, you implicitly forecast a lot of things. But if I forecast, we want to forecast two thousand things and take tiny bets on all of them. I'm not especially not a fan of trying to forecast big giant things. Occasionally, something like the tech bubble will force me into a corner where there's no other bet to make.

Either bet it goes up or down. But by and large we try to diversify, and and and if we do have to forecast, forecast, forecast as cowardly as possible. But right now Schiller pas are around UM without mean reversion. I mean to get about a four percent real return historically on stocks from here UM per example year, not including dividends, No include total return. Excuse me, real return over inflation that thank god you asked, because that's really

including dividends. And after taking off one or two percent for inflation one or two now knowst long term, if inflation goes up, this goes up because not because earnings growth will move with inflation, we believe it makes some On a nominal basis, stocks are a great return, great investment.

In a period of high inflation people all the time, surprise inflation tends to hit all assets, including stocks, But long term, steady state inflation is kind of what stocks are for UM Now bonds uh it bounces around call him fifty basis points tiny real real expected yield. So take your classic sixty forty portfolio six of four percent or four hundred basis points of fifty rounded, it's about two and a half percent real to forty and it's a bit above two and a half. It's not right.

Did I mentioned quantas in my title? I can't do math in front of people. It's really so six times four is two four times where he's another twenty. Um, I liked a round teach Cliff a little bit, a little bit. But but but but I but I could take the derivative of it in a heartbeat. Um. The it's fun to have kids who are ten and eleven, by the way, because I'm trying to teach them division. Um,

it's it's it's very humbling. Your kids are completely unimpressed that you're a quant of any kind of Like Dad, you're doing it wrong. That's not how I see the way they do it now. It is so different than the way we learned. I know. And the first thing I have to do is go on the web and figure out how they're teaching it now. Well, everything's gonn wrong to you and I but I gotta really it's like it's it's a lot of work. I got I'm learning relearning division. But that's not the Let me get

back to it. It's two and a percent reel on rough the other numbers are all around it too, so we don't have forget this exact anyway. Long term, again rounding you made about five percent reel on sixty for about a hundred years, so we would forcus you make half the real return as you've made historically. Stocks are priced more expensively again Schiller P or dividend yield plus expected growth, whatever model you like, call it roughly about more expensive than about of the last hundred years at

the time. Bonds this shocks some people are really not worse than stocks. They are more expensive than about nine at the time. The difference teen stocks and bonds. Bonds are bumping against zero, so they're more dramatic looking, but that difference in in spread is roughly average. But they're both really low. They usually don't happen at the same time. Stinks another bad being bad stinks to really and now

I'm not being quantitative at all, really really stinks. We find forty portfolio is approximately as bad as it's ever been perspectively two and a half as bad as it's And by the way, people, the funny thing is with the math of this. People assume zero is as low as you can go. But if you pay attention you'll you'll know you can actually have negative no, not even

real returns, negative nominal resent realized returns. Anything can happen even over longer periods, and people, many people think, um, I agree with that. If we ever had negative expected returns, that would be I'd be willing to use the word bubble there. We talked about that earlier because negative expect real returns were negative expected real returns very very hard for me to imagine a world where people would rationally on stocks and bonds, say, and we've seen some negative

nominal returns on bonds. Those are places that have convenience yield, meaning keep my money protected. Or maybe they're worried about deflation and they're actually expecting positive real returns because you know, if deflation comes in a small negative nominal negative one percent of inflations minus two percent, that's still one percent

better than inflation. But if you on your diversified broadly stocks and bonds portfolio, if instead of two and a half, which is disastrous versus history, we're expecting zero negative, I'd have to start, Uh there, I'd be screaming bubble here, I'm I'm screaming more expensive than history. Lower your expectations, which isn't the same as a bubble. Let me shift gears a little bit about with you and talk about um the small cap premium. I love the title of

your paper. We got channel channeling Seinfeld a little bit. It's real and it's spectacular on the small firm effect. That was my blog entry. The title was even worse. What was the blog That was the blog entry title. The title of the paper was size Matters if you control your junk. It was a bit of a double end, which I've been apologizing for though. Well, well, the theme of the paper was people sort of downplay. So first

let's back up. The small cap premium is by small cap stocks over time, and you'll outperform big cap stocks. Now that seems some people have been questioning that as that shrunk. But your your paper says, well, there's so much bad stocks. The SMB five, you know, get the same sort of junk filtering into that. So now when we look at the two thousand small cap stock, pull out the junkie lower quality stocks, and what do you

have left? You're exactly right. You needed to do do the research and let me take people a little bit back. This is was the first crack in the armor of the famous capital asset pricing model. Back in the and efficient markets if you will UM back in the early eighties, a guy named Ralph Bonds, who was a former student, also found the first version that I know of. There might have been others of the small firm effect that after adjusting for the famous cap EM beta, small stocks

beat large stocks, and you know, why should that be? Uh? And they've been all kinds of theories about this. CAPEM tries to adjust for that with beta. Some of the early studies said, maybe we're measuring risks wrong. Maybe the beta is really higher. That got you a little bit, not much, Maybe it's a liquidity premium. There are stories, but basically there's one thing. I don't want to confuse it with small value stocks. Buy cheap small stocks, at

least in the data that's unassailable. UM. You know, going forward, as always, will history repeat? I believe it will there, but I can't prove it. You mentioned David Booth Dimensional Funds, which now runs if anything, that's that's that's the core premise of their's and I'm I am certainly believer in that. The small firm effect, though, is exactly what it says it doesn't buy small cheap, it buys all small stocks.

Uh and should they beat large stocks. Well, that's far weaker than many of the other so called anomalies, the findings of value momentum, a few others in in in in the finance literature. It's kind of the weak sibling to those immediately went on a bad fifteen twenty year run after it was discovered. Has come back somewhat since then, but if you look at it through time, has other quirks. Almost all happens in January. That's not necessarily terrible, but

it's a little weird. Confidence a little bit, even if you don't really understand why. Uh and in general wasn't nearly as strong as the other as the other fall value, as small value certainly, as as as momentum, small momentum, whatever you want to do. Most of the rest of empirical finance was better than the small firm effect. It was a weak and people have been losing faith in it. We discovered irrelatively recent research by US and others totally

separate from this, looks at quality investing. This son Warren Buffett figured out thirty or forty years ago. It took us. Took us a little while to get to it. But what's what's this war is onto something? Well, we do it much geekier than he does, of course, and we're doing in a diversified way. He does it by picking the right quality, and he also cares about value and other things. But what's the quality stock? It's anything that you in not just theory, but in in intuition, anything

that makes sense that you pay more for. Why would you pay more for stock? Well, if it's more profitable, if those profits are growing faster, and and you believe by the way this will continue, and you can show that that a profitable company tends to be profitable next quarter or whatnot, you should pay more for these. You should pay more for a lower risk company. All else equal if it makes as moch money now son as they don't of course, but if it makes as much money.

We love low risk. I'll pay a little bit more if I have less risk for the same for the same money. And finally, if they're able to pay you a bigger dividend, while everything else is equal, growing the same same profitability, same same risk, why not more more dividends are good? These are all things that we call quality.

We have a separate work and we're not the only ones to look at this, but we we of course love our version that looks at these things and goes all of these things seem to have an unexplained out performance. And you can get in your old debate as this risk is it is it inefficient markets? But we think it's very statistically valid. If you go look at other countries, it shows up again and again and again high quality

beats low quality. Then we we decided to take a look at how does what does this mean for small and we noticed something that kind of jumped out at us. The small universe was very low quality, what we often called junkie. Something you fire universe to small capitalized. There are high quality small cap, but it had far more junk in it. And you said this early here um then as a percentage of the index than the large

cap And I think it's fairly intuitive. But but it turns out that small was being seriously hurt if you believe. Not everyone believes it, but we believe it strongly. That high quality has and will win over over the past. High profitability is my favorite of them. That profitable firms uh will outperform for either risk or inefficient market reasons. Go look at small firms. You're shorting that effect. You're

betting against it. Small firms are less profitable, far more junkie unprofitable firms, so you're betting against something that you think works. One thing that academics and quant and applied quants are pretty good at doing is saying, what if we remove that, What if we bet on small, but we make it so their average quality. Take what we know that's good, remove what we know is bad, and don't cheat. Don't only buy quality, but make it just

average quality. So so small on net doesn't have a tilt towards high quality or junk, so it's just neutral on It turns out we've restored the small farm effect. Small crushes large does really well and about comparable to the value and momentum effects. We've restored it, we think to kind of equal standing with some of the other major findings in finance. We've also confused everyone, including ourselves, because we don't have a great economic story for this.

It is too big of a premium. I don't yet, I like I'd like to start with gene Fama stories with efficient market stories and only be willing to go to inefficient markets if I fail, and small winning is one of the ones. Some people find it very intuitive, But when you ask them, why is it intuitive? Well, they're less liquid? Well then how come the higher quality ones when more consistently they're they're a little bit more liquid um. It's hard to come up with a great

economic story why why why small winds value? I think it's quite easy. Whether you like risk or inefficiency momentum, you can tell pretty simple stories about people under reacting information small. If two small companies merge, do they suddenly go away up in price because now they're a big company and have a lower cost of capital, lower expect to return and a higher price. They don't seem to do that. They're weird things that go on. Why small works we have not helped, but we have helped for

store to. It's kind of so you don't have you don't have an you don't have a narrative that explains the data as to why small minus junk trounce is large. There's not a narrow I really hate to say no, but I gotta go with not yet, let me be more optimistic and yet and it's nothing as simple as well. Big caps run into the law of big numbers. Small has huge head room and there's a lot of place for them to go as more and more people discover them,

find them, and they grow and side Verry. That could absolutely be the answer, but that's a very inefficient With any other issues, you can say no, no, no, no on after you get that could be the answer. You jumped on the credit a little too fast because I said, I like to start to try to figure out a risk story in a markets stories are quite simple to come up with. Why people people are people under But

these these these things they don't appreciate the upside. Inefficient market stories which I'm not quite willing to go there yet, but those are easy to come up with. Um they these are neglected people just don't pay as much attention, no Wall Street coverage whatsoever. They're unknown. There are a host of stories like that. I like to get there after I've exhausted all possibilities. I don't feel we have

I have not found yet. This is the part A risk based story, a rational story, all those stories, when you say they grow faster, why don't the market recognize that? Barry market? If an efficient market the market should recognize exactly what you said, that it has upside and large cap does. There's not a lot of coverage. Remember, institutions have certain rules about what they can and can't buy. There's a hundred little stories. I'm completely I bet you

know all of that. I am completely with you. And and at this point I have to say my money would be on some version of that being right because I haven't come up with the others. But they are in the inefficient markets irrationality camp. So so this conversation about small cap and value, UM, small value could be risk Let me throw that in because value can be very risky. But go on, But you you triggered two

things I want to not forget to ask you. One is about smart beta and factor investing, and the second is what happens when you take a quantitative approach to warn Buffett. So where do you want to go with that? Let me start with with smart beta. UM. You and I talked about hedge funds earlier, and I gave you a schizophrenic answer. I'm gonna give you another one. UM. I am both a fan of smart beta and its most famous version, fundamental indexing. UH and UM A skeptic

in a in a very narrow sense. Now before before you get into too much detail, I know you're friendly with Rob. Are not right. We're also friendly with And he was here not too long ago. Some people have called him the father of fundamental indexing. Um. I don't know if that's overstating it'll little bit um. I don't think it's overstating it. I I do think and and and and Rob's an honest guy. He'll he'll tell you this. People were doing some fundamental indusseries. Uh, there's some people

of Goldman sacks. But the father of something is an early adapter who's the one most responsible for its popularity by far. And my disagreements with Rob and we we are friends, and we are co authors, have been intellectual, never about whether they would outperform Um. I believe, and I think the math is more of a proof than a belief. I'll go far on this one. That fundamental indexing versus the market is a rather clear, straightforward tilt

towards value. If you build a fundament. Hold on, let me stop you there, because I want to break this down so so people who are listening to understand what this is. You take the SMP five hundred. It's a market capitalization waiting, which Rob points out and Jim O'Shaughnessy also points out that at the end of a cycle, everybody piles in and you end up with this wildly disproportion in it handful of stocks um attracting all the assets in the SMP five hundred. We saw it, we

saw it again um in oh seven oh eight. But towards the end of that cycle, half a dozen to a dozen stocks are driving the vast majority of the gains in the index. And so when that and some prices are exceptionally high against fundamental summer very low, and so this old they just in the down cycle, they really the big ones end up really getting punished. And the first version that we knew that there was an issue here was if you just take the SMP five

hundred and equal weight at all of them. Now there are reasons to say, why do I have Apple and some tiny little company at the same weight, But it tends to at certain points to outperform. So that's not what we're talking about. We're talking about waiting companies instead of based on their capitalization. You mentioned these earlier, as you mentioned uh dividends, earnings, growth, sales, growth, book value. There's a whole bunch of fundamental facts. Let me give

you the example. First. I respect the heck out of both Rob and Jim. Um. They are a little bit more on that on that we talked earlier about the Schiller Farmer spectrum of efficient markets to inefficient. Maybe they're just more courageous than me. I'm in the muddy middle. They're a little bit more towards Schiller in their explanations. I'm always I think bubbles and insanity like you talked about do happen, just more rarely than probably those guys do.

And I'm more willing to entertain efficient market risk based. Maybe it's just in my DNA and I'm still scared of my my professor. Um, but that wouldn't fature. You're right, if if fundam if a fundamental index. Let's make it simple and just use one measure. Earnings is formed waiting things by earnings. I had a friend, Bob Jones, who was doing this back in the eighties at Goldman sachs Um. It turns out that if you do the math and you compare and index weighted by earnings to one weighted

by market cap. It's exactly not similar, but exactly the same as starting with a market cap and tilting with a precise, simple formula towards a low price to earning stocks and away from high price to earning stocks. So it's it's away from momentum and towards value. Towards Yeah, that's more accurate. Momentum will vary some sometimes, so it's

away from growth towards value. What I think Rob has come up with is a great way to explain value investing in a different way, explaining it as ignoring prices and waiting by fundamentals, but you get to the exact same place. What I don't think and Rob knows this, we've argued about, we've debated it at the Q Group a quantitative of finance gathering is I think he's come up with a great way to explain in market value investing.

But but that is different than saying he's come up with something that we didn't know about before we did know about value investing. If he's brought more people into the fold, if if, if on net this makes markets better, because I think more people did value investing, some of the efficacy would go away like it does for any strategy, but prices would be a little more accurate. These are all things, but I don't think it was as new. My title, as you know for this was was it

fundamental indexing? Not uh not not indexing, not new, still awesome? That was a smart beta smart bank, not beta, not new, still awesome. And why is it not new? Because we knew about value forever? You gave the example in the

tech bubble of a few stocks driving everything. You know what if you tilted towards towards low price to book to earn, low price to book, low price earnings, low price to sales, you avoided the exact same stocks, and you overweighed all the same jump that that a fundamental index or rob or not would be underweighting. Get to the same place. He came up with a great way to explain value investing as being indifferent to price. It is a very specific value tilt um. So it's it's wonderful,

it's just less new. The paper he put out that I found endlessly amusing, if you can say that about a white paper, was that you could take any of these fundamental metrics Devan, and you'll earnings, growth, sales, growth and either the that metric or the inverse of that metric beats capitalization, meaning we're gonna take the and wait this by the fastest growing earnings or inverted and and reverse it. As long as it's essentially what that says is, as long as it's not market gap, it's going to

be better what happens there. Um And I don't remember the specific measures e e use, but if you get anything close to an equal weighted portfolio and to a random or an equal way to portfolios, why you named after Malkiel's monkeys, Because that's the ultimate, uh you know statement about a random portfolio. If you get any kind of random portfolio, it ends up tilting towards small value. See rob phrases it in terms of say that again, if you take a random portfolio diversified enough that you

can't randomly pick just tech stocks. Um, if you take a random portfolio, it starts to look a lot like an equal weighted portfolio. Both of those random or equal weight will on average look small because there are a lot more, and we'll look cheap because those guys were overpriced or expensive because of rational reasons. I'll try to

not to not to fight that battle here. But those guys who are are very expensive are bigger market caps, so they're to make up the total market cap to have to be more so if you get that random portfolio, it's a fun finding, but it really is saying something. And again I this one. I'm not saying I'm not kind of lacking. There's great originality in this finding, but we kind of knew it. Again, Um, we were not beta, meaning it's not the market. We doubt there's beta going on.

I get, I doubt this is tremendous. If you randomly select the portfolio probably goes the other way. You're probably a litt high beta and it's not new because we knew this for a lot. You're saying this was no great way to show it. It's awesome again, Yes, but if you pick a random portfolio, you will be smaller and cheaper than than than than the market. Um doesn't mean you should pick a random portfolio. Once you think small and cheap work, you might want to be a

little more systematic about it than throwing darts. Rob's way, our way, other d phase ways, other ways I would say are better than random, right, but random will get you a little towards small and which is a fun finding. It absolutely is. Let's take, um, keep trying to buy Rob's monkeys, he won't sell them. Um, you could go and pick up monkeys pretty much anywhere these days. Any

monkey will work to Maryland special monkeys. No, he just takes, you know, just just he takes discarded traders and and puts them. Uh. And I still work in this field. I'm not gonna laugh at that. On so do I. But on I care less than um. So let's talk about the Uh, let's talk about the buffet. A quantitative approach to Warren Buffett, which I thought was um white, it's charming, the right word for a white paper. We'll take charming. Um. This was written by colleagues of mine,

David Cabilla, lass A Peterson and Andrea Frasini. Um. So I'm just gonna take credit for their work or blame because I'm the one. I'm the one here. Um, they did a really fun thing. Um. They And by the way, let me say beforehand, in case we don't get to it, we ended up with we We had tremendous, incredible respect for his investing skill beforehand, and we ended up there afterwards Um, when we say, and we do a couple of times, and I'm gonna guess he wouldn't agree with this.

I have not spoken to a man personally about it. We say things like we explain his alpha, that is saying that after thirty forty years, we've seen that these are factor tilts. He did it thirty four years ago, thirty forty years ago. He's stuck with it through incredibly big ups and downs. He has not always made people were like nineties and seventies, he suffered greatly in the

bear market. He's he's had his ups and downs. Um, But what they did was they took some of admittedly the standard things people like us look at the same things you and I have been talking about. Value. Yes, not surprisingly, he has a tilt towards systematic value. Doesn't mean he's a quant following the strategy. It just means his returns tend to correlate, tend to move when when

cheap beats expensive, it's a better time for Buffett. A time like when expensive crushes cheap, all I'll see equal your guests would be not as good a time for Buffett. He had no waiting on momentum. Not surprising How could a man who's holding period preferred holding period is forever, an actual holding period is very very strong, very very long, really have a loading on momentum. You need to rebalance to load on momentum. If he had, when we would

have doubted our data. He also loaded, though interestingly, on the major measures for quality, things like profitable companies and low risk companies. And he but he talks about that all the time. Is I buy this? Is this as if I'm buying a company that's private, unaware of what here's Here's it accurate but very nice, but still I think not not overnice, just just accurately, nice way to describe it. He does what he says he does, and

that's what our guys verified. Now that might seem like a small thing, but do you know how many times you go look and find someone doesn't do what they say they do. He systematically, and he's not following a quant system, but he systematically with a great nice fit long term. Looks like someone looking for cheap, profitable, low risk stocks. And then here's something that I do believe, we just know he does. He applies a modest amount of leverage to it. If you buy low risk stocks

you tend to and this is something we believe. So let's let's talk about let's let's pivot on this to your discussion on risk party where right. Well, that's why I wanted to bring it up, because most people talk about allocation in terms of asset class. When we talk about risk parity, we're really talking about allocation in terms

of different types of risk. And you have said, you know, and I'll give you an opportunity to caveat that huge judiciously used with the right assets, used at the right time. A little bit of leverage is not a terrible thing. Yeah. Um And and here you guys can all think I'm wimpy for all the caveats, but you've got to be very careful. I would never want to be quoted. It's just saying leverage is a good thing because you go take a concentrated bet that's already scary, and lever you've

made it super scary. You go lever something that's not very liquid. Um with leverage that has a shorter time arise and shorter term long term capital. That's the postal child for that. Yeah, it's they've certainly become that. Um I I we call that the death combination to bid melodramatic uh, and it can happen, you know if anyone does. No one has magic leveraging a a illiquid asset with with leverage have to pay back tomorrow. That's that's extremely dangerous.

And as we saw in the last crisis, UM, borrowing long and funding it short is a meaning long term obligations that are funded with short term cash flow is a is a terrible combination. It always has been, and there's always the lower and it always happens again. Now here's where we think leverage can be useful. UM and you I, you and I just talked about the case of Warren Buffett where he has low risk, low BITA stocks, so he think that those do tend to outperform their

risk over time. There has been a strong results for very long periods that lower stocks do better than they should. But that doesn't mean they actually do better than high risk stocks. They're supposed to lose, and they refuse to lose. If a lower stock keeps up with a high risk stock just keeps up, you go, wow, that's not supposed to happen. The risk premium if if correct correct. Having said that, if you don't apply some leverage. Buffett actually

went about performed. He would have kept up at low risk. And I don't think he was too interested in He's not looking for risk adjusted return. He wanted to eat them. People always say you can't eat risk adjusted returns. With some mild leverage, you can. You can go too far. One No Warren buffets one point six to one. Pretty good idea and a guy who's also sitting with forty billion dollars of cash and no borrowed money, and the bullet proof and the way he structured his business exactly,

there's a form of alpha to that. We say he's stuck with things through thick and thin. He that requires incredible mental fortitude. Even with a great structure. Anyone can cave on their own just from panic. He didn't do that, but he also structured it so no one else could make him throw in the towel. So now let's talk about something, because you're you're making me think of things we didn't get. Sorry, I'm I'm I'm I'm a tangent. No no, no, I love these digressions because you're making

me think of other stuff we didn't get to. The August. Oh, seven, avoid I was hoping to run out the clock line. We could, we could do something. So so so let me set this up in a way that I couldn't done the radio because it was too long. So oh seven. So in Juno seven we have the bear Stones hedge fund collapse. A lot of quant funds are crunching the same numbers. I don't say they're looking at these same things, but a lot of the same data everybody looks at.

And so you ended up with similar positions across a lot of different quand funds. You actually talk about this in the book The Quants to some some degree. And so August oh seven is a debacle, and your fund gets she lacked. You're down thirteen percent in a month, in a week, in a week, I'm sorry, in a week down So down thirteen percent in a week? What the you know? The number is better than I don't even remember the precise number, but I do remember the

timeframe thirty and by the way, you wanted to the number. No, no, I believe you. I was not thirty nine billion across this is this You were smaller fund ten years ago, and this was right in the middle of the financial crisis. You started out at thirty nine billion and you ended at seventeen billion. Now that's got to be a painful thing most But before before you answer, you and you and I are two walking tangents, So so before you answer, I just want soon an't have to stand. This has

a happy ending. Stuck with the model and you recovered and then some it actually turned out to be long term a winner. But what was it like in that month when you're just watching assets get destroyed? If you'll permit me, I want to back up one section on on your numbers sound exactly right on on the shrinkage of our firm, which is another sign I told you I have a great research stuff. With that said, one thing that I should have made clear much earlier is

and I think you know this barriers. We're not, uh by any means only a hedge fund. That's a minority of what we do. A lot of what we do is long only. So a fair amount of that came from just market shrinking. You know, every asset manager shrunk by a lot. And we had a very rough time we had. That was a couple of months the whole market and then over the whole financial crisis. It was more than draw down. We actually didn't lose a ton of clients. We we we we lost some, but mostly

we watched our assets shrink with the markets. But none of that makes your figures for August wrong. This was a harrowing. Maybe it wasn't near death, but it felt near death. Hold on a second, you said, and I love giving you your own quotes. Um, I'm looking for your exact quote. We were looking the grim reaper in the face. Well, I mean a particular person. I'm friendly. I'm friends with Ken Griffin Um, who is one of the head fund managers. I I believe in. I think

this guy is a pretty amazing guy. Uh run citi um he Um is famous for being a smart investor. When something's very distressed and facing doom, he goes and buys it very cheaply. Ken called me near the negative of this, and my assistant just goes Ken Griffins on the line and um, I think, I actually wrote, I could see the valkyries coming, I could feel um and in fact, he just wanted to shoot. And and I literally said, you know, I think we're actually pretty stable here.

I don't think we're but but if Ken thinks were dying. We must be dying. Um. So if you were an sharing you would you would say, if Ken thinks were dying, we're gonna be okay, Well I go to stay. I will be honest. For most people, I am a contrarian. Which can I start to think, maybe he knows something I don't know. Um, maybe he knows it's worse than I think. But so let's let's let's roll roll back what happened. You are exactly right. I do not deny

for a second that that quants do related things. Everyone has their own twist on it, um how to measure it better. Some some parts of what we do or others do are completely different than others. But by and large, the two of the key things in all of quantitative management I've talked about with you for a few hours our value and momentum investing. You can have every twist in you in the world you want. We think value

works better if you don't make an industry bed. For instance, if you buy the cheap and sell the expensive within every industry, within each each group. It can work a little bit for industries, but it is stronger risk adjusted. Certainly you're that industry is harder to compare one tiny example. Everyone has a twist, is my only example, but they're correlated. If you're if you're if you're running a quant shop, and let's do a hedge fund not to beat the benchmark.

You're long cheap with good momentum, and you short expensive with bad momentum. Again, the models do other things than that. But let's say that's it, and I'm doing the same, And we've worked for ten years separately and we've done tweaks, and we both think our models better than the other guy and better than they were ten years ago. That might or might it's not gonna be true for both of us, but we both can be better than ten years ago, and one of us is in reality better.

It's not gonna matter that the in the in the in the ten days value and momentum both get utterly obliterated. We both have a common theme that ven diagram is gonna have a huge overlap and it's gonna be the most extreme in that period. Now I can speak for ourselves, we were not I think maybe we were um, but

I don't think we were naive about this. Going into that time, we knew a ton of more people were doing quants than when we started fifteen we started in the mid nineties, two thousands, twelve years later, we're a ton more people. We're doing it um. We measure we wrote a paper on this during the act bubble and we still do it. We measure the longs verse of shorts. How cheap are they? They're always a little bit cheaper. Remember, values a big part of our model. So if they

weren't cheaper, we're just doing it wrong. So we hope they're cheaper or else, or else we're adding it up wrong. You know, if if if cheapest part of your model, a big part of your model, and what you're long is not cheaper than what you're short, you that's backwards. Your your math is off. So but but they're not always the same amount cheaper at the at the peak,

that spread can vary dramatic. Flip it over to talk about how much more expensive the expensive stocks are, as you can imagine, at the peak of the tech bubble was the most that numbers ever been. The expensive stocks were ridiculously way more than going into August of of oh seven, and we were thinking about this, We're worried it was crowded. This number was about its long term average. Really yeah, which now there Now there are a lot more people doing quant but someone is on the other side.

This is a question we try to ask ourselves all the time. Um, my colleague Aunt Dilman, and I are going to write a paper this with the title Who's on the other side. Anytime you do a strategy, a trade, whatever you do, you should say, who's money am I taking? And if you don't have a good answer, you probably shouldn't be doing it. We think who's the sucker at the exactly if it's not you, it's more if you can't spot after everyone has a different version after half

an hour. If you can't spot the spot the soccer, it's you, it's the it's the trading version, the strategy version of that. So what we said to ourselves is this has not been arbitraged away. This is not a ton of capital that has made cheap stocks no longer very cheap, but it compressed that whole spectrum. And here's where I think, you know, I think we went further than most and even worrying about it. A lot of people were pretty blase about it, but we didn't get

it right. We still had a disaster. So what happened is if you had asked me before August of oh seven, I would have thought that a not a precondition, but but two for something to crash, it was far more likely to crash it was expensive, and this was not expensive, it turns out, and this is really quite obvious. I just thought it was less likely, not impossible, that if everyone tries to sell on the same day, it doesn't matter if it's expensive or cheap. It was really just

the crowded trade unwind it. And my version of what happened in July and August of oh seven it's very similar to what you said. But but I think we've actually tracked and we still don't know the actual firm that began the selling. We joked home patient zero um, but it was. But that's a great metaphor because a virus. It was the first kind of echoing. The first adimbiration of the of the of the financial crisis was in July,

following that Bear Stern stuff. In July, credit got really pummeled and a lot of particular hedge funds had added quant during a great five year run, and this is I think dangerous. They weren't quants in their in their DNA, they added it. They they saw it was doing well. They hired a guy that gave him some capital and said, trying not to message. And then this is hard literally still hard to prove. But what we think happened is credit got slammed in July, and a lot of these

people said, we just got a lower risk. We weren't particularly against quant, we just got a lower risk. And all try to lower everything. They do it once and we're very common in their quant traits. And then like like all these stories, Um, it just got rolling. And this was much more. This was not a bear market for quant. This was closer to a QUANT flash crash. It was no one's described it that way. I grew up it in the car on the way here. But the longer than the flash crash. But it was three

weeks instead of a day. But it's not. It was a brutal three weeks. Yeah, the and roughly the first half of that was down on the next half of it was making two thirds of it back. Um, and you are right. We did stick with what we do. Which is a question I have to ask you, just from a um a judicial temperament question is how do you live with that as the c I O. Everyone at my firm is laughing here because, um, I wish

this was not public information. Uh. But the Wall Street Journal ran a couple of stories, and the Quant Book talked about this. Uh. By the way, that Quant book is one of my favorite books. It's fent. I am my major beef for that book. Is they they tell him he reports I was a fat kid in high school. I'm a fat guy. Now it's not fair. I was not I was. This is why is he assuming that that's a tough yellow journalism. Um, but it's ill sea I had. I had several friends from high school called

me up and go, yeah you chubby now? But you were okay about um? But um, you know to your point, Uh, this is a little embarrassing. But I might have punched my computer screen a couple of times and and had it visible and had the Walster Journal actually write about it. So you just smashed yeah, I and and either I throw a lousy punch or view sonic. Really I should have been a commercial for them, because I did it

with my best cross and did no damage to it. Um. The journal, I'm sorry for the segue, but the journal I wrote a letter to the journal, thinking they would never publish it. I love the Walster Journal, but they're not known for their hilarity. And I wrote what I thought was a humorous letter doesn't translate into type area. But but I forgot that as the subject of a story, they they feel and they have great journalistic integrity. I think they feel a h that they should publish your response.

But I wrote what I thought was a whimsical response that had no chance of being published. I wrote, your reporter wrote that on several occasions, on bad days, I punched the computer. Um. I can't disagree with the facts, but he left out a very important thing on each of those days. The monitor deserved it. The next day it's in the journal, and I swear to God didn't. What was the response to that, Because people like that, Um, human foibles are okay, but being able to laugh at

yourself is okay too. And I do find myself ridiculous at times. Uh, you met my wife. There's no one more ridiculous than me. And all right, spouses and children have no respect for you, no matter who you are. That's why you get dogs dogs. You know. The line I love is we we hope to become the person

dogs think, Oh that's awesome. Have a Winston Churchill line that he said he prefers pigs because as pets, because dogs look up to your cats look down to your pigs looking straight in the eye, which I don't know if that's actually true. It's a great. So let me bring this back. So you're you're running thirty billion dollars or so, the market is just we're getting Actually do you take that home at night? How do you keep

faith with your quant world was miserable. One thing left out occasionally is this was after a bad month and before the GFC, but over the full painful period for quants, the SMP was actually up slightly. We didn't rattle the world. The world had nothing to do. We lost I like to say we lost money all on our own. Our shorts went up and our longs went down. But the market was it was it. We were about to have a bad neutral funds Well, I'd hate to try to sell us two clients at the time. Is no, it's

okay because because we are market neutral. But I would prefer it to happening there then in a crash, because it does fit the spare it so emotionally, emotionally, are you taking this home at night? Other than the occasional view sonic, I'll try to be very introspective about this. I'm really bad at internalizing something. I preach that this is a statistical process in a fat tailed world. Stuff will happen, it will work long term. UM. I I

do get emotional because I wanted to work. UM. And it's frustrated to stare at red long absolutely and you get something UM that that I and others have called time dilation. We're trying to be physicists here, but what feels like a like a very long time is actually not. You know, you stare at it for a whole day, which we're not supposed to do by the way you're supposed to Um. You know, it's a statistical thing you check a few times, but staring at it every day

is not old day. It's not productive. You stare at something old day, you'll feel like you just went through every up and down since since since the flood. Um. But what I've actually and I and my firm are actually pretty good at is not letting our emotions affect our investment process. So so stuck with the models, even though it might have been really churning you and the Kishkas. It was really bothering. The Kishka's were a flame. But uh,

we did a few things. Now, when something's not working I think of the time, the right thing to do is nothing. Maybe some risk control if the bets too big, but but almost nothing. Don't just do something, sit there exactly, and that's very often, uh, the right thing to do. Far more often. I think you want to keep your mind, if not open slightly, Ajar. You can take that a few different ways too. You know, has the world really changed? It almost never does when they say it does. But

could happen? Is there some reason our process won't work going forward? Um? And we try every time there's a bad result, and that that was the ultimate example, but every time we've had you know, we've done this for almost twenty years, including Goldman Sax. Life's been net good to us. But if it's never we're not better than Warren Buffett, and he's had bad times. Um So so

I sense that you're good and emotionally compartmentalizing. Yeah, people, the the volet aility and the you know, you're the natural human reaction to panic would get greedy. I'm I wish I were good at having it not get to me the same way I have. I and my firm have gotten very good and always have been pretty pretty darn good at not letting an effect what we actually do.

If I like to put it this way, Um, we trade on what we think or at least partially, somehoat risk and we're still in the farmer camp partially but somewhat. Behavioral biases that desire to run away and take off a process you know is a good process is a behavioral bias. It's what is what is uh a run on the strategy where people too many people try to get out? That makes it better going forward. If you're a believer, you've been right all along. It was a

crowded trade. Now it's and I'll tell you we took too much comfort. And I mentioned it earlier that it wasn't expensive in the beginning. It's about the fifties percentage by the NAT or by the low point. It wasentie attractive and you love that intellectually. Doesn't mean you're Kishkas are not battling each other. I I'm gonna say that more often. Um, but we've gotten very good at at sticking with with things while keeping that mind a jar

sounds a little crazy. I'm gonna have to come up with a not quite open that mean that's too willy nilly, that's like, yeah, maybe we're wrong. You're you're open to the possibility that everything you're doing is wrong while knowing mathematically it's unlikely. So you should look at it an open mind, expecting not to find anything. But if you do, if you you know, for instance, it are certain strategy strategy that are about speed. Um. They're famous ones earning

surprise when earnings announcements come out. Maybe that still has a little bit of efficacy, but nowhere near what it once had because the world has not much faster. Um. So if you see an actual reason why your strategy shouldn't work anymore. I'm not saying you should keep doing what you've done in the past forever. But if you see no reason why what you've done in the past, what you think has worked for a hundred years in fifty different places, should not continue to work. You should

not let your term results dissuade you. And we have gotten very very good, and I think we've always I've always been good. But even better over time and learning that lesson. A few times I've ever violated that, and those stories I'll take to the grave. I have regretted anytime you've violated when you know the math backs up with you haven't haven't done it in more than a decade. But a few times, you know, you don't say I'm violating this. You convince yourself, Well, this is the exception

to convince yourself it's the right thing. You get data on it, you change your model, you tweak it. The whole world is fa And by the way, this is not just quants. How many how many non quants have a strong investment thesis that will turn out to be right, but occasionally cave on it when it gets too painful.

How how often do we hear about a fun blowing up and find out, gee, you know, if they weren't either using borrowed money or so leverage or what have you, if they just stuck it out another six months, the uh MF Global, even the thing that blew up MF global a year later, that would have been a great

that's that's exactly right. Things like whether leverage is useful, how much leverage is safe, how much volatility you've and take getting those lines of credit lined up right if you if you do that, how much you can take. Are all about surviving the short term. At no point should you do a strategy. And this is art not science.

I'm not claiming that I have a perfect quant model for this, but you should the perfect strategy that you can't stick with, whether for real reasons that your creditors say you're done or emotional reasons that that that we all have a breaking just can't just can't, can't take it. The great strategy you can stick with, and this is obvious, but I think really important. The great strategy you can't stick with is obviously vastly inferior to the very good

strategy you can stick with. Suboptimal beats optimal if you can't run with options. This comes up with investment advisors a lot um and and and this is something you know much more about than I am, and I do um. I think they have a huge role in helping structure a portfolio, but I think the single most important thing they do is make sure people stick with their plan

through the long term. We we talked about that in the office all the time, that we well like to pretend that we're investment managers, but were really behavioral counselors. And a lot of that is before anybody puts a dime to work. Hey, this is a great strategy. But when this is down, are you gonna? Uh? The old joke is you know your your portfolio is getting killed? How how are you sleeping? I sleep like a baby? Really you you're down? Well? I wake up every hour,

went myself and cry for mommy? Is is that that that cliche has never worked for that exact reason? Baby sleep lousy? Yeah? No, it's a terrible But now innocent is what they're going for? Um, but go on? Sorry, so no, but it's that thing is is It's funny because the more I'm listening to you, the more I'm thinking you are precisely, precisely halfway between farm and which

is not a bad place too. You know, if you're gonna pick an island to live on, that's a damn good I. Um, you know I'd signed for that in a heartbeat. Quality wise, I think philosophy wise, I really am and have been for a long long time. I And it all comes back to thinking markets are not perfect, but they're they're harder to beat than people think. There's the Schiller's the first part faum is the second part um taking risk and and again are mixed with science. Uh.

Taking risk gets paid off over time. Taking too much risk and you won't live to see to see the ending and then the things. Uh. You know, it's very funny Fama Schiller. UH. Fama would probably believe in value more than momentum, but the firm he works with, d f A uses some momentum UH in their in their in their process. We would use more. I'm not saying there aren't differences. Momentum is more of an inefficient um market story, but they try to avoid shorting momentum. And

I won't get into the the geeky side. So even there, we're a point on a spectrum difference. We're not a sea change. One joke I had, I did a little tv UM where I had Fama and Schiller come on after their Nobel Prize separately. I wasn't trying to create a steel cage match um, but uh, and I pointed out to both of them, and I think they both I think they both agreed with this, that they both put on pretty similar portfolios, mostly value tilts a momentum

to what they do. Again, probably more momentum for Shiller than Fama. Uh more market timing for Siller than Fama, but they would interpret it as working for radically different reasons. So it's kind of like, remember, me and Rob are not um fundamental in the mixing wins. He thinks it's brand new. I think it's the value effect. But we get to the same place, just just take different routes. Cliff, You've been so generous with your time, and I know your your staff is looking to take you to your

next appointment. I want to thank important. Um, well, you are important, You're You're Let me blow a little smoke your way. It's not just that fortune of Forbes or whoever it was called, your hedge fund very influential. You consistently publish deeply thoughtful white papers. Forget the fact that they regularly win awards Best Paper with you this, and that you are part of the philosophical and financial debate

that is moving the world to finance forward. And the joke in physics we you and I talked about about science earlier, there's a famous joke I forgot who I'm I'm I'm stealing this from who said physics advances one funeral at a time. It turns out finance doesn't have to advance that way. It advances one white paper at a time, as long as it's written in an intelligent, coaching and persuasive way that enough people say, hey, this guy is really impacting finance, and um, that's a smoke

fellow your way. Very nice to you to say, Um, I appreciate that. I also punched computers when we lose, and I have a face for radio, but I will take the compliment same same. Here I've been speaking with Clifford ass Neest. He is the founder and c i O of a q r UM. If you enjoy these sort of conversations, you can look up an Inch or down an Inch on iTunes and see all of the previous UH Masters in Business series. Cliff, thank you so much for spending so much time. Thank you was great.

This is ay Rehults. You've been listening to Masters in Business on Bloomberg Radio.