Top 5 of 2024: #3: Cliff Asness - EP.385

We're counting down the top 5 episodes of 2024. Coming in at number three is Episode 385 with the irrepressible Cliff Asness from AQR. Cliff is part brilliant quant and part standup comic. That combination always makes for an entertaining conversation, chockfull of research-backed insights. Head of Business Development Job Posting https://www.capitalallocators.com/about/#openings Learn More Follow Capital Allocators at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (https://thepodcastconsultant.com https://thepodcastconsultant.com/)

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Ted Seides?

  We're counting down the top five episodes of 2024 and are down to the top three. Coming in at number three is episode 385 with the irrepressible Cliff Asness from AQR. Cliff is part brilliant quant and part stand-up comic. That combination always makes for an entertaining conversation chock full of research-backed insights. Please enjoy this replay of my conversation with Cliff Asness.

• 0:30Speaker 01

  Before we get going, we have some exciting news at Capital Allocators. We're hiring. We are looking for a head of business development to really lead all relationship-building efforts with you, our community, the followers in the institutional investment space. The role will involve all aspects of external-facing engagements. That's our gatherings, whether it's our summits or our universities, from planning to leading correspondence with managers and allocators, to marketing the events that have open registration, to hosting. The role will also collaborate with existing sponsors and establish new sponsor relationships. And then the role will take on any new initiatives that arise.

• 1:10Speaker 01

  We're always experimenting with new things and we anticipate this person being a leader in those new initiatives. Ideal candidates are someone with five to 10 years of experience in financial services or investment management, especially in client-facing roles. That could be investor relations, cap intro, maybe it's software sales, institutional investors. Really what's most important is that this person is passionate about our mission, of bridging knowledge gaps and making valuable connections for institutional investors. And without question, they are a fan of the podcast. The job spec is in the show notes if you're interested in learning more and applying. It's also on our website at capitalallocators.com/about. That's capitalallocators.com/about. Scroll all the way to the bottom of the page.

• 1:53Speaker 01

  Thanks so much for spreading the word about Capital Allocators and our Head of Business Development job opening.

• 2:05Ted Seides?

  Hello, I'm Ted Seides and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can join our mailing list and access premium content at capitalallocators.com.

• 2:30Speaker 02

  All opinions expressed by Ted and podcast guests are solely their own opinions and do not reflect the opinion of Capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of Capital Allocators or podcast guests may maintain positions in securities discussed on this podcast.

• 2:49Ted Seides?

  My guest on today's show is Cliff Asness, the founder and chief investment officer at AQR, an investment management firm at the intersection of financial theory and practice that oversees $100 billion in assets. Cliff is famously intelligent, comical, and irreverent, all wrapped into one. Our conversation covers Cliff's journey from studying market efficiency under Eugene Fama to capitalizing on market inefficiencies at AQR. We discuss regime changes and factors, difficult periods for performance in AQR's business,

• 3:28Ted Seides?

  research innovation, machine learning, index funds, pod shops, areas of cognitive dissonance, private equity, and serving on investment committees. Please enjoy my conversation with Cliff Asness. Cliff, great to see you.

• 3:45Speaker 03

  Great to see you, Ted.

• 3:46Ted Seides?

  You got to bring me back. What were you like as a kid?

• 3:49Speaker 03

  Often, people don't believe me, but I was certainly an underachiever. Sounds obnoxious, but I was considered pretty smart on standardized tests and whatnot. But I got Bs and even some Cs in high school. Nowadays, I don't think kids could get away with this as much. I went to a fairly decent but public school on Long Island, and the teacher would come around occasionally and go, "You didn't turn in the homework again." And then- And I'd get either a zero or the famous check minus. I played ball. I was never very good, but I had fun in high school. My wife gets mad when I still say senior year of high school is probably the most fun year. Cause I didn't know her back then, but I was already into college because I got an early decision. I had a girlfriend. I had a car. I had a job. My parents always make me work.

• 4:31Speaker 03

  But I was the last year I was what you might call type B, happy, go lucky. I had told everyone, my parents, teachers, whenever they yelled at me that I didn't try and had potential. I'd be like, I'll try when I get to college. It'll count. I will say when I went to college, I probably had a very tense freshman year where it was, all right, I've been telling people I'll pick it up and I'll be great once I get here. And no matter who you are, you're not that confident that you're right, that you'll be able to do that. And I was a wise ass, which has never changed, but I didn't even think I had to mention that. That's a given.

• 5:03Ted Seides?

  How did that come out when you were a kid?

• 5:05Speaker 03

  Well, no one worked for me back then, so no one had to pretend to find my humor good. I was a class clown. That was my thing. Some teachers took it very well. They liked the banter. Some didn't take it so well. I think my fellow students thought it was okay. It wasn't as cool as being captain of the football team, but it was something. No matter how serious I get, I can get really serious or too serious at times. Never taken myself fully seriously. I've always had a, I think, a pretty good sense of humor about the world and myself.

• 5:33Ted Seides?

  So that freshman year stress period, as you mentioned, could be a little bit of foreshadowing of sticking to some conviction. What was that first experience like of trying and not being sure you're going to get there?

• 5:45Speaker 03

  Everyone feels anxiety at some point. It's not like I went through high school, even as type B is with no anxiety. But it was by far the most I've ever experienced. I'm immediately revealing more to you than I think I've ever revealed publicly. But the only time in my life up to that point, I ever talked to a counselor or something. This was shocking for me because I never tried that hard or cared that much. But at some point mid-freshman semester, first semester, I went to the university's counselor and just said, I'm really tense. I think I ended up talking about my dad the whole time, which was odd. It was just cathartic. It was not like I was in deep trouble or needed great lessons, but.

• 6:21Speaker 03

  It's a statement on how serious it was for me, and I just fought through it. It was a good ultimate experience because I realized stress sinks at the time, but it has a purpose. I did my freshman year, which quelled many of the fears. Basically, the fear was I wouldn't do well. The fear was that I told everyone, I'm really smart. I just haven't tried yet. And then I'd get there and discover that actually even trying, I wasn't that good. But I overcame that fear freshman year and I had a good time freshman year, but it was definitely my first experience, not my last, as you alluded to, but my first experience with type A anxiety. Is this going to work out permeating your thoughts at times, that kind of stuff. What else can I reveal to you? I've never told anyone.

• 7:03Ted Seides?

  Maybe this is the second therapy session. I'm not sure.

• 7:04Speaker 03

  Yeah, it could be.

• 7:06Ted Seides?

  Walk me through just quickly the path that led to H U R. It's a well trod path for you.

• 7:12Speaker 03

  It goes way back, all the way back to that high school that I talked about when I had very little direction. I did very well on the S A Ts. So I was this weird, very high standardized test, highly mediocre G P A and I believe zero extracurriculars. I had one. I joined the chess team only for junior year because I liked a girl who was on the chess team. Didn't really know how to play chess, learn to play chess and then quit senior year. So I got to put one year of mediocre performance on the chess team. I didn't mention on the applications that it was in pursuit of romance, which did work out. We dated for about maybe three months. At the end of high school, my dad found this program at Penn. It's now very well known, the management technology program, a dual degree program between Wharton and engineering.

• 7:58Speaker 03

  He said, you don't really have any direction and you're mathy. So why don't you study two things? And my dad didn't put it this way, but he was an early proponent of diversification. Little did he know, he was dooming me to vocational school because I got one free elective in this program. But I was a computer science major in the engineering school and a finance major in Wharton. That combination, computer science and finance, I'm a boring guy. I'm on 40 years of that combination being what I do. I'm not one of these polymaths who pursues 10 different careers and is Great at all of them. And then I was going to go to Wall Street, but I ended up being a research assistant for a few professors. That was just for money. They put up something they

• 8:41Speaker 03

  needed a computer programmer to run what today we'd call event studies and they called them event studies back then, but I didn't know the term. But I programmed for them. I thought it was pretty cool. And at one point I said to one of them, what if I wanted to do this kind of stuff? And they said, well, you got to get a PhD. I went to, I think it was 12 or 14 Wharton professors. Back then, I said to all of them, where should I go for a PhD? Assuming they'd say, stay here. And 13 of them said, go to University of Chicago. Many of them had been to the University of Chicago. One, a guy named Bob Litzenberg was a great guy, said, go to Stanford. I applied to Chicago and Stanford, got in both. Chicago had the money and offered to fly me out to visit. Stanford did not. Everything else was the same, stipend. So I visited Chicago on a gorgeous

• 9:25Speaker 03

  spring day. This is probably not true. The memory fades, but I've been fond of telling people for many years that I'm the world's only person to choose Chicago over Stanford on the weather. And I hope I'm not that stupid and impressionable. But went to Chicago, thought I'd be a professor. Then after, I don't know, three years there, my best friend and one of my Wharton professors were at Goldman Sachs, running a relatively new fixed income group. They asked me to come for initially a year to see if I liked it. It's a long story about me deciding to stay and Goldman starting a quant group around me, but I'm on year like 37 of that sabbatical.

• 10:02Ted Seides?

  What was the first spark for you going from studying under Gene Fama to practicing that what you were learning at Chicago Efficient Markets wasn't quite right?

• 10:13Speaker 03

  I think you're being a little unfair to Gene Fama when you say that. There's a moment after getting the preliminary ideas out there, the first two or three weeks, Gene looks at the class and said, markets are almost assuredly not perfectly efficient. And you get a gasp. And only at the University of Chicago and only in Gene Fama's class, you probably get a gasp at that statement. It was really simple. To be fair, he probably thinks they're more efficient than I do these days. Perfect efficiency is an extreme hypothesis. It's perfection. Grossman and Stiglitz wrote a paper introducing a paradox about a perfectly efficient market a long time ago that people need to spend a lot of money making something perfectly efficient on research, on time. And why are they going to do that if it's perfectly efficient? They're not going to make it perfectly efficient.

• 10:58Speaker 03

  They're going to spend an optimal amount of money to get it close. Forman French later wrote a paper about tastes in agreement, saying if any part of the market has an irrational love for a set of stocks, unless somebody else has a perfectly balanced irrational hate for those set of stocks, those stocks are going to be overpriced. Because the perfect arbitrage is not possible. If you, Ted, think a bunch of stocks, you're crazy, you're a bad investor, I'm choosing you as an example, and you think a bunch of stocks are way overvalued. Me taking the other side of a little of your mistake is a really good bet. It's not an arbitrage because you could be right by accident. But once it's 80% arbitrage away, me spending a lot of money to take that additional risk, now we're not that mispriced.

• 11:43Speaker 03

  And you might be right randomly, it's not riskless to bet against you. So there are a lot of different ways to get at this, but this notion of perfect efficiency, I think, is, and Gene will tell you, it's a little silly. Then we can all debate exactly how inefficient they are, even if the market's inefficient, you do have to explain why you're the people on the side of correct. So that's not a small hurdle. But I crossed that bridge of perfect efficiency a long time ago. I wrote a dissertation for Gene on the success of what was then brand new in academia, not brand new in the real world. We were great at taking things people have done forever and then studying them formally and forgetting to mention they've been done forever. The academics had a lot of value doing that. There are things that people have done forever that turn out to be wrong. So going to test them makes sense.

• 12:28Speaker 03

  But momentum or trend, really simple versions, one-year price momentum to choose relative value in stocks. I wrote a lot of my dissertation on that. I've told this story before, but it's one of my favorites. Going to Gene and telling him I want to do this was really scary because, again, he might admit markets aren't perfect, but he's not a big fan of inefficiencies you can drive a truck through. So I told him I want to write a dissertation on The price momentum strategy, and I swear to God, I mumbled the second part and it worked really well. And Gene was like, what was that? I'm like, it works really well. And this was a very warm moment. I don't know if Gene even remembers this, but he said, okay, if it's in the data, write the paper.

• 13:06Speaker 03

  Which felt like a dramatic religious statement for him. No matter what I might like the result to be, if it's in the data, write the paper. With almost any strategy that we believe produces an excess return. I always say we believe, you never know if you're right, but if you believe it, there are almost always two twin competing explanations. An efficient markets explanation, one that says you should be paid a higher expected return because in a very formal demonstrable sense, this is a riskier bet and it's undiversifiably risky and you need to be compensated. And then this behavioral finance explanation, someone out there is just making an error, you're taking the other side of that error. And it may not work for a long time, but over time you get paid for doing that.

• 13:46Speaker 03

  These aren't mutually exclusive. So I would say even back in my Gene Fama days, I was already moving down the spectrum to somewhat less efficient markets. I still think even today, I think the markets are more efficient, I think probably than the average active manager. I think they're harder to beat. If we were doing this interview in the Midwest, I'd be much more pro efficient markets because I'd be afraid Gene was around. But I give probably more respect for the risk stories in efficient markets than I think the average. And I think I would do that even if I weren't afraid of Gene.

• 14:16Ted Seides?

  The early years, when you're writing your thesis, you're then going to practice this. The world doesn't know about factors. You could drive a truck through the differences. So how did you over time calibrate regimes changing or the markets catching up with what historically looked very good?

• 14:36Speaker 03

  Most things get somewhat attenuated over time. They get somewhat arbitrage away. They don't have to go all the way away. This is a key. It's the same concept I was talking about before. If there's an error people make on average and people catch on to it, maybe they invest enough dollars to arbitrage half that error away. But then it gets to be a pretty low risk adjusted return to do the last half. Literally since our Goldman Sachs days, this is more than 25 years ago. We've generally Used half a back test out of sample as a bogey. And life has worked out fairly close to that. Now, we've built more factors, improved our back test. So it's not necessarily half of what it used to be, but that's not been far off. And we would consider that a victory. If you have a decent back test that you don't think is over data mine, that you think is reasonable,

• 15:21Speaker 03

  that you understand the economic spirit, that you've tested robustly in a whole bunch of places. All of that, still assume half going forward. And half is obviously a rule of thumb. You may sometimes think two thirds, one third makes more sense, but it's good to have a simple thing you don't deviate from. Some things I think are much more susceptible to being arbitrage away. Strategies that are about acting quickly. Maybe they don't go to zero, but as you can imagine, someone's always quicker. And maybe someone can still make money from it, but it gets harder. The closer you get to an arbitrage, the more over time, people who originally started doing index arbitrage. They made a ton of money for a while, but that was clearly a trade that could be taken much tighter. The famous value factor that can kill your world for three years.

• 16:07Speaker 03

  That's a terrible thing to live through, a wonderful thing if you don't want a factor to be arbitrage away. Prior to 2018, when our value factors were still holding up, even though the worlds were tough since the GFC. One of the most common questions I'd get about our whole process, not just value, was if this stuff is so great, why isn't it arbitrage away? And I had lived at least through the tech bubble of 99, 2000, which was horrendous for not just quants, not just value, but any rational strategy. I think the GFC was a bit of a different beast. That wasn't so much about investing styles. That was just a incredibly wild investing period where you could make or lose a lot of money on Vols. And I would tell people, you think it's easy to arbitrage away, but I've lived through some crazy things, making it much harder to stick with long term,

• 16:51Speaker 03

  which is paradoxically good news if you can, because that's why it remains. I quote my friend Corey Hofstein all the time, who came up with the phrase, no pain, no premium. So I think some of this is susceptible to shrinking. Some of it is less so. So we experienced that it's difficult to arbitrage these things away. While the pain is going on, it's really hard to have that. This is why we make money over the long term stoic perspective, but that's still the accurate perspective. Just because it's difficult, doesn't make it not accurate.

• 17:22Ted Seides?

  I'd love to dive into the challenges of marrying the need for that long-term perspective when factors can go against you for longer than people are comfortable with, with the reality of being in business.

• 17:33Speaker 03

  I'll start by an admission that will surprise no one who's listened to me before. I am a complete hypocrite on this. I don't think I'm actually a hypocrite in my actions, but I will preach the long term, and I believe it, and I'm honest about it. And then I'll be in a terrible mood, possibly chucking things around my office. Let's not get too deep into that. On a bad day, I think that just says that the emotions that drive some of these things are pretty hard to get rid of, even if you've studied them your whole life. If I'm really trying to be, have a rationalization day. I say this is actually good news that I'm in a terrible mood because it shows that I can study this for 30 years and still not get it. There's no magic bullet. We've shrunk when we've had bad periods. We grow when we have good periods. I've encouraged investors to do the opposite.

• 18:17Speaker 03

  I don't think there's any asset manager in the world, except the ones who'll never give you back your money, who doesn't shrink when they have a bad few years and doesn't grow. It probably shouldn't. At three to five years, contrarian tends to hold. So I do think a lot of allocations in our world are mildly backwards. With all that said, your job as a manager in a tough period is twofold. One, honestly, keep asking the question, are we right or is there new evidence that we're wrong? The last thing you ever want to do is go try to defend your process to clients, to the outside world, to the media, and give off any sense that you're defending your business, not keeping an open mind. If, big if, you've decided, yeah, we're right, this is, we're going to be proven right, this is going to come back.

• 18:59Speaker 03

  Then your job is to plant your feet and say, we will not be moved. And try to convince as many people as possible, because it is in their interest, to plant their feet with you. And you'll never succeed with everyone. You're fighting human nature. But again, I feel this is fair. Those who can do it, I think, reap great rewards from being disciplined investors, but it's really hard to do, which in some sense is a balanced, fair world.

• 19:22Ted Seides?

  You've gone through two significant periods of AQR of that tough time. The first-

• 19:28Speaker 03

  I don't recall either. I'm kidding.

• 19:30Ted Seides?

  And that very beginning. What happens in that early part of the tenure of a business where performance is just moving against you?

• 19:38Speaker 03

  When you go through a bad period, my partners and I, the ones who were there, and only back in the early days, would discuss what was more painful, a really horrible period from inception, first year and a half, or really horrible two and a half year periods when you're running hundreds of billions of dollars and have many more clients. And in one sense, it's clearly the first one because you face existential risk. At no point in the depths of COVID, when value was particularly doing its crescendo of losses, which turned out to be totally irrational. People thought all you needed was Peloton and Tesla forever, but at no point did we face going out of business risk. It was just excruciating. We were losing money for clients. We hate, quite obviously, I hope any money manager hates that, did a lot of business pressure,

• 20:23Speaker 03

  a lot of have you guys lost it kind of questions and you got to defend yourself, but not an existential risk. The only existential risk would be if we gave up and that was not going to happen. But as you survive in this industry, you will find duration of pain is as important as intensity of pain to how damaging it is to both your future life expectancy and to your business. A crash that quickly reverses itself, almost by definition, people are tense, why'd that crash? You have to talk about it, you have to figure out what happened. I would argue a three-year drawdown that is somewhat more shallow than a two-year drawdown is worse in a lot of ways, harder to stick with. You're going back to people with the same explanation in year three that you had in year two. You're saying, remember what we said in year two? It's even crazier now. And we've kept an open mind and we've tried to investigate 50 more

• 21:08Speaker 03

  stories why we might be wrong. That is highly dissatisfying to people. When you lose money in your first year and a half, especially when you're so stupid that you launch only one extremely aggressive north of 20% vol, to geek speak for a second, aggressively, long and short, our drawdown from inception was in the two some odd standard deviation range. Two times north of 20 vol is, in my world of geeky rationality, that's no different than happening at 3% vol. It's a two standard deviation event. It happens more often than probably it should in financial markets, but it's certainly not a 20 standard deviation blow up. It was poor business. Designed to only have that.

• 21:49Speaker 03

  My partner, David Kabila, and I did most of the marketing for the fund when we were starting out. You did a roadshow and you can't launch 20 products at once. We had always planned to replicate what we did at Goldman, which was a broad set of both alternative investments and traditional with more constrained ones using the same models, different risk levels, but we decided to lead with our most famous thing from Goldman Sachs. I probably had 20 investors say, hey, guys, how about you do this? I like this, but I don't need to make what you made at Goldman. I'll take half or a quarter of the vol. I responded every time, and I know you find this hard to believe, we kind of flipped. I was like, oh, that's great. Why don't you just give us a quarter of the money? I refused to bend on the math. I was right on the math and completely wrong on investor psychology.

• 22:32Speaker 03

  Having a large set of our investors who have given us a quarter of the money at a quarter of the fee, because I did say that it's fair. One of the scams in our industry is to start out really high vol and slowly lower it over time as you keep the fixed fee the same. So I was not trying to do that. Had I just acquiesced, which would not have even been hard. You do a master feeder. I think it would have been a much less unpleasant first year and a half, but I was stubborn about the math. I'm no longer stubborn. Well, I'm stubborn, just not about that.

• 22:58Ted Seides?

  Given that initial say business mistake, how did you survive that initial drawdown?

• 23:03Speaker 03

  The two big, really tough periods that were specific to us were the tech bubble and then really 19 and 20 that were value debacles, where the other parts of our process didn't pick up value. Most of the time, we're not very heavily loaded on value investing. Most of the time, we're fairly diversified. But when value gets absolutely clocked and it turns out it's not the profitable, the low beta or the good momentum companies, that can be really excruciating. But one nice thing about value is if it's a bubbly reason why it's losing, but if it's just losing on a price frenzy, you see it in the spreads between cheap and expensive. And we did this a million ways with a ton of robustness checks, a ton of might we be wrong? We had the same playbook in 99, 2000 as we had in 2020.

• 23:48Speaker 03

  Let's consider all the stories out there for why this time is different. See if we can express those. In the last round, it was intangibles, maybe intangibles. We already knew that was not going to be the main story because we have value. Factors. Everyone thinks a value is price to book. I blame my heroes, Fama and French, for that. Most modern managers use a very broad set of measures. But price to book is probably the most susceptible to being warped by intangible values. Conceptually, the idea that if half the value of a company is intangible, it's not going to be in book, so it's going to look expensive. It's reasonable. We already knew, and we wrote about this, that value measures that worked at least as well as price to book, like price to sales, that are absolutely not susceptible to intangible

• 24:29Speaker 03

  problems, there's no such thing, were as bad, and the spreads were as bad. So we did all kinds of work on that, but at the end of the day, we had something to point to and say, do you really want to sell this? And it's funny, we had a lot of stick with us, which I'm thankful for. We had a lot of people who didn't, and I understand, because I stare at that and I say this jokingly, but it's actually true. I look at the spreads on what we were trading, and what I thought was close to a proof that we'd eventually be right, close to a proof. If you ever think you've proven something, you've gone too far in this industry. There are always crazy things that can happen. But I have two simultaneous emotions. One, how did anyone leave us? Given it was so clear what was going on. It wasn't magic that was happening to us, it was market-wide, and we've seen this movie before.

• 25:14Speaker 03

  Second, I look at the drawdown and the pain and how long it lasted, and I think the exact opposite. How did anyone stick with us? So I'm either bitter or thankful, depending on what mood I am in that day.

• 25:25Ted Seides?

  So that messaging based on valuation that you tried, and some people stuck with you through the pain, and others didn't. At the same time, for those that are coming out, you have your organization that's contracting. How did you go about either keeping morale or keeping people motivated to the mission when some people who presumably believed in it couldn't stay?

• 25:45Speaker 03

  That's the human cost, when you have to shrink. And the financial industry is too cyclical. I preach against it, but financial firms shrink in assets and people when they go through really tough times. The math doesn't work. Some of that, this does sound really cold, but we had a pretty good decade prior to that, and we got a little fat and happy. So the initial shrinking's not that hard. It can be hard on a human level. I dread giving these messages. If I have to let someone go who's a good person who's done good for us, but we're just in a bad situation, I'll spend three days very tense about it. I'll never say it's this is harder on me than you. That's a lie, but it is hard. It's not a fun thing, but the early ones are hard to do, but are easy decisions. You've grown too much. As the drawdown goes on, the decisions are more painful.

• 26:30Speaker 03

  But there is a pretty big self-selection bias that works for you. People who are not true believers, here's another irrationality. Someone who's been with you through another drawdown, seen you come back. It's far more likely the second time to say, I've seen this movie before and we're going to prosper. Someone who joined an hour and a half before the current drawdown began and has only seen you lose money for two and a half years, even if they are just as smart and intellectually get it as the other person, doesn't feel it the same way. So even there, you have a selection bias where a fair amount of people who don't believe leave. And it works out, you actually don't have to let go that many people who absolutely love it and believe and are going to stick with it. I won't say there aren't some very painful

• 27:11Speaker 03

  things. Those are my least happy memories of 25 years of running AQR. But the world becomes a sorting hat at that point as to who thinks we're right and who thinks we're wrong.

• 27:21Ted Seides?

  So as we talk about it today and you started to come back, it's easier to say, we believe this all along. It was clear in the numbers. When you're going through it, as you mentioned, there's always some doubt. How do you go about thinking about sticking to the models that have worked alongside of trying to figure out whether it's through innovation or new research that something isn't working and may not come back?

• 27:45Speaker 03

  I see these as two very parallel things that interact, maybe a little less than you might think. We've done very little research. It's a really tough period. We just need better stuff. We got to go find better stuff. We do a lot of research at that time, as I said, to say, is our stuff broken? Is there a reason why this is going on that's not going to reverse or even go back to working normally? It doesn't always have to reverse. So I'm not saying we don't apply that, but that's only because it's fairly empty statement. Because we always have a big research effort going on.

• 28:18Speaker 03

  Things we've done in 25 years, we did in the last five to 10 years. And they were not in response to the drawdown. But I think consistent, things are often oversold. The internet in 1999, 2000 was oversold, but it does appear to be lasting. Maybe the biggest improvement I've seen at AQR. And I'm going to get in trouble because I love all my AQR children. You're not allowed to have favorite children. I have four kids and my wife would get very mad if I had a favorite. Katie, by the way. I'm joking, Grace, Charlie and Leo. That is just a joke. What we've done in trend following, which 10 years ago was the simplest of all strategies. It was one to 12 month price trend on the major markets. Of course, not everyone did the same one. A different trend follower will use a moving average, will use a filter, will use simple.

• 29:01Speaker 03

  But we've extended that tremendously to very esoteric alternative markets and more structured trades that have lower capacity, but we think are decently higher sharp. And diversify the nature of a trend from price to all kinds of fundamentals also. And I think we've made that product a lot better. And that had nothing to do with the drawdown. These overlap maybe a little bit. I think the drawdown showed us again that the traditional factors tend to have horrible and great periods. They have one year events that are normal, but three year events that are abnormal. Because three happen in a row. It's really hard to stick with these things. You do research on that, you do research on new stuff. There are two overlaps. One is you always have a budget for risk.

• 29:46Speaker 03

  So if you do new stuff, you think is great, it's got to play its way onto the team. It's got to take some risk off of something else. So how good it is, how good new stuff is compared to old stuff is always there. One of the beautiful things is as long as they're not highly correlated, you could do a little of both. Second, this notion that some of the factors have a tendency to go crazy for longer. I give more credence to than I would have after seeing it a second time. Fool me once, shame on me. Fool me twice, took twice. Fool me a third time, serious shame on me. Some of the newer stuff we're doing, and I hope these aren't famous last words. I do think they're truly a little more idiosyncratic and a little less susceptible to world events going crazy for multiple years.

• 30:30Speaker 03

  Doesn't make them make more money long term, just will make them easier to live with. But easier to live with means people can make more money at them. That's where they overlap a little bit. Some of the newer stuff I think is a little more eclectic and less susceptible to those wild streaks.

• 30:44Ted Seides?

  When you start bringing in the idea of machine learning, the complexity of understanding what's happening in the markets and the idea that the factors that you want to test are behavior-based, you can understand why they might work. Then you have this stream of, let's call it Renaissance or something, that's pure machine learning. It's ahead of the human. How do you decide whether you're going to adapt, in this case, say, a signal that you don't understand, knowing all along that as machine learning picks up, say, trend following is a great example, what period of time you're working with probably isn't that based on behavior?

• 31:22Speaker 03

  It's a great question. And it was a hard one for us because we've always prided ourself on always needing a strong economic story. Data mattered a ton. A strong economic story that didn't work for 50 years, not so good. But that merger of the two, a story with strongly supporting, robust, out-of-sample data was always our thing. And I feel guilty about this. I think I probably slowed us down on some of the machine learning stuff by a couple of years with a little cynicism along the lines of exactly what you're talking about, that we could turn over more of the decision to the machines. I think ex-Anti, the old man who's been doing this for 30 years, having a little cynicism, probably a good thing. But if it overcomes that, it means you retarded the whole thing a little bit. I think we've crossed that bridge in a few ways.

• 32:06Speaker 03

  First, we don't use machine learning to say, "Go look at any data you want and come back with something cool." It'll way overfit. We still believe that. One key insight, and usually when I talk about machine learning, our head of machine learning, Brian Kelly, if he were somewhere, you'd see his lips move. I'm the last guy who can actually do the technical details. So I just want to give credit where it's due. I'm parroting really smart things other people at AQR, not just Brian, but he is our head of ML. He's written a paper with some co-authors called "The Virtue of Complexity", which I love because obviously it's a play on virtue of simplicity. I had an alternative title for him he refuses to use, which was "Occam Was Wrong: The Simplest Explanation Is Not Always Best." And this is going to sound trivially simple, but letting machine learning go to say,

• 32:51Speaker 03

  "Choose what factors you like best and put them together." If you Let it look at every possible factor. It's gonna be a giant insane data mining exercise. I believe it'll have zero out of sample power. We started with probably ten plus families of factors and two hundred factors when you count on different ways to measure the same ones that we already believe are good for those first principles. It turns out that if you use M L or even simpler Bayesian techniques, if you start out with factors you already believe in, turns out it can be a pretty powerful way to choose the best combination. That endogenizes correlations, that formally builds in out of sample evidence. And that was a wonderful marriage because we're not doing anything we don't believe in. We're just weighting it differently.

• 33:33Speaker 03

  Another place is just building factors from the ground up. There are some things where M L comes in very handy. We've always measured momentum or trend using both price and fundamentals. One form of fundamental momentum is parsing corporate statements. Are good things being said? If good things are being said, that's one corroborating piece of positive fundamental news. Quants have in some ways been doing this, gotta be more than twenty years. The early versions until relatively recently were word counts. Count up the word improving in a statement, and if they're more improving in your statement than my corporate statement, you look better. Of course, everyone can immediately see the flaw. If the sentence is, we have utterly ceased improving, it's probably not that good.

• 34:17Speaker 03

  Now to a quant, that's okay if that's less than half the time. More than half the time improving is a good thing, but it can be made better. And letting M L through natural language processing extract is this good news or bad news from relatively unstructured data. I think of this as reverse chat G P T. Chat G P T, you put a query in and you get words. This starts with words and gives you something out. That's been a beautiful improvement. We are not doing this yet. We're about to be doing this. We've built some valuation models that vary much more by geography and industry and other ways to compare apples to apples firms that don't just look at valuation ratios, but compare them to fundamentals.

• 34:59Speaker 03

  A lot of those comparisons are being done now with M L. It's again a virtue of complexity. You impose a basic structure. And then let it vary to a certain degree, but not willy nilly. So I would say at least two places or probably others, how to combine factors and how to create factors. Now there are limitations. I'll give you an example of something M L I don't think will help us on. And maybe I'll be proven wrong about this, but vital numbers to people like us. What is the equity risk premium? What is the premium for high quality against low quality stocks? There you don't have a big data problem. You have a small data problem. I don't think M L will tell us one more thing about that. Maybe there'll be some clever way that'll prove me wrong or some outside data. But by and large, I think we're stuck with long term data intuition. And then do we believe in this?

• 35:43Speaker 03

  But there are so many places where it's making life better. But everything is an effort to be as good as you can. And I think M L is making us better.

• 35:51Ted Seides?

  How do you think about the risk of that game of Go when the machine does pick out the move that you just were never going to see?

• 35:59Speaker 03

  I don't think we are even trying to use it at that kind of level. Our techniques trained on Go from scratch. They literally had it learn the game on its own. And as many permutations there are of Go, it's still, I think, probably a more tractable problem than every stock and other tradable asset over 100 years. This is a matter of computing power. And maybe there's a way to constrain the problem where there will be some insight. Those insights will probably take the form of weird nonlinearities. If yeah, value's good, momentum's good, but not if you have these other three good things at the same time. We can use our techniques to look for those. You just got to put a big penalty function on so you don't overfit. It's an interesting question. I haven't gotten it before.

• 36:42Speaker 03

  I will check with the experts afterwards.

• 36:46Ted Seides?

  So over these last couple of years before this bounce and you're thinking about other things that could be impacting the performance. A lot of the common discussions were around the rise of passive investing, trading in the hedge fund pods, the rise of the mag seven. I would love to get your perspective on each of those.

• 37:05Speaker 03

  Passive investing is a very hard one. I do think too many people make extremely bold, very confident assertions about what passive investing is doing. Often in the, it's destroying the markets. Just read a wonderful piece by Owen Lamont of Acadian. I'm not above plugging competitors. I find that to be a sign of confidence in a manager. Owen said some things I will claim without proof that I've been saying also for quite a while. It's much less clear than people think. You can't have everyone indexed. Everyone agrees with that. I often refer to that as the black hole singularity. No one even knows what happens. Everyone cannot index and have a functioning capital market. Owen probably goes a little further than me and says it could be a tiny number of people looking at valuations. I do think we need some quorum.

• 37:48Speaker 03

  Whether we need as many as we have, I think there's probably a strong argument. We've had too many people trying to beat the market over time, generating costs and just churning. So where we are in that spectrum is really hard. And another thing Owen talks about that I've talked about forever is a lot of this depends on who is moving to indexing. If you start a very simple and obnoxious model, because I'm going to say there are sharks and minnows out there. There are informed investors and uninformed investors. They've been indexers, but then sharks and minnows as active managers. If half the minnows move to indexing and none of the sharks, it's harder to make money. Doesn't make prices less accurate, maybe make them more accurate. Fewer people making errors.

• 38:26Speaker 03

  If more smart people, sharks, move, then it's now going to be easier because the remaining sharks are a smaller fraction. Given what we've seen with particularly value strategies and this fact that spreads between cheap and expensive are still considerably wider and recently hit their widest level ever. I don't think there's a lot of evidence that only the dumb money has left and smart money is still here because then prices would be tighter. So it's very anecdotal.

• 38:53Ted Seides?

  On the other side, we think a lot of the pod shops as the sharks of the sharks. How has what you've seen of the activity and the growth of the pods impacted any of us?

• 39:04Speaker 03

  First, let me start out with an important caveat. I don't really know. I keep asking Izzy and Ken to send me exactly what their trades are and what all their strategies are. And they keep politely refusing. Actually, they don't even answer the emails. Everyone knows that's a joke, right? I don't actually ask them. That though they would not tell me, I will tell you this, something I would have gotten dramatically wrong. If you had told me 20 years ago that here's my strategy. I'm going to go find people I think are really good at this. Pay them a lot, charge that to the underlying investor. So the fees are when you add it all up are gigantic. And then I'm going to fire them rather quickly if they have losses. I would have said, and obviously I would have been wrong because the results speak for themselves. That's terrible strategy.

• 39:48Speaker 03

  There's not that much alpha out there and the investor is paying a ton. And even good strategies, as theme we were talking about before, go through bad periods and I'll be firing a lot of good managers. That leads me to believe that a lot of it is how good some of these shops are at identifying that skill. Ex ante, something I've never tried to do. And sadly, we'll be sharing no special insight on, but I'm narrowing it down to what it has to be. If you just told me that's our process and a lot of people have tried to set up these shops. And maybe not spectacularly failed, but failed, fizzled. There are a handful that have done it really well. I think they must have serious skill at identifying these managers and living with getting rid of some good ones too quickly, but on net having that be right.

• 40:32Speaker 03

  Which again defies my intuition from before looking at this. I do think they've gotten quite big and there has to be a fairly decent limit to how much capital can do this. True alpha and they claim to hedge out the factor risk. Most of them do, again, I don't know what everyone. So if they're doing that perfectly, which is still scary that no one does anything perfectly. Then at least to the part of our world, what we do that is more known factor related. We should be uncorrelated to them. We should be neutrinos passing past each other if they're doing that. I tend to think those shops probably can't grow by another factor of five. There's just a limit to alpha, there are a limit to how many great traders that are out there. If they are hedging out the factor risk, they are doing things that are inherently lower capacity.

• 41:16Speaker 03

  One beautiful thing about the old school factors, which again we've diversified away from two, but we still do. Is they might have point five sharp ratios, which are not what the pod shops are looking for. Particularly the slower turnover value. Quality, you can run hundreds of billions of dollars in them. So I think of the pod shops as fascinating. I'm arrogant enough to think I'm not dramatically wrong too often about finance, but I would have been dramatically wrong about this, which is inherently interesting. When you're dramatically wrong, there has to be something. And I've given you a few of my conjectures, but I think they will remain a serious force, but it will almost by definition be harder for them going forward.

• 41:54Ted Seides?

  When you move from equities, there's a lot of what we're talking about, to other asset classes, you could make the case that the behavioral aspects of investing are the same. You don't hear as much about this type of activity in the kind of scale in credit, in rates and some of the other assets. What have you found as you've explored those different areas?

• 42:13Speaker 03

  I'm going to go back to 1995. So this is a 29-year-old deep cut. When we did our first version of a long, short aggressive fund at Goldman, I think there are three of us left from that experience. Three of seven strategies were macro strategies. Early on, it was, all right, if value and momentum worked for individual stocks, if we added up the valuation of the DAX and the valuation of the FTSE and said the DAX was selling for price of sales, double the FTSE and had the similar momentum. If you're a behavioral finance person, people are over optimistic about Germany and under optimistic about the UK and not super high sharp, but clearly positive. It held up over time. So forever, we've done both.

• 42:58Speaker 03

  And mainly for the old school factors, we think of this as a beautiful out of sample test. If we went to equity markets, we wrote our first paper on this in 1996, on showing that then it was only value and momentum. The world has expanded tremendously past that. And size, though we never traded size, showing that the same things hold up for country selection as they do for individual stocks. If we had tested that and it had failed, maybe we wouldn't throw out the individual stock results, but if you're honest, it would give you a little pause because you'd go, why did it fail? Why would the same story, if my story is real? And you don't want to be so flexible. You're always coming up with a story that fits the data. The good news was we didn't have to throw things out. It did hold up. Your question is a simple one.

• 43:39Speaker 03

  We will trade anything that's liquid and has these things measurable. The most extreme example I'll give you is there's a one place in our entire business. We trade crypto, pure trend following strategies in places that we have a broader model where we're doing macro that has valuation, carry, doesn't have any of those, or at least beyond our ability to do. But everything has a price trend, so it's this very small position when it's only in trend and only price trend. And dollar positions are tiny because you may have noticed the stuff is a little volatile. But even there, if something can be described in our way, we will trade.

• 44:14Ted Seides?

  I want to turn to some of the wise guy stuff you talked about from your childhood.

• 44:19Speaker 03

  Now you're going to try to get me in trouble.

• 44:21Ted Seides?

  Oh, yeah, I'll let you get yourself in trouble.

• 44:23Speaker 03

  Yeah, it's okay. I enjoy that.

• 44:25Ted Seides?

  You recently wrote a blog post about cognitive dissonance. Some of these things that investors can't believe.

• 44:32Speaker 03

  Shouldn't be allowed to believe at the same time.

• 44:34Ted Seides?

  So I'd love to just pick apart some of these. And I guess, starting with illiquidity in private assets is probably a good one for you.

• 44:42Speaker 03

  A few things in the private world. You're not allowed to believe that we're getting north of equities and essentially better than the equity risk premium. But we're extremely safe because reported volatilities are 5%. And there are some very good allocators and private equity managers that are very honest about this that will tell you we're past regular equities in terms of our risk. We just think we're great at this. I have no bone to pick with that, which really irks me because it's getting into the quant world like efficient frontier charts, where private equity is well to the left of public equity. And it's concentrated, often levered equity. So if that's vol on the X axis, it is not to the left. It may still be a great investment. Some of these people are simply great at what they do.

• 45:26Speaker 03

  So I'm not saying don't invest in it, but I think that is some cognitive dissonance. And by the way, cognitive dissonance just says two things you can't believe at once. You're allowed to not believe either. Sometimes people challenge me, but I like private equity and I know it's risky. I'm like, then you're not suffering from cognitive dissonance. Another one is this notion that you'll often hear a private equity investor, and I think this is totally legitimate, say, it makes me a better investor not to be able to. To get out of it and not even to be able to see it makes me not as susceptible to the things we've had to suffer. When things go up and down and I admit some of my comments in this are just professional jealousy. That I have to live through these periods when they really are, but they don't have to see them. And therefore they sail through them and I say that's fine.

• 46:06Speaker 03

  If you go back to the David Swensen, I think a lot of the idea of private equity was illiquidity in all its effects. Not being able to trade out, not knowing what the real prices are perfectly. That's a bug and one of the reasons we love this is we get paid for bearing a bug. And David figured out that Yale has a really long time horizon and could accept that bug. If over time, people are arguing that, no, this makes me a better investor. I love it. That's not a bug. That's called a feature. And a feature is something you pay for in this sense is higher multiples and a lower spread. If you're doing something that you like and makes you a better manager, you pay for that. You don't get paid. Some of my best friends are private equity managers. Some of them agree with me. Some of them argue with me. But most of them will tell you multiples are closer to public markets than they used to be.

• 46:51Speaker 03

  So I think it is consistent with my story. So you're allowed to believe it makes you a better investor. But I don't think you're allowed to believe I get paid the same illiquidity premium as I used to get paid historically. When most people assumed it was a negative and insisted on getting paid for doing that. Again, cognitive dissonance.

• 47:09Ted Seides?

  How about international diversification?

• 47:12Speaker 03

  International diversification is always a hard one because it's been so poor for so long in the U.S. I am barely old enough for this one, but I'm old enough to remember the late eighties. When it was why invest in the U.S. IFA and driven mostly but entirely by Japan had crushed the U.S. for 20 years. Maybe where the cognitive dissonance comes in. I find it very consistent to believe international diversification stinks for a U.S. investor. Just look at the last 30 years. And then you could go, is international diversification good for a non-U.S. investor? And people start to realize they're caught in the trap because they want to say, yeah, you get U.S. stocks. And then you go, do you know what's going to happen going forward? By definition, an internationally diverse portfolio is somewhat lower risk.

• 47:55Speaker 03

  We can debate how much lower risk, but it's somewhat more diversified. I wrote a paper on this totally separate. Point showing that over the short term, it's not very diversifying because things crash at the same time. But over longer horizons, country disasters are often idiosyncratic. And it does provide diversification. So I think pretty much by definition, global diversification is a lower risk portfolio. And unless every country assumes they're the winner going forward, it's always going to be good ex post from one country's perspective and terrible ex post from another country's perspective. And to look over some period and go, we know which one's right is at the best case, I think, bad analysis. At the worst case, backwards. Because yet another piece, I've written too much. I start too many sentences obnoxiously.

• 48:38Speaker 03

  But I wrote a piece on that. A piece on the website called The Long Run Is Lying To You shows that US equities have indeed crushed global equities in the last, call it 30 years. Don't hold me to the exact numbers, but call it 80, 85% of that victory has been multiples going up. US started out cheaper and is now considerably more expensive in terms of current cash flows, sales, earnings. That doesn't necessarily reverse. Maybe the US deserves. Maybe it's a safer bet. Maybe you're with all the good companies that are in a broad sense safer, so you're willing to pay more money. But you don't want to assume it repeats. You don't want to assume you get another relative valuation where instead of going from, I'm going to completely make up these numbers, 50% cheaper to 50% more expensive, you're going to go to four and a half times more expensive.

• 49:22Speaker 03

  These are challenging because they take really long horizons to play out, something like this. But you play the game going forward and you do as much of the rational thing as you can. So I'm a fan of international diversification and I think to dislike it, you often have to hold two ideas in your head at once that you probably shouldn't hold.

• 49:39Ted Seides?

  That gets into performance chasing.

• 49:42Speaker 03

  Everything leads back to performance chasing. It's the original sin of investing.

• 49:45Ted Seides?

  And your thoughts on the cognitive dissonance of performance chasing?

• 49:48Speaker 03

  I think if you asked most allocators, investment committees, individuals, is it a good idea just to buy what's up in the last three to five years and sell what's down? They'd say probably not. No, that's too superficial. There could be good reasons. Maybe it's cheap. And then as an industry, we all collectively do it anyway. That one doesn't have a great subtlety. I think it's just pure cognitive dissonance. We say one thing and we do another. Again, the eternal paradox is there wouldn't be a whole lot of stuff for active managers to do if people didn't make some crazy errors like this. Be careful what you wish for. Not that I'm gonna single-handedly do this, but if myself and a thousand other ever convince the world to be perfectly rational, we're also out of a job. The perfect world is I get to complain about this and whine about this and convince some

• 50:30Speaker 03

  subset of people I'll probably write and not convince most of the world, which I think is the path I'm on.

• 50:35Ted Seides?

  How about technology innovation?

• 50:37Speaker 03

  Technology innovation as it relates to specifically how efficient is the market is what I wrote on in Cognitive Dissonance. And the reason that technology comes up is there's this general belief, it's often called a Whigish belief. Whigish is the force of history is gonna make everything better. That, hey, we get all the information instantly now and it's ubiquitous, we can have any information we want. So prices have to be more efficient than they used to. And I don't think that's even close to true. I think the ubiquity of data, social media, maybe indexing, these things have added up to a market where inefficiencies are bigger and last longer. This can be a bit circular, because I admit I probably started here, but I pointed this spread between cheap and expensive. We can't come up with a reason to rationally explain why it's wider.

• 51:21Speaker 03

  In the tech bubble, in the dot-com bubble, 99, 2000, it hit the widest level ever in 50 years. If you wanna come up with a way-too-extreme, I'm not saying this is the base case, example of this, it's the US meme stock phenomenon, where social media and ubiquity of information, where everyone can look something up, think they understand it, circle it, post it, and everyone can go, ah, I've proven this, and trillions of dollars can move. Actually, it's usually $8 and tremendous stock price percentage movements. That is probably a way-too-extreme example of what I mean by these things not making us better investors. Essentially, crowds that are independent, the wisdom of crowds, are extremely good.

• 52:03Speaker 03

  Crowds that are coordinated are dangerous mobs. And I think of the internet, I'm not saying it has huge benefits. I'll go down a YouTube rabbit hole about 70 sitcoms like anyone else for three hours and be very happy I did. But the internet is also a near-perfect vehicle for turning crowds from independent evaluators into mobs. I do think our net markets are somewhat less efficient.

• 52:26Ted Seides?

  How about one more dissonance? Talking about leverage and concentration as a risk.

• 52:31Speaker 03

  You shouldn't be scared of leverage. Leverage is exactly what it sounds like. It's upping the risk and return on something. If you take that too far, it can be dangerous. We think if you have a certain portfolio and you want to make it better, there are often two choices. And I'm being very broad in my explanation. One is to concentrate more in the things you believe in most. The other is to diversify more across more things. That often raises a risk-adjusted return, but lowers risk. So then you have to apply some leverage to it to actually make money from it. You can reduce risk, which can be great on its own. But most people are interested in some combination of reducing risk and making more money. We think people are essentially too accepting of concentration risk and too frightened of leverage risk. Both can be taken way too far, right? Put all your money in Tesla? Maybe you're going a little too far.

• 53:16Speaker 03

  Lever 17 to 1? Both can be taken too far. But we think there is more leverage aversion than concentration aversion in the world. Remember that story in the beginning about doing too high of a vol in our initial product? That wasn't the real mistake. The mistake was not also offering low vol. One fair knock on true alternatives. Imagine you found a good one. Meaning it's not very correlated to anything you're doing and has a decent risk-adjusted return. If it's a low-risk alternative, 5% vol, you can make your risk-adjusted portfolio better. But unless you do one of two things, you're not making your total expected return better. One thing you can do is even without leverage, you can shift more to the risky asset outside of that. It could be a bond substitute where you sell some bonds and buy some stocks.

• 53:59Speaker 03

  Our favorite thing to do, we used this for a few years, maybe I'll bring it back, said we believe in moderation using leverage shorting and derivatives. And we were very happy that spelled out LSD. Because we thought that was an implied form of disclosure. So another way to do it is to run higher vol alternatives, truly diversify. And that's a form of leverage that's embedded in the alternative. I think they're underutilized. I think they test you because when there's a drawdown period, it'll be bigger and there's no magic to it. Truly good alternatives can still be disappointing if done at very low vol without any other shifts in the portfolio. Your sharp is higher, but the old adage you can't eat sharp is true. I think there are various ways you can eat sharp. And I look forward to offering more things along that line.

• 54:44Ted Seides?

  I want to play around a little bit with your thoughts on private equity and volatility laundering. How do you respond to the thought that maybe the private markets are right? If the public markets are some combination of behavioral implication on returns and fundamentals, and the private markets are a little more tied to just fundamentals, that you would expect there not to be those movements?

• 55:05Speaker 03

  If you say it this way, let me say it back to you. That markets are not perfectly efficient, and there are occasional bubbles. Therefore, the private equity prices are closer to true. That doesn't necessarily have to be the case. Maybe halfway is true and they don't move them, but it's pretty plausible that they could be closer to accurate in a metaphysical, what is this really worth sense. My question then does become one of competitive jealousy. For both private equity and what we do, you can always value things at least one of two ways. You can say, what would the market bear if I sold this tomorrow? Or you can go, what do I actually think it's worth? Private equity managers are better at valuing a company than I can ever dream of. They don't have to tell you so they don't. But if the market crashed 30% tomorrow, and they had to come up with what do we think we could sell our portfolio for today?

• 55:50Speaker 03

  They could absolutely tell you. No one would be happy with it, but they could absolutely tell you. When we are suffering in the public markets, in March of 2000, when NASDAQ was at 5,000 and we were down 30 some odd percent since inception, I could tell you what I think if prices were fair, what the portfolio is actually worth. And in fact, I did those exercises. I did it more in the sense of when it comes back, what I think we'll make. But it's the same calculation. What you'll make is the abnormal return that brings prices back to fair. What I don't get is, once everyone realizes this, why we have to do it one way and they get to do it the other way. So it's not that they're wrong. They really might be more accurate than the public markets. But I don't get why these two things are treated differently, particularly once you say it out loud. I've joked about this numerous times.

• 56:34Speaker 03

  No one thought about this and you just said, oh, they're not moving that much. But once you say it out loud, yeah, we love these things. We don't have to mark them. Why does it still work? But to be fair, I will pose this to the entire marketplace. If they want to keep treating privates exactly the same as low vol, but accord us the same courtesy. And when the stupid public markets say we're down 30% at 20% vol, you are really not and they're perfectly comfortable and they're. I'm good with that being the detente.

• 57:02Ted Seides?

  All right, I want to turn to asking you about being on the other side of the table on investment committees. You mentioned earlier, you don't know how pod shops, for example, might select managers. How have you thought about the manager evaluation process?

• 57:17Speaker 03

  I have no magic bullets, but I've been on plenty of investment committees. Whenever I get involved with a new organization, a charity, a school, they almost always stick me on the investment committee. They often regret it for various reasons, but largely because if they have a philosophy that's worked for them. I try not to be too much of a jerk. I don't come in and go, I make this all quan. No, I'm not. I'll make my observations at the edges. But having participated in many, and I'll brag and say some of these have been absolutely stellar committees with luminaries of investing, and I'm not being sarcastic. People I really respect, including myself, we can collectively be an idiot because there's a dynamic to a committee. Individual members of the committee get far more punished for disasters than they get for good portfolio returns.

• 58:02Speaker 03

  That's true in a lot of walks of investing. I think it's particularly true of committees where they don't own anything. They don't get the upside. They just get the opprobrium. There are other weird things. My partner, John Liu, who ran a major investment committee for a long time for his school. He pointed out to me once an interesting effect. Let me be crass here. Those on the committee are often some of the biggest donors over the last 10 years. Let's just be honest. The biggest donors are the most successful parts of the financial world over the last 10 years. Therefore committees tend to be people of goodwill who believe in what they do, but they tend to be dominated by what has worked the best. So that anti-contrarian nature is a little bit built in. But if I had to say what is the biggest thing I see in.

• 58:44Speaker 03

  This is a general investing error that can apply to others, but particularly on investment committees. A throwaway, which I'm going to skip and not make it my biggest error, but it's always the biggest error. It's just not having a long enough time horizon. Too easy. That one. None of us have a long enough time horizon. These things sometimes take decades. Good things cannot work for decades. I talked about international diversification before. A different one. Is over focusing on line items, particularly at a committee. When you have a whole group, we tend to look down, the royal we of many committees I've served on, and say, what's the worst thing here? And what's even worse, akin to my comments about our early vol and not doing half vol or quarter vol, we tend not to do that in a risk-adjusted sense, which is human nature, but is also silly.

• 59:29Speaker 03

  And then we look at things that are not doing as well as the rest of the portfolio, or even doing poorly, and those are the ones we focus on. And that is, again, often backwards. If you're focused on line items, you put things in, many things in a portfolio, precisely because they're diversifying. And then you over-focus on line items, on the ones that are not keeping up. Well, there's a quote I love about diversification that's allegedly Yogi Barrett. He said, "You have to go to other people's funerals, otherwise they won't come to yours." Love that quote. And it's true about portfolio diversification. One of the things I do when I'm on a committee, I'll make suggestions like, if we're bringing in our three worst managers, let's bring in our three best, too, because those are anomalous returns also.

• 1:00:14Speaker 03

  They're more pleasant to have anomalous big returns, but they're no less a mystery. That's a subtle way to get people's mind thinking, all right, if these are big events, do we have a reason they were big? Can we justify them? Can we explain them? Do we want to put more or less? I'll tell you one last story to cap it. During our initial drawdown in 99, 2000, we had, he's now well-known, and I won't name him here because it's a little bit of an embarrassing story. Smart guy, loved us, believed we were right when we were losing money, but his committee was giving him hell about it. So he got the committee to agree that I would come down and present why we thought we were going to be right. And then they would do one of two things, which I thought was really cool. They would either redeem 100% or double up.

• 1:00:56Speaker 03

  And given we were down and markets were way up, even rebalancing would almost do that. So it's not crazy to say, either you think these guys are right and you should at least restore where you were, if not more, or you think they really are crazy. So I went down and did the presentation. I thought I did a great job. About three days later, he calls me and he confirms that, "You did a great job." And guess what? The committee's going to let us retain our investment. And I'm like, what about the doubling? He goes, yeah, gonna work on that some more. But he was a little embarrassed by it because he wanted to double up. They just wouldn't let him.

• 1:01:30Ted Seides?

  So now that you've come out of this trough, as you look out on AQR over the next couple of years for the business and the research you're involved in, what's exciting you the most?

• 1:01:40Speaker 03

  Oh, I have not always said this. This sounds like such a marketing line, but I have never been more excited about our research than I am now. I think, and this was excruciating and had a human cost, but having to shrink by half made us make very hard decisions about being blunt. Who are our absolute best commando team researchers, men and women who just excel. We started out this way and we're back to this way. We are a collection of small teams now. We have reorganized things to somewhat, who are not pod shop tied to their P and L, but are tied to the success of their area more directly, are judged more on both ex ante, how well their research produced and ex post, how it did. And we found that to be very motivating.

• 1:02:22Speaker 03

  So all the things I've been talking about, ML and not just the formal ML group, but ML and stock selection, sneaking into a whole bunch of other things, stuff we do, which we haven't even covered on after tax optimization, I think we're cutting edge on. Trend following, we still have a ways to go. We've made it ridiculously better. I don't know if compliance likes me saying that. I did not say where we started. For compliance purposes, we started out at terrible and we've made it ridiculously better. No, I don't actually believe that. I think we've made it ridiculously better. Next thing I'll be saying is this is investment advice and really just send me to, to third level of hell. I've not been this excited since the very early days.

• 1:03:00Ted Seides?

  Cliff, before I let you go, I want to ask you a couple of fun closing questions. What's your favorite hobby or activity outside of work and family?

• 1:03:07Speaker 03

  You know, this is embarrassing because it's so on the nose, but I collect comic books and comic book art. It's on the nose for a quant geek to be a radical comic book fan. Possibly outside of my children, the greatest development in my life was when movies, special effects finally caught up. I was watching the 1970s Hulk, which Lou Ferrigno was a tough guy, but he didn't look like the Hulk. I still collect those. Thankfully I have a money manager's income with a child's taste. I'm not competing with Stephen A. Coen for impressionist paintings. I'm trying to buy the cover of Avengers number 147 in pencil, but I have a lot of fun with that and I love that stuff.

• 1:03:47Ted Seides?

  What's one fact you find interesting that most people don't know about you?

• 1:03:52Speaker 03

  I think I'm nicer than people think. I have a short temper. Anyone who's on Twitter knows I have a short temper or has read my blog occasionally. I don't hold grudges particularly well. I have a couple I've stuck with over time. But mostly even they have to get me mad all over again for me to rekindle it. Even at AQR, I think when people will tell you I'm kind of a softie on a lot of things. The drawdown made our firm get more harder edged and it was very hard on me because I'm naturally a softie. So I think my public demeanor, which I definitely bring on myself, would be a harder edged person than I actually am.

• 1:04:24Ted Seides?

  I've asked this next one of everyone and it may be the most challenging for you to bring to the top. But what is your biggest pet peeve?

• 1:04:32Speaker 03

  Oh, you say that because I have so many peeves. You want a real one or an amusing one?

• 1:04:37Ted Seides?

  Both.

• 1:04:38Speaker 03

  Okay, I'll give you the real one and I truly, and people might not believe this by some of my writings or even tweets, but I truly don't mind being disagreed with and having a good debate. When I get the sense someone's not debating fairly, avoiding the question. This is the worst on social media because people, there's no feedback loop where you can go, you didn't answer the question. They just ignore you. That drives me batty and I end up saying some stupid things. Let me issue a blanket apology to the world about some of those things. And I don't think any of them have gone too far over the edge. I haven't canceled myself yet. But I don't deal with that well when I think someone is intellectually dishonestly arguing. Wrong is fine. Being right when I'm wrong is fine. When I think someone's doing that, that's an honest peeve. A true peeve, but a little more whimsical.

• 1:05:22Speaker 03

  And I'm guessing a lot of people share this. I spend a non-trivial part of my evening trying to find which streaming service the Yankees are on now. Someone's got to fix this. It may be on Amazon. It may be on Apple. It may be on TBS. It may be on YES or it may be on a network. I'll literally go on Twitter sometimes and just post, does anyone know what channel the Yankees are on? And somebody, thank God, this is social media at its best. Within minutes, somebody tells you, if there's a kitty being taken up a GoFundMe page, I'm in to help do this better.

• 1:05:51Ted Seides?

  Which two people have had the biggest impact on your professional life?

• 1:05:54Speaker 03

  I gotta go with three, but one of them comes in a pair. My dad, my dad gave me that advice, what program to go to. Something else I didn't tell you, when I was an undergrad, I always assumed I'd go to law school, even though I was studying computer science and business. My whole family were lawyers, tiny exaggeration, but one of my cousins was actually John Gotti's lawyer in the eighties. That's a great story that we can do at another time. I promise you, I've never had any interaction with the mafia. I don't want to get tarred with that brush. But up through junior year, I was signed up to take the LSATs. And my dad, again, and my dad was not a Gant, not a math guy, but he just said, you're really good at math. Shouldn't you do something that actually uses that? And at the same time, I was doing some research for some professors, which I mentioned earlier, that I really liked. I was impressionable kid.

• 1:06:39Speaker 03

  It took me about eight minutes to go, yeah, I'll switch to the GMATs. And then I decided to get a PhD. So my dad, he had some very specific influence on me. And then I gotta go up my two dissertation chairs, Fama and French. We don't agree on everything these days. Again, I probably think markets are more behavioral than Gene does. Ken might be in between Gene and I. When I told Gene, I want to write a dissertation on price momentum. He said, if it's in the data, write the paper. I still get chills at the near religious statement of respect for data. And the way those guys do research, as a PhD student, you gotta learn all the math, but that's largely to impress people. I think most of the best results in economics and investing and finance are fairly simple. They use tables and maybe linear regression. And not that tools don't come in at some time.

• 1:07:24Speaker 03

  I've talked about machine learning here, but a lot of the original stuff. The typical Fama French paper would be eight tables and a graph. And it wouldn't have stochastic calculus in it and the generalized method of moments. And they got at things. They were intuitive. Intellectual honesty, even if they don't like a result, respect for data and the ability to do things in simple, clear ways that were powerful. I'm not as good at them as they are, but I learned a tremendous amount from them. And to say they influenced my career is the understatement of the century. I still do what they taught me 30 years ago.

• 1:07:57Ted Seides?

  What's the best advice you've ever received?

• 1:07:59Speaker 03

  This is actually great advice and a little funny. And I'm not going to name who said it to me. Someone very close to me in some situation gave me the classic advice, just be yourself. And then added, but not all the way. Wish I knew exactly what they meant. I can be a little much at times. I probably didn't follow it because I'm me, but I thought that was both hilarious and simply fantastic advice.

• 1:08:25Ted Seides?

  All right, Cliff, last one. What life lesson have you learned that you wish you knew a lot earlier in life?

• 1:08:31Speaker 03

  I've only one-third learned this. I'm on a path, but I'm better than I used to be. That this too shall pass. Barring a declaration of war, a bad day is not going to kill you. And to take that longer-term perspective I said I can be a hypocrite about, I've gotten a third better about having the long-term perspective. I still preach it, and I think that preaching is helpful and accurate, but it's hard to live. And I do think I'm getting better.

• 1:08:55Ted Seides?

  Cliff, thanks so much for sharing this great story of your career and AQR.

• 1:08:59Speaker 03

  This was so much fun. Thank you, Ted.

• 1:09:02Ted Seides?

  Thanks for listening to the show. To learn more, hop on our website at Capital Allocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one and see you next time.