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

24:01I 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 problems. There's no such thing. We're as bad and the spreads were as bad. So we did all kinds of work on that.

24:35But 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?

25:09It wasn't magic that was happening to us. It was market -wide. And we've seen this movie before. 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. 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?

25:46That'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 will 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 is 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.

26:17I'll never say 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 a drawdown goes on, the decisions are more painful. 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, is 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.

26:57So 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 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. So as we talk about it today and you started to come back, it's easier to say we believe of this all along. It was clear in the numbers. When you're going through it, as you mentioned, there's always some doubt.

27:31How 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? 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?

28:06It doesn't always have to reverse. So I'm not saying we don't apply that, but that's only because it's a fairly empty statement because we always have a big research effort going on. Some of my favorite 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.

28:38I 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 does the same one. A different trend follower will use a moving average, will use a filter, will use simple. 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.

29:15And 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. So if you do new stuff you think is great, it's got to play its way onto the team.

29:49It'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.

30:30Doesn'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. 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 research, you can understand why they might work. Then you have the stream of what's called renaissance or something that's pure machine learning.

31:02It'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? It's a great question. And it was a hard one for us because we've always prided ourselves 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.

31:41And 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 -ante, 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. First, we don't use machine learning to say, go look at any data you want and come back with something cool.

32:12It'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 someone, 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 coauthors 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.

32:44The simplest explanation is not always best. And this is going to sound trivially simple, but letting machine learning go to say, choose what factors you like best and put them together. If you let it look at every possible factor, it's going to be a giant, insane data mining exercise. I believe it'll have zero out of sample power. We started with probably 10 plus families of factors and 200 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 ML 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.

33:28And that was a wonderful marriage because we're not doing anything we don't believe in. We're just weighting it differently. Another place is just building factors from the ground up. There are some things where ML 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, got to be more than 20 years. The early versions until relatively recently were word counts.

34:03Count 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. 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 ML through natural language processing extract, is this good news or bad news from relatively unstructured data. I think of this as reverse chat TPT. Chat TPT, you put a query in and you get words.

34:38This 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. a lot of those comparisons are being done now with ml 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 there are probably others how to combine factors and how to create factors now there are limitations i'll give you an example of something ml 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.

35:25What 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 ML 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? 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 ML is making us better. 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?

35:59I don't think we are even trying to use it at that kind of level. Our techniques train 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 you have values, good, momentum's good, but not if you have these other three good things at the same time.

36:35We 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. I will check with the experts afterwards. 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 -7. We'd love to get your perspective on each of those. 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.

37:13Often 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 index. 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.

37:46I do think we need some quorum. 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.

38:17If half the minnows move to indexing and none of the sharks, it's harder to make money. It doesn't make prices less accurate and maybe make them more accurate. Fewer people making errors. 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.

38:52So it's very anecdotal. 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 this? 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.

39:26If 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 a terrible strategy. There's not that much alpha out there and the investor is paying a ton. And even good strategies, this theme we were talking about before, go through bad periods, I'll be firing a lot of good managers.

39:58That 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, which again, defies my intuition from before looking at this.

40:36I 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.

41:09There are limits 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. One beautiful thing about the old school factors, which again, we've diversified away from two, but we still do, is they might have 0 .5 sharp ratio. 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 is 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.

41:43When 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. When you move from equities, which is 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? I'm going to go back to 1995.

42:15So 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 work for individual stocks, if we added up the valuation of the DAX and the valuation of the FTSE and said the DAX were selling for price to 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.

42:54It held up over time. So forever, we've done both. 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?

43:29Why 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. We will trade anything that's liquid and has these things measurable. The most extreme example I'll give you is there's 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 is valuation, carry, doesn't have any of those, or at least beyond our ability to do. But everything has a price trend.

44:01So it's a 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. I want to turn to some of the wise guy stuff you talked about from your childhood. Now you're going to try to get me in trouble. Oh, yeah. I'll let you get yourself in trouble. Yeah, it's okay. I enjoy that. You recently wrote a blog post about cognitive dissonance. Some of these things that investors can't believe. Shouldn't be allowed to believe at the same time.

44:34So I'd love to just pick apart some of these. And I guess starting with illiquidity and private assets is probably a good one for you. 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 to the quant world like efficient frontier charts, where private equity is well to the left of public equity.

45:16And it's concentrated off and 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. 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.

45:49Not to be able 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. If you go back to the David Swenson, 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.

46:20And 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.

46:51So 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. How about international diversification? International diversification is always a hard one because it's been so poor for so long in the US. I am barely old enough for this one, but I'm old enough to remember the late 80s when it was why invest in the US. IFA and driven mostly but not entirely by Japan had crushed the US for 20 years, maybe where the cognitive dissonance comes in.

47:31I find it very inconsistent to believe international diversification stinks for a US investor. Just look at the last 30 years. And then you can go, is international diversification good for a non -US investor? And people start to realize they're caught in the trap because they want to say, yeah, yeah, you get US 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. 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.

48:04But 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 exposed from one country's perspective and terrible exposed 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 with.

48:38I wrote a piece on that. A piece on the website called The Long Run is Lying to You shows that U .S. 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. U .S. started out cheaper and is now considerably more expensive in terms of current cash flow, sales, earnings. That doesn't necessarily reverse. Maybe the U .S. 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.

49:11You 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. 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. That gets into performance chasing.

49:41Everything leads back to performance chasing. It's the original sin of investing. And your thoughts on the cognitive dissonance of performance chasing? 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 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.

50:17Be careful what you wish for. Not that I'm going to 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 subset of people I'll probably write and not convince most of the world, which I think is the path I'm on. How about technology innovation? 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.

50:49It's often called a Whiggish belief. Whiggish is the force of history is going to 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 expense. We can't come up with a reason to rationally explain why it's wider.

51:21In the tech bubble, in the dot -com bubble, 99, 2000, it hit the widest level ever in 50 years. If you want to 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 as better investors.

51:58Essentially, crowds that are independent, the wisdom of crowds are extremely good. 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 on net markets are somewhat less sufficient. How about one more dissonance, talking about leverage and concentration as risk? You should be scared of leverage. Leverage is exactly what it sounds like.

52:34It's upping the risk in return on something. And 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.

53:06We 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. 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.

53:40If 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 can be a bond substitute where you sell some bonds and buy some stocks. Our favorite thing to do, we use 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.

54:14So 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. I want to play around a little bit with your thoughts on private equity and volatility laundering.

54:49How 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? 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 and the metaphysical, what is this really worth sense.

55:24My 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, they could absolutely tell you. No one would be happy with it, but they could absolutely tell you.

55:54When 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 fare. 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.

56:28But 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. 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 propose 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 I'm good with that being the detente.

57:02All 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 Podchops, for example, might select managers. How have you thought about the manager evaluation process? 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.

57:33I don't come in and go, I make this all quant. 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. That's true in a lot of walks of investing. I think it's particularly true of committees where they don't own anything.

58:08They 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.

58:40But if I had to say what is the biggest thing I see, and this is a general investing area that can apply to others, but particularly on investment committees, a throwaway, which I'm going to skip and not make it my biggest era, but it's always the biggest era. 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. AIDS. 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?

59:19And 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 it's also silly. And then we look at things that are not doing as well as the rest of the portfolio, 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 Berra.

59:55He 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. 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?

1:00:26Do 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. And given we were down and markets were way up, even rebalancing would almost do that.

1:01:01So 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 is going to let us retain our investment. And I'm like, what about the doubling? He goes, yeah, going to 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. 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?

1:01:40Oh, 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 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 &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.

1:02:20And we found that to be very motivating. 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.

1:02:51Next thing I'll be saying is this is investment advice and really just send me to third level of hell. I've not been this excited since the very early days. Cliff, before I let you go and ask you a couple of fun closing questions, what's your favorite hobby or activity outside of work and family? 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. And 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.

1:03:29I still collect those. Thankfully, I have a money manager's income with a child's taste. I'm not competing with Stephen A. Cohn 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. What's one fact you find interesting that most people don't know about you? 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.

1:04:07Even at AQR, I think when people will tell you I'm kind of a softy 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 softy. So I think my public demeanor, which I definitely bring on myself, would be a harder edged person than I actually am. 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? Oh, you say that because I have so many peeves. You want a real one or an amusing one? Both. 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.

1:04:47When 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. 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.

1:05:18A true peeve, but a little more whimsical. 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.

1:05:51Which two people have had the biggest impact on your professional life? I got to 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 80s. 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.

1:06:21But up through junior year, I was signed up to take the LSATs. and my dad again and my dad was not again a quant 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 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 got to go with my two dissertation chairs, Fama and French. We don't agree on everything these days.

1:06:53Again, 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 got to learn all the math, but that's largely to impress people. I think most of the best results in economics and investing in finance are fairly simple. They use tables and maybe linear regression. Not that tools don't come in at some time. 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.

1:07:31And it wouldn't have stochastic calculus in it and the generalized method of moments. And they got it 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. What's the best advice you've ever received? This is actually great advice and a little funny, and I'm not going to name who said it to me.

1:08:04Someone 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. All right, Cliff, last one. What life lesson have you learned that you wish you knew a lot earlier in life? 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 a long term perspective.

1:08:47I 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. Cliff, thanks so much for sharing this great story of your career and AQR. This was so much fun. Thank you, Ted. Thanks for listening to the show. To learn more, hop on our website at capitalallocators .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.

1:09:31Thank you.