E427: AQR's Peter Hecht on AI, Market Bubbles & How the Best Investors Build Portfolios

28:20Yeah, that could be another, like it gives you the conviction to stay with the trade. Now, that being said, we also want to be open-minded, right? It could be that we were wrong. So there's sort of a healthy balance. Our founder, Cliff Aspen, has always said, we want to be open-minded, but not so open-minded that our brain falls out, right? Because there are people where once things just don't go well, they bail, but they don't bail and make it sound like bail. They just, no, it's because I'm flexible and I learned something and I actually have a different view. Again, that could be true, but again, that's where the subjectivity comes in and whether someone has really good judgment.

28:58Are they just pulling the plug prematurely or did they come up with rigorous evidence to suggest they need to change their mind? Are you looking for a 51 % hit rate, a 55 % hit rate, a 90 % hit rate? In stock selection, the way it ends up working on average is, let's say, if we're right about about 55 % of the time, we've hit our target return and at that reasonable risk level. So that means 45 % of the time we're wrong. And when you look at it, again, there's always exceptions. If you said like, or let's say one year we were 52 % right and we hit our target return. And let's say we're having a bad year and you must be like, well, instead of 52%, you must be like at 37%, you're having a bad year.

29:47No, we're at 49%. The difference between hitting your target return or having a good year versus a bad year, it's small, right? It's a small edge. So while we're still maybe right 48 % of the time or 49 % of the time, and again, that's why we believe in diversification. That's why we're doing the innovation to bring in more signals so that we could have that better batting average. Growing up, I thought managing money meant paying bills and balancing a checkbook. But as you know, that's only a small piece of the financial puzzle. Managing your money takes more than just checking your bank account every once in a while.

30:23And great financial decisions come from having a complete picture and proactive management for your income, expenses, and investments. Take control of your finances with Monarch. It brings together all of your accounts, investments, saving goals, and spending into one place, making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals. What I like most about Monarch is that it doesn't just tell me what already happened. It helps me plan ahead. The AI assistant lets me ask questions about my finances in plain English. And the AI weekly recap highlights spending changes or upcoming expenses before they become surprises.

30:53It's like having a financial advisor in your pocket. Write your own money story with Monarch. Use code invest at monarch.com to get your first year of Monarch core half off at just$50. That's 50 % off your first year at monarch.com with code invest. Growing up, I thought managing money meant paying bills and balancing a checkbook. But as you know, that's only a small piece of the financial puzzle. Managing your money takes more than just checking your bank account every once in a while. And great financial decisions come from having a complete picture and proactive management for your income, expenses, and investments.

31:22Take control of your finances with Monarch. It brings together all of your accounts, investments, saving goals, and spending into one place, making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals. What I like most about Monarch is that it doesn't just tell me what already happened, it helps me plan ahead. The AI assistant lets me ask questions about my finances in plain English, and the AI weekly recap highlights spending changes or upcoming expenses before they become surprises. It's like having a financial advisor in your pocket.

31:49Write your own money story with Monarch. Use code invest at monarch.com to get your first year of Monarch core half off at just$50. That's 50 % off your first year at monarch.com with code invest. Growing up, I thought managing money meant paying bills and balancing a checkbook. But as you know, that's only a small piece of the financial puzzle. Managing your money takes more than just checking your bank account every once in a while. And great financial decisions come from having a complete picture and proactive management for your income, expenses, and investments. Take control of your finances with Monarch.

32:18It brings together all of your accounts, investments, saving goals, and spending into one place, making it much easier to understand where your money is going and whether you're actually on track to achieve your financial goals. What I like most about Monarch is that it doesn't just tell me what already happened, it helps me plan ahead. The AI assistant lets me ask questions about my finances in plain English, and the AI Weekly Recap highlights spending changes or upcoming expenses before they become surprises. It's like having a financial advisor in your pocket. Write your own money story with Monarch.

32:45Use code invest at monarch.com to get your first year of Monarch Core half off at just$50. That's 50 % off your first year at monarch.com with code invest. Yes, it's not like we're right 80 % of the time. It's more like low 50s, mid 50s for our stock. Is trading a place where you seek not to lose any of the alpha that you made through investing or can you also capture additional alpha on the trade? If you're like a market maker, if you're Citadel, they have a whole team that's making money through trading because they're providing liquidity. They're providing liquidity who want liquidity and they make a liquidity premium.

33:21So you can't. For us, the type of investor we are, we are not a high frequency trader. We are always trying to minimize the impact on our alpha ideas. So we're not trying to be a market maker. That's not your business. That's not our business. Our business model is we're a fundamental systematic manager. We're thinking about the next month, the next quarter, the next year, not the next tick or the next five minutes. Speaking of your business, you operate with customers, institutional investors, high net worth individuals. What type of strategies are they asking for today? There's some commonality.

33:59The first and foremost is a multi-strategy. And why is that? Because people have realized that it's hard to pick the single sub strategy that's going to outperform next year. If you think they're all good over the long run, get the benefits of diversification in the single line item that does a multi-strategy approach. So it will include stock selection, market neutral. It will include market neutral macro. It will include directional macro like trend following. It will include corporate arbitrage. So people see that as their core sort of beta neutral diversifying hedge fund position or liquid alts position.

34:40And then from there, that multi-strategy, while it will have trend following, which has some protective properties, the first question most clients ask, or we ask them to see if they should supplement this multi-strat, is do you want more protective properties? And if the answer is yes, you might add in more trend follows. So you might put the levers up and down depending on your risk tolerance. Exactly. So your multi-strat will be there. It's something that will diversify your stock and bond risk, public or private. It's something that can do well both in a growth shock or an inflation shock.

35:18But if you want more protective property, something that can outperform in a challenging market environment, The only hedge fund sub-strategy that has sort of bona fide evidence for that type of a result is trend following. So those are the two popular project, I would say, product types of strategies, both within institutional and the sort of high net worth channel. I like to keep track of these mistakes that smart people make or these beliefs that smart people have that are incorrect. And one of the most common ones I would probably define as momentum. You see these tweets about, well, if you had just invested in the MAG7 the last seven months, you would be up 2x.

35:56Why even buy the market? And then this year, the Magnificent 7 is underperforming the index. But it's crazy to me that these very smart investors have these recency buys and oversimplify investing in such a way. Your point brings up a broader point, tying it back to diversification. let's say they're even right, like versus they're just ex-post trying to be a talking head on like what's going on and what they should have done. You shouldn't put all your eggs in one signal or one theme like momentum, right? Even if that's a good theme over the long run. So when we're putting together portfolios, when we're trying to determine whether a security, a stock or a macro asset is attractive or not, we're using multiple themes, multiple signals, and they're not all going to be flashing green and they're not all going to be flashing red, right?

36:46It's the weight of the evidence. And I think a more diversified approach would also protect people from putting too much weight in momentum, for example, even if momentum is something that should be in your portfolio. Perhaps you could double click on trend following. It's a strategy that a lot of smart people believe in. How would you explain it to a lame person? Trend following is taking advantage of the fact that market participants tend to underreact to news in the short run. They underreact to news. So that's why when prices went down in the recent past, they went down the right direction, but they underreacted.

37:24They should have gone down even more. So if I look at past returns and it's negative, I should short with the assumption that eventually the market will catch up for where it should go. Just like if there was good news and the price was up, it didn't go up enough, but it'll eventually get there. That was sort of first generation trend following signals where they would look at past prices. So that type of strategy has delivered attractive returns over the long run. Again, taking advantage of this behavioral bias of underreaction and you do it across hundreds of macro assets. It's delivered a diversifying return, i.e.

38:03very low correlation to most people's main portfolio. So like a neutral correlation? So like a zero correlation. So something, if you think of the main - Half of the trades go up, half the trades go down. It's just when, if the main risk in people's portfolios is equities. When I say something has zero correlation with equities, that means, hey, the S &P was up a lot. Is that good news for trend? I say it's meaningless. It has no information. Okay. Oh, S &P is down 15%. Is that good news for trend? Meaningless because it's got zero correlation. They don't tend to outperform together. they don't tend to underperform.

38:36It's random. And that's what you want because you don't want all your eggs in one basket. The third property that trend following has, so we said competitive return over the long run, low correlation, so it's a diversifier to stocks. It also, I mentioned before, has these protective properties. Protective properties are different than diversification. Protective properties are, do you tend to have an above average return during challenging market environments like an 08, a 22, the tech bubble burst, et cetera. And trend following has that. And you could sort of make sense of it because if it's a protracted, challenging market environment, prices are going down, a trend follower shorting, shorting, shorting, and it's protracted.

39:19Just like if markets are going up, they're going to be going long those asset classes. So trend following, that's the sort of behavioral basis behind it. And that's why people include it in their portfolio for diversifying competitive return that has those protective properties. Is that a smarter version of looking for something that's negatively correlated to the market because you're actually capturing upside instead of just holding money as a hedge? So if it's negatively correlated, so let's take like a put on the S &P 500, negatively correlated tends to have a negative expected return over the long run.

39:54So even though It's like your home insurance. Like when your house burns down, you make a lot of money, right? Because you paid your$5 ,000 premium and they gave you, let's say you own a million dollar house. They gave you a million bucks to rebuild your house. But most people are paying 5 ,000, 5 ,000 or 10 ,000, 10 ,000. They expect to lose money on their insurance policy, but they do it because it's insurance. So I wouldn't call trend following like a hedge in the same way like a home insurance contract or put option, but it does have some hedge-like features, but with some basis risk. It's not automatically because the other thing is like a COVID crash.

40:36COVID crashes are fast. It's not a two-week downturn. Trend following is not really designed to do well in that type of environment. Not that it's going to do poorly. It's not a protracted, challenging market environment. So trend following people have for those protective properties, but it is not a negatively correlated asset like a put option, but put options have negative expected returns. People can't hold on to them because it bleeds and bleeds and bleeds. I know you can't give investment advice, but you're constantly dealing with the smartest investors in the world. And when it comes to their public books, the smart investors are managing their own money.

41:12How much typically do they have exposed to the market? How much beta do they have in their portfolio? Most portfolios, no matter how many line items they have, explicitly have a ton of equity risk or have investments that are so highly correlated with equities, we can just call it equities. Because like that thought experiment I said before with trend following, S &P's up. If I say the S &P's up a lot, what does that tell me about your private credit? And you tell me, oh, it's up. And I tell you the S &P's down a lot. What's up with your private? Oh, it's down. credit is sort of like mini equities, right?

41:50They don't do well when there's massive recessions and they can do well in an expansionary period, for example. So most people's portfolios, 90 % of the risk can be explained by some type of an equity factor, no matter how diversified it looks like when you look at all the line items. And so that's usually the first thing I'm trying to address when thinking about how on the margin can I improve someone's portfolio? And that's where we were talking about before adding in a multi-strategy hedge fund or adding in trend following as a supplement if you want more protective properties. One thing we didn't talk about, since I'm going to tie it back to these portfolios are equity dominated.

42:33Sometimes I interact with clients or investors who just love their equities. They're not giving it up. And that's where a solution like Portable Alpha comes in. So Portable Alpha takes that multi-strategy, which is market neutral, and let's simplify it, puts on one additional security, an S &P 500 futures contract. So now it's beta one equities plus high quality special sauce active return long short from the multi-strat. Now this can be in their equity book. So you always have to be thinking about, of course, I always want to try to give people my opinion. But at the end of the day, if it's your portfolio, you know your risk tolerance.

43:15You know the types of risks you like and don't like. And I have to work within those constraints. Maybe that's going to be a market neutral, uncorrelated hedge fund, like a multi-strat or trend following. Sometimes I'm going to package those with beta one in order to make it a core equity solution that can meet the needs of someone that has, hey, I have an opening in my bench on my core equity team. Your market neutral stuff doesn't have beta and I need beta. So portable alpha solves it. I want to get into portable alpha in a bit, but the sharp investors, are they typically one beta? Are they more levered?

43:54What is smart investors doing in terms of their equity exposure? If I look at their overall portfolio, smart investors are doing different things. They're sort of a crowd that's doing a lot of privates. Yeah. Right. Endowments. They might be doing a lot of private investing, private equity, private credit, private real estate, private infrastructure. But then you have other really smart investors that have this sort of total portfolio approach mindset that are really trying to get the most bang for the buck and trying to maximize capital efficiency. And they're doing overlays internally, effectively doing portable alpha.

44:32So I think it just depends on the investor. So, yeah, I would say the more sophisticated investors do see the role of a diversifier, even in a market environment where equities are crushing it, where it's easy for people to say, why do I need diversification? And then I say, but that's what people were saying before 22 and before 07, right? The whole idea is we don't know when markets are going to tank. You don't know when your house is going to burn down, right? Otherwise, you wouldn't get home insurance until the year of your house. And I would say it's not even knowable. It's Bayesian, meaning nobody could definitively know that COVID would spread.

45:14Exactly. So you're always good risk management. There's many. One thing is to have a really good imagination of what could happen. You're not saying it's going to happen. You're not saying it's probable. You're just saying it could happen. And then you have to ask yourself, what happens to my portfolio? And when we do asset allocation, we do those types of exercises to give people a sense of how bad it could get and are there ways to make it more resilient. At the former CEO of a trillion dollar plus asset manager, he said that the 60-40, there's a lot of correlation. 2022 is correlated. So in some ways, you're almost as correlated as if you were 100 and zero.

45:55The correlation was almost one-to-one in some portfolios. So this is a great point. Most people before 22 thought central bankers got rid of inflation risk. The only risk out there are recessions. And if there's a recession coming, they'll lower rates because they don't have to worry about inflation. And they will get rid of the cold of the economy. And if it's a growth shock like 08, treasuries are going to do well when stocks go down. So treasuries or core bonds, high quality bonds are a good diversifier to stocks. If it's a growth shock, 22 comes around and people are like, oh, actually, if it's an inflation shock, stocks and bonds both get crushed.

46:42And that's when people would talk about the stock bond correlation started to get really high and positive. So when inflation news becomes a dominant force in the macro economy, stocks and bonds tend to move together. So one of the reasons why we always tell people to have these like market neutral multi-strats or trend following is while bonds might be a diversifier to stocks, they're only a diversifier to stocks if it's a growth shock. You have to think about inflation shocks too. Multi-strat or trend following can do well in either a growth shock or inflation shock. So if you want someone to sort of understand it, you just say, how will your portfolio do in an inflation shock?

47:24And when they realize a nominal bond paying fixed coupon, if there's inflation, your real payout is much lower. That's why bonds tank. Do you have any bonds in your portfolios? Yeah, we believe in bonds. Bonds in terms of like a core long only base, it should have global equities. Global, so including emerging markets, get the benefits of diversification. You will have global bonds, right? Get the benefits of diversified bonds. do, again, are helpful. They provide a risk-adjusted return that's competitive to stocks, risk-adjusted, not total return. And then an allocation to inflation-sensitive assets like commodities and tips.

48:08So that would be without going sort of long-short, our sort of ideal portfolio would try to get the most out of all of the sort of asset classes that offer a positive average return over the long run. And we would sort of risk balance them. And we would be thinking about things like, do I have something that can do well if inflation is higher than expected? So you have stocks, bonds, commodities, and you're long only. Now let's introduce leverage. What are the principles? How much leverage do you put in? For that long only, it would depend on what is the risk tolerance of the client. So a lot of times people say, well, if 60-40 was acceptable and 60-40 has roughly a 10 % volatility, we would use enough leverage to get that portfolio to 10 % volatility.

49:00And the amount of leverage to get there will vary over time depending on how volatile markets are. So that would be, so it's always driven by - Presumably the expected return is higher, but the volatility would be. So think of it as we have these global equities, global bonds, and we have this global inflation-sensitive commodities. Unlevered, let's say it has a good risk-adjusted return. It's got a better risk-adjusted return than 6040. But unlevered, it's got such low vol. Its total return is low, even though it's got a great risk. So we need to boost up the vol. We do that through leverage.

49:35So when we use that leverage to get it to 10 vol, vol, it's now 10 vol, just like 60-40, but it will have a higher total return base case than 60-40 because my portfolio is more diversified than just holding stocks and bonds. It's interesting that you guys use volatility because you could also define risk - We do other stuff, yeah. As the risk of losing money. So if your expected return is higher, the volatility could be higher if your metric is, can I lose money? So I actually wrote a paper about this, about this whole notion of like, is volatility a good measure of risk for people who care about permanent loss of capital?

50:11And I think that gets to what horizon are you measuring volatility? Are you measuring one-day vol? Are you measuring one-month volatility? Are you measuring one-year volatility? If you're a long-horizon investor and your horizon's 10-year, you should measure 10-year volatility. And there are ways of doing that. So I do think - If you can hold. Right. But I'm just saying in terms of the framework you would use, because one-day volatility annualized is not the same as 10-year volatility annualized. Most people are using higher frequency daily or monthly data and annualizing it. And then people like Howard Marks will come in and criticize it and say, well, that's not a good measure of permanent loss of capital.

50:53And he's partly right, but that's because people are misusing. They're not measuring the right volatility. There's almost two different use cases. One is if you're cryogenically frozen for 10 years, what would your portfolio be? And two is, if you were not cryogenic for 10 years, what would be your ideal? Because there's a behavioral aspect to it. Yes, yes, yes. And again, so you need to be mindful of the short-run volatility, short-run risk levels, because you aren't frozen. Let's say you could put it under your mattress and go to sleep for 10 years, then 10-year volatility will be a good measure of permanent loss of capital.

51:31It won't be perfect, but it'll be a good measure. And some of the criticisms of volatility are really about using the wrong horizon. An investor at Marc Andreessen's family office told me something fascinating, which is if you have a high expected return over time, even if you have a relatively high volatility, you're going to have a high expected return. In other words, if you have a coin, the best way that I found to explain this is if you have a coin with three sides and two out of every three sides is a positive outcome and only one is a negative. If you flip it enough time, you're going to be doing pretty well.

52:08Normally, when someone thinks of a long horizon return, so let's say I care about my 10-year return, they're not thinking of a 10-year expected return. They're thinking of a 10-year 50th percentile return, the median. What's the most likely? And you might be like, well, isn't the expected return the 50th percentile, the middle of the distribution? No, because when you have compounding, your distribution gets highly skewed. OK, so most people care about the 50th percentile. The 50th percentile will be equal to the expected return. And I don't know if you've heard of this concept called volatility drag.

52:48Some people call it the 10 year base case. 50th percentile return will be that expected return that you talked about. minus one half volatility squared. Okay, so that volatility of that asset actually lowers the actual base case 50th percentile return. And what's that equation for? Some people, like depending on who you're talking to, again, this is getting a little geeky. It's a difference between a arithmetic mean and a geometric mean. And that's essentially if you own a stock at$10, it goes down 20%, then it goes up 20%. you'll be at$10. Exactly. There's that asymmetry. And that's always to the downside.

53:29That works too. If you're interested in the 50th percentile outcome. So I think some of these examples are, they are more difficult, but I would always come back and say, be diversified. Even if you think you got this great asset, I would never invest in that one good trade thinking that over the long run, I'm automatically going to win. In the same way, people think of like, well, stocks are only risky if you have a short horizon. They have a higher expected return than bonds, of course, they're going to always outperform bonds over a 30-year period or 50-year period. And the answer is no, they're not.

54:01They might be expected to outperform, but I guarantee you there are scenarios where they underperform. And then I'll bring up Japan. No one ever thought the Japan equities would be in this malaise for so long. So just because something has a higher expected return with higher volatility doesn't mean it will eventually outperform over the long run. There will be parts of sort of outcomes that are unfavorable. So is there another aspect to that? You said that it'll be slightly below the 50th percentile, but is the expected return actually higher? Yeah. The expected return is higher. Yep. Because of compounding effects.

54:42What kind of questions are you asking yourself these days? One is which asset classes should I have if I'm really scared of inflation taking off because of what's going on in the Middle East or what's going on in Ukraine or what's going on with tariff policy. That just reminds me that most people's portfolios are very pro-growth. They want growth to happen because they are equity dominated and they want disinflation, not in inflation. The way really to sort of start making progress on balancing out those macroeconomic exposures is to bring in things like commodities, to bring in things like tips, if you're thinking of long only.

55:22And like we talked about earlier, some of those long short strategies, it's not magic. It's like it's because they don't have beta, right? If something is market neutral, either short run and long run or over the long run, it doesn't have the stock in bond beta that's giving those asset classes the macroeconomic exposures. So bringing in those multi-strategy hedge funds and bringing in trend following are ways that I continue to preach can help out if you're worried about inflation or you're worried about tail risk. And then to the other point where we're talking, I brought up portable alpha. A lot of times people will come to me and say, you improved my risk adjusted return, but you didn't improve my total return.

56:08I sort of went into these long, short hedge funds and I pay bills with total returns, like do something for me. And so we've really had to rethink like that's a capital inefficiency problem. It's not a problem with the hedge funds per se. It's how can I package them to be more capital efficient so they get more bang for the buck so I can improve their risk adjuster return and I can improve their total return. And the easy way of doing that is through design of the strategy, and that's taking those strategies and adding in that one additional security, let's say an S &P 500 futures contract that gives full beta exposure.

56:47So people care about inflation. They care about capital efficiency because they know they can't just rely on passive equities because valuations are stretched. They need active management, but long-only active management's been really disappointing. And so we're trying to think through, well, let's take the shackles off. Let's not have it be long-only active management. Let's have it be long-short, and let's package it and construct it properly to solve these foundational problems. How would you explain portable alpha to a layperson? So portable alpha. Normally, when someone wants to go active in an asset class, like equities or fixed income, they actually, if that's the beta, that's the benchmark, they go find, let's say for equities, they go find if it's U.S.

57:34large cap. I got to go find a U.S. large cap active manager. So the U.S. large cap active manager gives them the beta plus the alpha. Okay. And they're doing it long only. Portable alpha, the original insight 20 years ago was, why should you, given that alpha is so hard to harvest, why would you constrain yourself to looking for alpha only in U.S. large cap? Right? You need U.S. large cap beta, but why should the alpha have to come from there? You can get the alpha from anywhere where you think there's high quality alpha, then have that manager put on an S &P 500 futures contract. So you're porting, you're making the alpha portable so that you can take the alpha from another market, another strategy, and bring it back and have it sit within your S &P 500 sleeve.

58:28And that's where the name portable alpha comes from. And the S &P 500 futures is just giving you the net exposure. So if it's up five, it's up five. If it's down five, it's down five. But you're not taking the 100 % of exposure there. you would earn the return on the S &P 500 minus the implied financing cost, right? Because it's unfunded. So think of it as like T-bills plus some financing spread, okay? So for portable alpha, if you sort of did all the math, you would get the total return of the S &P 500 plus the excess of cash return of your hedge fund alpha strategy minus any frictions. So let's put it in dollars and cents.

59:16You put in a million dollars into a portable alpha strategy. Yeah. Where does that money go? So depending on the implementation, right, it could be let's talk about an integrated solution. So there's a single fund. let's say you want 7 % volatility to trend following as your alpha source. Okay. So you give me a million dollars. I put this million dollars in this fund. It will give you a million dollars worth of S &P 500 exposure, and it will give you a million dollars of managed futures trend following exposure at 7 % volatility. Importantly, you don't get the total return of both the S &P and the managed futures.

1:00:06You get the total return of the S &P 500 plus the excess of cash total return, right? Because when you borrow, you have to pay a financing rate, right? You don't get to double down and get... So for your million dollars, you are getting a million dollars of S &P exposure plus a million dollars of managed futures trend following exposure at 7 volt. It's the cost of treasury plus trend following return plus S &P 500 roughly equals your return. Yeah, the cost of treasuries plus a little financing spread because people need to make money who are in these markets. Yeah, so that would be part of the frictions.

1:00:44Yes. And you mentioned it yourself, trend following has been around for a while. A lot of people blew up in the previous version. I believe it was around 08. Why won't that happen again? Well, in 08, it actually did well. So that's actually why everyone got in after 08. And so it did really well. And then in the 2010s, the industry was sort of mediocre. And we actually wrote some papers on this. That was because there was actually low macro volatility in the 2010s. It was really calm. So if trend following is based on underreaction to news, if there isn't much news, there is very little to underreact to.

1:01:23So after 08, where it showed its protective properties, it did awesome. A lot of people got out of trend following after holding it for 10 years, and it was sort of mediocre. And they got out in 2021. And in 2022, the industry was up, let's call it 30 % or 40%. So managed futures trend following for people who don't have the patience, right? Because we don't know when the next crisis is going to come, right? Sometimes holding it with equity beta is a way to force discipline. Because if managed futures is just having mediocre returns and you have it with S &P 500, mediocre returns plus S &P, you're top decile as a active S &P manager.

1:02:08If you're just holding managed futures standalone and it's just having a two, three percent returns, you're sort of like, oh, is that a good use of my capital? I'm getting these tough questions from my CIO, getting tough questions from my investors. Right. So that's one thing. one advantage of something like portable alpha, it gives the staying power to stick with these diversifiers. And it's sort of funny, these diversifiers, it's a feature, not a bug that they don't track the S &P 500, right? But when the S &P is doing well and they're not tracking it, people lose patience because they forget the fact that they have this in the portfolio because they want it to be different.

1:02:47But they only want it to be different when the S &P is down. And the portable alpha helps adjust for those behavioral mistakes. That's one reason, right? Like portable alpha, someone came to me and said, so what problems does it solve? One, long only active management is inconsistent because of the long only constraint. It's like being a world-class sprinter and you have cinder blocks in the 100 meter dash. Taking, doing portable alpha, using a long short source that's as your alpha source, unconstrained, high quality alpha, pair that with beta one. Now, all of a sudden, you can do active management much better in your beta one equity sleep.

1:03:23So that's one reason. The second reason people love portable alpha is a decade ago, the people who went into multi-strat hedge funds or any hedge fund or liquid alt, they had to sell down stocks and bonds to fund it. And stocks and bonds crushed it, right? Stocks crushed it. So they start to feel like they have egg on their face. And they're a little bit worried, like even though equity valuations are stretched, maybe I have to be concerned. What if equities just keep going up? I don't want this funding problem of selling stocks going into something that maybe hits its base case return, but stocks beat it.

1:03:56So it solves the funding problem because you replace the equity beta one for one. And then the third reason, which is what we talked about, people complaining that sometimes these diversifiers improve risk adjusted returns, but not total returns. Portable Alpha solves that capital inefficiency problem. And Portable Alpha in its previous generation did not blow up. It just didn't perform well. It depends on implementation. So implementation has improved a lot. Some people were doing very risky implementations prior to the global financial crisis, and that reared its ugly head. We are big believers in having a single manager who manages the alpha strategy also put on the beta overlay because they then can manage the cash for the derivatives safely.

1:04:40They can make sure you're beta one. Sometimes people separate the two functions. They invest in an alpha manager. They either get derivative capabilities in-house or they hire an overlay manager, and that works 98 % of the time. But there's cash management operational risk. So there are many what I call turnkey solutions, integrated solutions, single manager solutions that pretty much take implementation risk off the table. And the main risk you face with portable alpha is the risk of active management, right? which is the risk you signed up for. Pete, if you could go back to, you had just left Harvard after doing your PhD at University of Chicago, you could give yourself one timeless piece of advice as you entered the investment world.

1:05:25What would that be? I was unwilling to share my credentials with other investors and colleagues. And I think that actually hurt my career. So I I remember there was a story when I was an allocator. And even when we used to have business cards, I don't have business cards anymore. I wouldn't even put PhD at the end of my name because I thought it was sort of like bragging. I didn't want to be a show off. I wanted to be the common person. I didn't even remember in high school. I didn't want to talk about I was in honors classes. I was a normal kid. And one of my colleagues, when I was an allocator, sort of took me aside and said, Pete, what are you doing?

1:06:05Like, this gives you credibility. We're in a situation where people don't know you. You need to signal to them that you actually have an engine because there's a bunch of frauds out there or there's a bunch of people who are willing to oversell their skill set. and the fact that like you were a Chicago finance PhD, you were one of Gene Fama's best students that year, which is why you were his TA. You were a Harvard Business School tenure track professor who taught in the MBA PhD program. And you were actually an allocator managing multi-billion dollar portfolios. That gives you credibility when you're sitting across the table with someone and they're thinking, is this guy the real deal?

1:06:43Is he chat GPT? Is he Claude? I didn't do that. I didn't leverage that enough. And while I still am somewhat humble, my wife always tells a story when I was at Harvard. Someone's like, so what do you do for your profession? And I go, I'm a teacher, which was technically true, right? But my wife's like, what are you doing? Like, what's the big deal? What are you ashamed of? And so I would tell people, if you really have bona fide credentials that signal real talent and you know you're competing against people who have resumes that are inflated, that are sitting in meetings claiming to be knowledgeable about stuff that they're not that knowledgeable about, use these hard credentials, concrete credentials, that are bona fide verifiable to signal that you're the real deal.

1:07:32And I try to do that a little bit more today, and I think that would have helped my career if I would have done it earlier. I've struggled with that as well. I understand where you're coming from. well pete this has been an absolute master class thanks so much for jumping on well thanks for having me we really appreciate it