Cliff Asness, Principal and co-founder of AQR Capital Management at Encounter Capital-AQR event

Sure. Well, it was fabulous the half of it that I completed. I've never fled a country before. So this was a new experience. I will tell you it was very disappointing to have to go. We had things, I have things this week in New York that I absolutely can't miss. Which is why we cut the trip short, which is why I'm this disembodied voice over Zoom instead of what I had intended, which was to be there in person. But we spent close to five days in Jerusalem and one day in Tel Aviv. It was supposed to be five and five. I have to admit I had not been to Israel before. I don't know how much personal biography you're okay with, but I...

New York City reformed Jew, which is really an argumentative form of Quaker. Hopefully people know I was kidding there. It's hard to tell over Zoom. But it's not even about Israel. I have never been practically anywhere that wasn't work till the last couple of years. Basically, if I visited your country, it was to ask you for money. Sometimes I visited to ask you not to take your money back, but it was mainly work. So, I've just really started, I'm approaching 60 very, very shortly. So, my wife and I have started traveling. And to be blunt, I'm somewhat of an October 7th Jew. I have certainly gotten more serious about it in every way, including Israel and supporting causes. And I had planned to go several times. One time in particular, we were weeks away from going and then my mother got sick and a lot of that plan was to take her. So it was high time.

Yeah, I think that's true. So I think it accomplished a lot for me. I got to see the place in person, to get the spirit of the people in person, stuff I kind of knew, but it's not the same until you're on the ground. And frankly had a lot of fun. I'm a history buff when I'm not quanting. I'm reading something, some historical either non-fiction or fiction. And you've probably noticed there's a fair amount of history in your country. So that was a lot of fun. And I don't know if you guys feel this way, you never know about how you feel about your home country, but it was some of the best food I ever had for five days. So, great visit. I'm probably going to be back in May. I'm going to try to make it a more regular thing. I think it's important. And sorry I couldn't be there in person. Almost made it.

Well, that's what we call a long-short strategy.

That's really cool and a little scary. But I got very lucky. And anytime you get to a certain point, you're happy with it. If you don't admit you had good luck along the way, you're probably not telling the full truth. I decided I wanted to get a PhD in finance. How I came to that decision, I have to go too far back and I'll bore everyone, but I showed up at the University of Chicago in 1988. This was a very fertile time. The very beginnings, and the form has changed a lot. The models we use today barely resemble stuff we were doing in 1988. But the core kernel of what would come to be called quantitative investing, what would come to be called factor investing, was just starting in academia. And Chicago, particularly the work of Gene Fama and Ken French, was at least one, I would call it the epicenter. Certainly not the only place doing great work on it, but I would say it was the epicenter. And I showed up there just when it was getting started and I got to work with Fama and French. I was Gene Fama's teaching assistant for a couple years. A standard joke I make, and if I sent you a bio maybe in that bio, is that working for Gene Fama I still feel guilty every day when I wake up trying to beat the market because Gene Fama is known for many things but probably most directly for the efficient market hypothesis and one of the implications of that is it should be pretty hard to beat the market. I think the things we believe in are pretty similar to the things Gene believes in. So I don't think he'd yell at me too much. But I got there and the state of what I'm going to call quantitative investing, keep in mind, we did not have these terms back then. Factor investing, quantitative investing. It's always funny when you talk about the past. You always use today's terms, but you weren't thinking of it that way. We were just trying to figure out why some stocks outperformed and some underperformed. And kind of the state-of-the-art at that point can be summed up in today's language as the value factor and the size factor. Small firms tended to outperform large firms. We don't actually, we've written a lot about this and we can get into it later if you'd like. We don't actually believe that one too much, but that was the state-of-the-art back then. And the value factor, low multiples beat high multiples. Early papers, I don't even think even called it the value factor. And I happen to think that's a terrible name because any competent active manager who's picking individual stocks, not a quant, someone really getting into the details who would call themselves a value manager is looking at a lot more than multiples. A low multiple might be justified. But we did find, and I say we, I mean academia as a whole. We did find that even as an imperfect, simple way to express value, low multiples did tend to beat high multiples. I wrote my dissertation for Gene Fama on adding what I would say was the next big factor. And again I got to be humble about it. I was not the only one looking at this. I think the first paper on this that I would say started it was by two professors, Jegadeesh and Titman in like '91. They beat me by about six months. I still dwell on that occasionally. But my dissertation for Gene Fama was on the simplest strategy in the world, the price momentum strategy. Buy what's going up over the last year, sell what's going down over the last year. If you ever want to do something hard, tell Gene Fama in 1989 that you want to write a dissertation saying you can beat the market by just looking at the price today and the price a year ago. That's not a result that's really easy to reconcile with the efficient market hypothesis. To Gene's credit when I told him I want to write this paper he said if it's in the data write the paper. So he was very pure about that kind of thing. I did not write a paper saying I found a better factor than Gene Fama. That would have been both untrue and poor graduation strategy. I did say that if one likes low multiples, they can outperform. But if one likes things that are heading up, they tend to keep heading up. And these two together worked considerably better than either one alone. If you, I'm going to be a quant for a second. Even they are negatively correlated strategies. If I'm buying what's cheap and selling what's expensive, even using simple methods, and you are buying what's heading up and selling what's going down, the evidence is if we both stick to our discipline and do it over the long term, we both seem to make money. But I think it's fairly intuitive that a particularly good period for momentum investors usually not the best period for value investors and vice versa. So I think it was the right investing conclusion but it was also the right graduation strategy to frame what I did as a wonderful complement to Fama and French's work. I then went to Goldman Sachs. I was enticed to go there for a year, to take a year off of academia. A professor of mine from undergraduate and my best friend were both working together at Goldman Sachs. I went there, I traded fixed income for about a year. When Goldman decided they wanted to start a quant team, trading fixed income for a year and writing a dissertation at night on quantitative ways to choose individual equities was a very weird life. You know, Goldman Sachs is famous for, and I experienced this, massive work weeks especially back then. I think they've gotten a little kinder and gentler now. But so it was an intense period trying to write a dissertation while being a fixed income trader during the day. This is probably way too much detail but many years later my wife and I had two sets of twins 18 months apart. That was tied for the craziest period in my life. Running AQR with four kids in diapers at home was tied with 80-hour weeks at Goldman Sachs and writing a dissertation. Different nighttime activity, you know, when you're up at 2 a.m. typing on your keyboard, it's a little different than the children. But Goldman asked me to start this group. For the fellow old, old guys or old, old people in the audience, you might remember this. The reason they probably asked me to start this group was the then success of a firm called Long-Term Capital. Long-Term Capital was this marriage of academics with old school Salomon Brothers. That's kind of old Wall Street fixed income traders. And they were doing very well. Now again the fellow mature people, I'll call them, I'll stop saying old, in the audience might recognize the irony that about five years after that Long-Term Capital had a celebrated blowup and went to zero. Luckily they hired me to do for them what Long-Term Capital was doing, but they had no idea what Long-Term Capital was actually doing, nor did I. So, we became a general quant team. And the first thing, and by the way, I'm not going to take this much time for every year in the story. You know, there are about 32 years left, so it would take a while. But the first thing they asked us to do was a macro question. I was writing a dissertation on choosing individual stocks. First thing they asked our new group to do was, 'Can you help choose countries? Can you tell us which countries are more or less attractive?' I think I probably said, 'Sure, of course we can do that.' And then went in a room with my four-person team and we all looked at each other and said, 'How are we going to do that?' I'll give you the answer we had back then which is still a similar answer to what we do today. Pretend the countries are individual stocks. A country, think of it, the whole stock market of a country has a valuation ratio. Whatever your favorite is, price to sales, cash flow, earnings adjusted for industries or not. Whatever your favorite valuation is, you can do it for the whole country. And price momentum is easy. You just look at the index. Luckily for us, again, luck rears its head. That held up for countries similarly to individual equities. So I've now brought you to the state of the quantitative art circa 1994. About three years later, 1997, I decided to leave Goldman Sachs to start my own firm. Goldman was very kind to us. We had a great experience there. But we were also a very isolated unit. We weren't using anything that was particularly Goldman Sachs. We were buying data from the outside building models. There's a separate story, a partner of mine named David Kabiller, who this was actually funny, during one of my tours in Jerusalem the guide said do you work with David Kabiller? And he had the same guide like three months earlier. So small world. But he kind of talked me out of staying at Goldman. He talked me into leaving. Spent about a year working on me. So in 1998 we formed AQR and we launched our first fund in August of '98. By that point we were trading equities not just in the US but around the world. We were trading countries using futures. We were trading country bond markets using either futures or swaps. And we were trading currencies. In each case back then, it was value and momentum based. Now, for you might be thinking for bonds and currencies, can't use what you use for equities. There's no price to earnings ratio. There's no price to sales. Simple things and models were very simple back then ended up working fairly well for bonds. Real bond yield. What are you getting over inflation for currencies? Purchasing power parity. That's a wonderful one because people all through the currency world think that has no efficacy because they think of isolated examples like dollar-yen has stayed misvalued forever or something like that. Turns out if you do it systematically across 20-30 currencies, there is an edge to buying cheaper ones. Now I've taken you to our model circa 1997. Since then they've gotten very different. The core of believing that things like value and momentum matter is still there. But how do you measure those two things and adding more richness? Remember when I said the quant calling things the value factor is a bad name, that value is a more holistic concept. If you look at both academic finance and applied quantitative models like ours and other firms, a lot of the additions in the last close to 30 years have been making it a more complete investment process. So it's not just is the multiple low and is the price going up. It's are the fundamentals going up along with the price. How profitable is the company? How risky is the company using accounting measures or the famous quant geek measures like beta and volatility? Are they buying back shares or issuing shares? It's become a very rich model that I think it's still a quantitative approach and that still is very different than choosing a concentrated portfolio of individual stocks. But quantitative processes like ours I think look a lot more like traditional investing in a more deep holistic way than they did in the past. Now I'm gonna stop and let you either tell me to keep going or ask another question. Because you may have noticed I will just keep going otherwise.

Yes, that's going to happen. Thank you. Have a nice day. I screwed up. Well, stepping back, on a sufficiently long time horizon, the combination of AI and robotics has put us all out of a job. It is above my pay grade to figure out what the world will look like when everything can and is most efficiently done by those. But I will tell you, I've written about this. I had a piece just over a year ago called the less efficient market hypothesis. Where this wasn't about AI and I will link back to AI, but the argument in this piece is that markets in my career, call that about 30-35 years, I believe have gotten a little less informationally efficient, not more. Now it's easy to think technology always makes things better. If you spend a lot of time on social media, you probably are disabused of that notion already. But in some ways, technology has made markets more efficient in certain narrow ways. They respond faster. You can trade cheaper. But an efficient market in a Gene Fama sense is one in which prices are accurate. Even Gene doesn't believe markets are perfectly efficient but in a perfectly efficient market prices accurately reflect all available information. That is not an exercise that is greatly affected by trading going from 10 minutes to 10 nanoseconds. We've seen in 1999 and 2000 the famous dot-com bubble and then in 2019 and '20 which we can call the COVID bubble, though you know I said 2019 it was definitely starting before COVID so I wouldn't just blame it on the pandemic, as we measure it, the two biggest dislocations within the stock market between the cheap and the expensive we have seen over the last hundred years. Now that is an odd fact to reconcile with the idea that technology just makes us better and smarter and things more efficient. In the paper I hypothesized, I have to admit that this paper was in the Journal of Portfolio Management. It was their 50th anniversary and they invited a bunch of the old guys to write on whatever they felt like. So it was less quantitative than my normal papers because it was a little more op-ed and opinion. But I had two main hypotheses for why I think these events have occurred. By the way, when I say have occurred, doesn't mean I can predict when they can occur. But why things have gone a little crazier live in my career than they did in, you know, a hundred years of data. One, you've probably heard a million times, the growth of passive investing. I'm not a passive hater. There are people who passionately hate passive and think it's responsible for everything in the world. There are active managers who will blame any bad hour and a half they have on passive investing. I think passive investing is a wonderful tool and I think the individual investor should be able to own the market at very low fees. But we know there's a paradox in passive investing. The whole world can't do it. If every single one of us tries to be passive, and here I mean like Vanguard, Jack Bogle, own the market proportional to the market cap, that means literally nobody is thinking about do prices make sense? Nobody is saying is Nvidia worth more or less than the corner drugstore? So we do know we need a certain number of active investors. In fact, you can think of passive investors as free riding. I don't mean this in a negative sense. I just mean it in a literal sense on active investors who are keeping prices somewhere in the direction of reasonable. And if there are fewer of them, less people thinking about this, less people willing to take active positions on it, then it's pretty easy for me to believe deviations can get larger. The other thing I think happened, and here I'm going to sound like a very old man complaining about the kids. That is because in this case I'm a very old man complaining about the kids. So you're not misreading. But I do think the environment, social media, trading on your phone 24/7. I don't know. I didn't ask when I was there if Israel has legalized sports betting. Not so much. But in the US we do now. And I'm convinced most people cannot distinguish their stock market trading app from their sports betting app. It's just this virtual activity. Our politics. Again, I'm going to comment on the US. If it applies to Israel, you tell me, but I don't find many people in my country who don't think our politics have deteriorated because of social media. Again, you could be on the left, you could be on the right. We all live in our own bubbles. Algorithms exist to make us more extreme about everything. Why the exact same thing would not be happening in stock markets, I couldn't tell you. Stock markets are subject to herding behavior. They're only efficient if we have the famous wisdom of crowds. Hopefully, we've all heard that term. The wisdom of crowds says, 'Yeah, all of us, myself included, might be pretty slow-witted. We might not know what's going on, but some of us do and some of us have an inkling. And if the crowd is pretty independent of each other, all the random stuff many of us believe averages away and the truth is kind of left in the average.' That's only true if the whole crowd is relatively independent. If the crowd talks to each other, it may get the right answer and be a wise crowd, but it may become a dangerous mob. So, I do think today's environment has led to some more extremes and some more mispricings. All of us, your original question was about AI. This is going to be the meanest, most arrogant thing I will say here for the foreseeable future. Again, on a long enough basis, yes, everyone's out of work, not just the quants. But for the foreseeable future, somebody thinking because they have an iPhone in their hand that has an app called AI Trader that that's the same thing as actually people who've been doing it for 30 years. Not the same people. We do, you know, hire new people over time. I think that makes us money. It probably makes me go crazy for the occasional year. Any active manager, quant or not, in the world is subject to the same hypocrisy. I will now tell you, remember, we think we make our money because markets aren't perfect, and it's our job to take the other side when there's an error. And then we get nice and mad when those errors get bigger and cost us money in the short term. I promise you we do. We all do. The paradox is we wouldn't have a business and we'd have no social function if markets didn't occasionally go crazy or get worse. So, managers like to complain about the markets and say, 'Oh, they're always nuts.' But they have nothing to do if they're in a perfect market. So, somebody thinking a tool in their pocket can cure all ills. You know, even the AI, let me make this as humbling for myself as possible. I don't have deep mathematical understanding of our AI models like I did our original factor models. Younger, smarter people than me have deeper understanding at AQR. Without a team that we've built over many years, I don't think I could be a very good trader with AI right now. AI is a bit of a nuclear weapon. It can overfit, meaning it's a very powerful tool for explaining what has happened but overfitting has always been a worry in statistics and investing. Finding patterns that have occurred in the past but are simply random is very dangerous. If you know for instance if you test a hundred things and all of them are just random, one of them after the fact is going to look one out of a hundred great. So if AI has increased our ability to do that, it's both a stronger tool in our hands but in some sense perhaps more dangerous. So if AI is going to make the individual investor so good, and here's where I'll link the two. What I talked about before with efficient markets and your AI question. The only way that gives us nothing to do is if it makes markets much closer to perfectly efficient. As long as there are inefficiencies and errors out there, we have to adapt our models. We have to build new models. They're not the same as they were a year ago, five years ago, and my god, 30 years ago. But unless markets get perfectly efficient, we got lots to do and we're using AI like crazy to try to do this now. But if I retired from AQR, didn't have these teams, I don't think I would be trading AI on an app on my phone. And I have some experience in this. So this sounds terribly obnoxious when you talk about the individual investor in a negative way but of the many things I fear the individual investor getting the tools and then acting rationally, which is the hard part, right, the tool is not always the hard part, that would make the market so efficient that we couldn't make money is not high on my worry list. Higher on my worry list is the individual investor going so crazy that even we can't take it. That has never happened to date and I don't think that will happen. But I worry about that more than I worry about the individual investor being so rational and so tooled up that they take away all the opportunity.