Cliff is one of the most influential figures in global Finance he has a PhD from the University of Chicago he studied there with Jean Farm and he is a founder and principal of aqr Capital Management in Connecticut so Cliff when I think of your work the very first word which comes to my mind is momentum could
you first give us just the super short version of what is a momentum trading strategy sure uh a momentum investing strategy is the rather insane proposition that you can buy a portfolio of what's been going up for the last 6 to 12 months sell a portfolio of what's been going down for the last six to 12 months and you beat the market
unfortunately for sanity that seems to be true seems to be true now you call it insane but if you were to give us a simple example on average statistically speaking not in a free lunch way but what kinds of super normal returns might you possibly earn through a momentum trading strategy sure as one example if
you were running against large cap us Equity something like the Russell 1000 and you bought the onethird of stocks uh with the superior 6 to 12 month returns you probably make 100 125 basis points extra longterm on average if you do that in small stocks it's more like 250 to 300 and why is it larger for small stocks almost anything we find in
investing almost any regularity this tends to beat this seems to be smaller in it seems to be larger excuse me for small stocks uh that it's not quite as good a deal as it sounds because the risk is also larger small caps have bigger fluctuations people have a lot of theories uh analyst coverage Wall Street
doesn't cover them as much perhaps if there's whatever degree of inefficiency is in the market is larger for small caps but it's a nearly ubiquitous finding anything anything you find Works in large caps tends to work somewhat better in small so if you have a in terms of excess return 100 25 basis points compounded over 20 30 years
obviously that's going to be a lot of money correct correct so what what's the catch what's the qualification why doesn't everyone here run out they don't even wait till the talk is over and as an investment strategy follow what you have done with momentum what's the trick um there are there are a number of them
um one hypothesis is I'm really not very convincing at all uh another is more people do it these days and and I'll I'll admit I think the strategy is going to survive that but it's a concern it is not something every investor can do uh I get this question from clients sometimes and I go are you going to do it and they go no and I go that's
why with that said I think it is a fairly unintuitive idea to some it's very intuitive just by what's going up to to someone who studies markets particularly for Gene F like I did the idea that you can beat markets and we do more than just momentum and Tyler I promise he's promised me he'll get to that um but uh
it's a very unintuitive idea if you think markets are are anywhere near highly efficient uh and I think that dissuades some uh and it nowhere nearly works all the time one thing I I I should really be careful about I throw out the word works I say this strategy works I mean in the Cowardly statistician fashion it works two out of
three years for a 100 years we get small P values large T statistics if anyone likes those kind of numbers out there so we think we're reasonably sure the average return is positive it has horrible streaks within that of of not working if your car worked like this you'd fire your mechanic if it worked like the word if it worked like I use
that word so I think it is harder than you might guess even if something works long term to have it go away because a lot of investors can't live through the bad periods they decide why it's never going to work again at the wrong time so I think of you as doing kind of metaphysics of human nature so on one
side there's behavioral economics they put people in the lab one-off situations untrained people but here it's repeated data it's over long periods of time it's out of sample There's real money on the line and this still seems to work so when you back out well what's the actual vision of human nature what's the underlying human imperfection that
allows it to be the case that trading on momentum across say a 3 to 12 month time window sorry investing on momentum will work uh what's wrong with us as people what's the core human imperfection um well this is going to be embarrassing because we don't have a problem of no explanation we have a problem of too
many explanations of course we can observe the data the explanations you have to fight over and and argue over I will give you the two most prominent explanations for the efficacy of of momentum the first is called underreaction simple idea uh it comes from from behavioral psychology the phenomena
there called anchoring and adjustment news comes out price moves but not all the way um people update their priors but not fully fully efficiently therefore just observing the price move it's not going to move the same amount again but there some statistical tendency to continue take a while to guess what our second best in my opinion
explanation for momentum efficacy is it's called overreaction when your two best explanations are over and under reaction you you have somewhat of an issue I admit but overreaction is much more of a positive feedback it works over time because people in fact do Chase prices so if you do it somewhat systematically
and before them you you make some money one of the hard things you find out in probably in many fields but I found out in empirical Finance is th those might be the right explanations but they're not mutually exclusive uh remember the movie Highlander you and I talk about SciFi the it's it ends up they always say they can only be one I use this
tagline a lot and only one out of a thousand people gets it and then one out of 2,000 people laughs that's not true in in in these things there can be multiple explanations both of these things can be true they can be underreaction and ultimately people can go too far very often in finance there are two other let
let me give you two other possible explanations also every empirical regularity meaning something that works or or or or or is terrible with some predictability is it does so for one of three reasons the worst one is complete accident you've data mind you know I sat there in my dissertation in 1990 I found this empirical relationship with a big
tat but I really checked 63 things so the tat is bit of a lie and it never works again momentum in my opinion this is editorial has survived 200 out of sample tests uh Through Time different asset classes so I don't believe that one but to be intellectual honest you never reduce that probability to zero
you just make it lower as it works again you go chance it's chance you're just lucky smaller second reason is a behavioral story someone out there is making a mistake I gave you two underreaction and overreaction are both a behavioral story they're both somebody out there making an era doesn't mean markets are terrible by any means I'm a
big believer in markets but at the margin they're making an error and you take advantage of it the third is risk in a rational world you get paid momentum would would would work in a rational world if the the the short-term 6 to 12 month winners were in some deep important sense riskier than the losers but they don't seem to be they don't
seem to be correct um they do show uh they there are terrible periods there are so-called momentum crashes but there are very good periods of course and those crashes don't appear to be a particularly painful times in in in the world of Economics it's not just that you have bad periods it's when you have
them so I don't think people have come up with a very good risk story but I'm not done but let me give you my intuition in favor of why it might be overreaction and you tell me what you think so you receive a signal about the world it's to some extent a private signal and you over interpret that signal and you think it's a signal about
the whole world so you overreact that leads to some price movement which is propagated through time but at least some people think past that 12-month time window momentum ceases and there's even a bit of price reversal So eventually you learn that you've been overreacting by thinking your private information is more General more
systematic than it is and then things snap back a bit and does that psychological hypothesis explain this mix of price reversal in the longer term and momentum in the shorter term do you think that makes sense or not yeah I'm going to go with that from now no I'm kidding yes it does I I think you're articulating a a version of the
overreaction idea and one thing Tyler just referred to is is if anything uh pride of place came before momentum and is a super important strategy to us uh he's asking me about momentum because that was a very early part of my work and adding it to the to the Lexicon but value investing at a longer time arising
buying what's cheap on pretty much anyway price divided by something reasonable price divided by earnings books sales just buying fiveyear losers fiveyear stocks that have that have suffered and and and selling or or or underweighting the opposite is also a very good strategy very much the opposite in spirit to to momentum now in
the Value World they have the same fight do does cheap beat expensive because it's riskier I I don't think they've done a very good job of identifying the risk but I find it inherently more plausible that something priced to a long-term lower level might have a risk element to it than a much more short-term phenomena
like like momentum and then that could also be overreaction of course the second big one is behavioral right um if if people make errors of any kind literally almost of any kind value is going to work because if if two stocks have the same fundamentals if there's an error in the price it's going to look more expensive
so you're going to dislike that one and you're going to like the one that looks cheaper the o one thing nice and I don't think it's dispositive and I think both momentum explanations can coexist and by the way there are other I've given you my two favorites there are other um one thing nice about the overreaction reason
for why momentum has worked over time is it is consistent with the behavioral version of value too if you're going to get overpriced or underpriced one would imagine at some point you overshot something right so it forms a nice integrated system let me give you another reason why maybe overreaction is
a possible explanation in finance I find it's one of the biggest puzzles why do people trade at all people who are fools people who are well informed but not better informed than the market people all over they trade like crazy it seems only a small percentage of that is liquidating funds to send your kid to college that suggests people are
systematically overconfident if the fundamental human bias is overconfidence and that leads to overreaction do we then have some kind of plausible these metaphysical human micro foundations for why Securities Market stay imperfectly priced I'm very pleased to get a promotion in metaphysical that's much deeper than
I've ever or a demotion uh but I started I was never a pure efficient marketer I was never a person who thought markets priced things perfectly nor is anyone by the way um the the Paragon my one of my investing Heroes and academic Heroes Jee F likes to shock the class at Chicago only at the University of Chicago and Jean's
class could this be a shock line yes but kind of day three he looks at the class and goes markets are almost certainly not perfectly efficient and this is University of Chicago with the Godfather of fishing market so you get a any anywhere else you guys did not do that you might you might notice that um and
he's making a point that that's an a Very extreme hypothesis that that all the information's there people individually usually make errors errors are not riskless for even informed people to Arbitrage away I think looking at the world I share your intuition I think it's backed up by the data that the most common era is some two kinds
and they're not exactly the same thing but overconfidence and overe extrapolation are the two of us overconfident let's say someone on Twitter I underreact or overreact I am I overreact and therefore I'm over confident if you tell your kids they can't watch their favorite TV show you're destroying my entire self-image right here or
overreact my kids are probably more grownup than I am yeah yeah but they they overreact they I can't find a lot of of examples of people who underreact I think this is is I'm picking up on your point here slowly this is my intuition you look at these other areas people at work they're given positive or negative feedback they may overreact
more readily than I react you let let me take this another way I think when it comes I think we are mixing overconfidence with overreaction a little bit new news people might be overconfident how much they understand it yeah but they don't seem to incorporate it enough and there is evidence on this outside of just
returns to momentum people look at at at the actual news that came out try to gauge what the reaction should be things like that I do think there are things we when it comes to processing new information I do think there is an an underreaction in that sense that anchoring and adjustment people do all kinds of psychological experiments you
show people a whole lot of numbers and you show them numbers out here they should move X they move half yeah X they are overconfident that they are right and I think that does lead eventually to the overreaction I really do think this is one thing that makes it very hard um when I go to academic seminars where
people are fighting about this there aren't many things in my life where I'm a peacemaker if I see a fire I'm far more inclined to throw gasoline on it than water but at academic seminars this idea that there can be multiple explanations I push at times because there'll always be you know two they want to win right somebody has an
overreaction somebody has an underreaction story somebody says it's risk somebody says it's behavioral it could be both and just to make our lives really hard the mix of what's more important doesn't have to be the same at all points in time and let me give you an example I'm I did start out a perfect efficient marketer I wrote
I I wrote my my my dissertation for gene on momentum I was already showing a heretical drift at that point he was quite good about it by the way the technology bubble living through that uh where momentum worked but the other thing we believe in many strategies actually but but the other biggest the second biggest one the tide
for the biggest one is value investing again and some of you distressingly fewer and fewer look like you actually remembered it live too many of you read about this in the history books something that my um one of my partners told me I look like Lincoln before and after the Civil War from the technology bubble to to which I
I was like we got a lot of of of we did well because we stuck with our value strategy but we were nearly destroyed by it and when he said that to me I'm like yeah that's that's about even Lincoln kept the union together and ended slavery I stuck with a value strategy that's that's perspective for you so you
need a lot of discipline to make momentum investing work right because for 10 years it might get you nowhere or even underperformed this gets back to your earlier question why doesn't everyone do it why doesn't all this stuff go away it is any of any of these things value momentum there are other things quality investing uh low-risk
investing so Fisher black of the black schs option pricing model discovered in 1970 and that everyone everyone forgot for 35 years it's another effective systematic form of investing um if everyone did them yes they they would go away they work in my opinion again using my word version of work in kind of a
sweet spot good enough to be really important if you can follow him with discipline not so good enough that the world looks at and goes this is easy they're excruciating at times and I hate those times I do not I won't pretend I'm neutral as as to those times but they help keep your Market franch I recognize intellectually you need those times
while I will whine and cry horribly during those time I'm not I'm not pretending I'm above that but meum investing still works I believe today stastically yes now if the momentum anomaly and the value anomaly uh those to me seem like the two biggest anomalies pricing Theory does Eugene F admit you are correct no you have an
academic record on this you have a track record right statistically and the success of your firm okay will he's just trying to get me in trouble I will tell you um I'm I'm in public here I'm I'm with someone I admire greatly this is going to be on the internet I'm still more scared of Jean so with that said one of the scariest
moments let me take you back was telling him I wanted to write a dissertation on price momentum and I swear to God I mumbled the second part and I find it works really well because it failing is a perfect Chicago Gene Fama fishing markets dissertation look what these crazy people on Wall Street do they make
all these indicators and they're throwing away their money to his credit he immediately said if it's in the data write the paper now we don't agree fully on it we don't agree on two things um and for all I know he changed his mind yesterday but as of yesterday I don't think we agree on this value investing remember I think
works for a mix of both behavioral and perhaps some risk reasons I think they're hard to identify but I'm more than willing to say that's that's a big that that might be a big part of it I think Gene would say it's mostly all risk I don't think he's very uh positive on the behavioral explanation momentum Jean's a risk guy he's an ficient
markets guy uh I I think Jean is still cynical about it I know his latest paper he and Ken fren try to if not the best among the best papers in in finance I read everyone to this day doesn't mean I agree with every word they started out with a so-called three Factor model about 20 years ago what drives return on
an individual stock the markets return and your sensitivity to that values return and how much of a value stock you are moment not M size is return how small firm uh effect it's called and how small you are they've added to that over time they've added uh an investment effect of firms that that that uh for instance reduce their share count tend
to do better and there are theories as to as to why and a profitability factor all else equal more profitable firms seem to outperform less uh profitable firms and again that's a very strong effect that holds up I wrote a a piece on our blog uh uh saying something our Factor model goes to six and for those
of you who are curious it was a reference to spinal tap where ramps go to 11 um I take the other side from them I I love these guys we agree on on nine out of 10 things uh I I don't see how momentum is not their sixth Factor it adds a tremendous amount of return versus their model the numbers I gave you versus uh that you can add versus
say the uh Russell 1000 125 kind of basis points understates the power greatly because momentum is also in geek speak negatively correlated with value Val in English a good year for momentum is often a bad year for value and vice versa that's easy to create if you just do the opposite with your left hand as
your right hand it's not easy to create two strategies that both go up on average that's difficult and so and that shows up statistically in a model it becomes even stronger so I don't understand why I think they should have it as a six Factor you'd have to if you can get Gene to leave Chicago Which is far more difficult than anything else
we're talking about he can he can tell you why he it's not a six Factor but it should be let me ask you a question about risk because this this key concept comes up again and again in finance the strategy may appear to have a high return but risk adjusted what are you really getting now when I read the very
latest papers on risk let me tell you what I see I see Talk of the third moment of probability distributions the fifth moment words like co- skis terms like the u-shaped pricing kernel and talk of the volatility of volatility and I'm just waiting for a paper on the volatility of the volatility of volatility when I read all this as an
outsider I conclude we don't know anything about risk these are pic epicycles and within a pretty broad range of asset classes is it possible risk doesn't really explain anything about asset prices true or FSE the epicycles held up for a long time they even got the little tiny movements right that's it's not bad okay of everything
you said a fair amount of those those risk models I think are utter nonsense um I don't think the fifth moment I'm gonna insult someone I care about now by accident I don't even remember who wrote this I don't think the fifth moment is a good measure uh I don't even think skewness is skewness is bad stuff really
even if saying work makes money on average occasionally really bad stuff happens more often than really good stuff co- skewness which sounds like one of the geekier things Tyler said very hard to identify very hard to prove very hard to isolate in the data but coess at least makes sense to me as a real risk
factor what that means is not only does do very bad things happen more often than you would imagine but they happen while other Very Bad Things largely the market crashing for instance if if if something has occasional giant losses but those are at very good times and makes money on average very reliably that might stink occasionally
but it's something you can live with if something is is extremely bad at the same time everything else in your life is extremely bad shotgun and can opener time right yeah and and exactly I use this example in a very different way if some someone says what if we get something five times as bad how do you invest if we get something five times as
bad as the global financial crisis and I and I say ammunition and canned goods um and I don't think there's a better answer for for for that uh but I but I do think uh something like coess it's a geeky idea I don't I think it's very hard to establish and prove and the data is not really even there momentum itself
and getting back to that one has had a what's called in it has negative skewness uh the Geeks call that a bad left tail Nim TB would call it a Black Swan event it has standard deviations you're not supposed to see big events they have tended to be more maybe this is luck but they have tended to only
occur in strong markets not in Weak markets we don't like that but we don't worry about that as much to be honest when it comes to Value Ken and Jee have never embraced this story uh I don't embrace it either but I give it some Credence value buying cheap and selling expensive has a little better of a risk story on this front
because it has suffered empirically in the Great Depression uh in the global financial crisis probably not enough it probably is not enough to explain it but that is the exact kind of measure of risk that should work does it hurt you this is a terrible English sentence and I AP I apologize in advance does it hurt you when it hurts to be
hurt is is is is an English language version of risk and any good quanti how geeky make it should get back to that if it's a good measure of risk it doesn't just hurt occasionally it hurts you when it hurts to be hurt are there still new and significant Market inefficiencies to be found or has that load been mined or
I am are you the end of this tradition or just the beginning I I think I'm going to take a guess that there aren't that many more um but some I won't rule it out because you know once you're horribly wrong about this you you hopefully you learn from that I would have told you 10 years ago I would not have guessed that
low-risk anomaly um and and this is the idea that that that stocks and by the way I I use stocks as a shorthand one kind of wonderful thing and and if we've done anything if there's something I can brag about a lot of these things we've participated in the research we've written the leap frogging papers we have been early in saying let's go look
outside of stocks let's go look at bonds let's go look at currencies let's go look at Commodities the things I'm talking to you about in somewhat different forms work work for all these these things but but let me talk about stocks because it's the easiest it's the most common language stocks that are low
risk backwards to Theory right risk should get paid right stocks that have low betas low volatilities low fundamental risks like low leverage outperform in a fairly strong way fiser black found that if anyone wants to be masochistic and ask me why I tell you about leverage aversion and the fact that no one does what you're supposed to
do in theory but low R outperforms another one is profitability this is a real anomaly uh stocks out there uh that make more money and make more money consistently not nothing about price it's not a value Factor more money divided by their Book value but scale by their sales outperform um you mentioned Fisher black on Leverage just to pursue
that a little bit so Fisher thaw and maybe you seem to be agreeing with him it's another human imperfection that at least some of us are too afraid of beverage because we could borrow some money buy some typically low beta stocks and actually improve the quality of our portfolio and that's something else
which doesn't quite happen as much as it should and that seems to be almost the opposite of overconfidence well is it just debt aversion we were brought up don't get into debt I I think it is some debt aversion it also might be less irrational and more constrained there may be people who just can't um mut
funds can literally leverage a little most have in their Charters we won't leverage so if you're constrained you have to do something let me let me step back I'm going to draw in my hand an efficient Frontier I promise you it is a perfect artistic rendering many of you I know have seen it before if you haven't on the x-axis you have risk on
the Y uh on the y- axis you have expected return everyone in the world wants to move up to the left you want less risk and you want more expected return kind of third week of finance class they teach you we should all agree of course we don't but we should all agree on the best portfolio of risky assets we should all own the same one
because it's the highest return for risk those of us who are aggressive should apply some leverage to it those of us who are not aggressive who are conservative should delever it add cash make it less risky why do you do that instead of Simply moving your money from from from from low return to high because you have to get undiversified if
you move your money from from low expected return to high expected return risky assets you lose diversification ultimately if you want as much expected return as the the best asset out there you have to be only in that asset applying leverage to the entire portfolio you you maintain the benefit of diversification what Fischer showed
is Imagine leverage was very costly or just no one would do it he points out that lowrisk assets are orphans now lowrisk assets function in a portfolio in an important way to make your return for risk better but they often don't make your Topline better they don't literally make you more money they make
you more money for the risk taken that's very boring if you don't apply leverage you don't make more money most people are interested in some version that makes them more money and fiser showed that if that's true which I believe it is and I think he was right those assets that are orphaned will be a little too
cheap because there no one wants them and people who want to be aggressive will a little too much be willing to be undiversified and there again Leverage is not riskless the perfect theoretical world not everyone should lever to the the moon if you're very aggressive but neither is concentration neither is moving your money into fewer and fewer
assets we don't tell people Leverage is riskless we we do tell people we think people think it's over risky versus concentration so I don't even know if it's risk aversion versus another uh it's risk aversion it's more I think people do Mis appropriate the risk of one of one thing against another maybe it's uh it's neither a borrower nor A
lender be your idea that people just taught Leverage is bad right uh but I think people prefer concentration risk to Leverage risk to their detriment let me ask you a very practical question about today's markets like myself and like Scott suner you're pretty skeptical of the concept of a bubble and just
going around and calling everything bubbles but your most famous piece is called Bubble logic there can be bubbles they may be hard to identify so if you were pressed today in the world the US the global economy if you had to pick what is most likely to be a bubble are you willing to give us your opinion yes
and it's incredibly boring there's nothing I feel is very very likely to be a bubble there but there's always a winner in any or loser in any if I had to pick one if I had to pick one and it's still going to be a different kind of cop out it's a diversified portfolio of stocks and bonds and let me take you through it okay versus history on the
measures I like one of the most famous ones we look at a bunch of different measures is Bob Schiller's cyclically adjusted PE it's price divided by a long-term uh rolling average of of earnings for the S&P 500 you like low prices you don't like high prices that number is more expensive and roughly 90% of of 100 some
odd years plus years of history that has is a terrible forecaster for the next month or next year do not do anything that is not just illegal it's a human disclaimer but over the next 10 years nothing's perfect even over 10 years but it's it's statistically powerful when things are expensive you've made less money when things are cheap you've made
you've made more money bonds are the same idea another a measure for bonds is very analogous to a PE for stocks is the yield on on a a Government Bond minus Economist forecast of inflation uh people call that a real yield it's what you should care about the nominal yield doesn't really matter it's it's what you
it's what you consum in that is worse lower this is a yield not a price so lower is bad but that is worse than roughly 90% of History the portfolio of half stocks and half bonds if you take those two measures scale them and combine them is the worst ever how is it the worst ever when the two are 90 percentile well I think you
all probably figured it out they're not usually 90th percentile bad at the same time that's it's a bit of a puzzle why they are but they are having said that Tyler I'm still going to be a coward we get to about the worst ever we've hit this level before for the portfolio I used to think 100th percentile is pretty impressive in my
career now you never go past the 100th percentile I know you're you're a math guy you know how it works math guy but I will tell you not all 100th percentiles are equal if you are the 100th percentile today but you're higher than but you're 150% of the of the prior 100th percentile excluding the last couple
years that means you've shot off to the moon in the technology bubble the Schiller Cape was probably 50% higher than it had ever been if you excluded the period right around that Japanese stocks in 8990 got to levels like that in you might call it an inverse bubble I think US stocks in the early 80s maybe got to a similar
extended well past anything we've ever seen on the downside in the very early 80s I was willing to call those bubbles and did real time I wrote that piece you're talking about because we spent a lot of time still a subject of measure but my my measure for the using the word bubble remember I'm a gene Fama student he hates the word
bubble too bubble is inefficient Market phenomenon I will use it but I hope I have a higher standard than many many in our field have I think dumb the word bubble down to mean something we think is kind of expensive that's not a bubble a bubble to me is something still subjective because your answer might not
be the same as mine but it's something that I have tried my best to come up with future assumptions of growth be it for a stock inflation if it's a bond and current price and I can't come up with assumptions that would lead any rational investor subjective again to want to own this when we did that for stocks anywhere late 99 2000 we assumed very
aggressive future returns we took wall Street's long-term forecasts which were nuts they had never been achieved before current prices and we came up with if that happens we make less than bonds we were willing to use the word bubble now right now this 100th percentile US stocks and bonds so you invest half your money in
stocks half your money in bonds historically you've made about 5% over inflation we think it's priced now at this level to make about two and a half percent over inflation rather than five rather than five is that a bubble I can't prove to you that that's that's a bubble that's an expensive Market versus history um so most likely when you take
a whole bunch of expensive things and they get very expensive when you put them together you are right you always can pick a most but if you ask me the follow-up question do you think it's a bubble I will say no I think it's an expensive Market but a bubble is something where you say this cannot last and I would not say that let me tell you
my biggest worry maybe you can set me at ease on it I'm not ready to call it a bubble but bubble related I look at the carry trade companies especially in emerging economies borrowing in US Dollars typically at quite low rates and forgetting a bit about future currency risk or future revenue and growth risk
on their side and there're being this extreme flow of liquid Financial Capital into those companies not really quite backed by forthcoming realities which will match to the expectations behind that borrowing I'm not sure exactly what's the single asset price here I want to call a bubble but that's my biggest worry where I think maybe the
market isn't pricing that whole combination correctly now were you less worried than I am I am less worried than you are it's hard for me to know how metaphysically worried you actually are um but Emerging Markets on that same measure um just looking at the local stock markets not the carry trade per se
um but you think if that that flow was was gigantic you're talking about it would show up on the kind of same kind of Schiller Cape numbers are considerably cheaper than us or even Western Europe so you might you might very well be right but again um even though I'm the bubble guy now I'm the momentum guy I think as people who try
to beat the markets every day for a living I'm a startlingly strong believer in efficient markets relative to to the norm I think what you're saying has truth to it but maybe largely in prices already a lot of people from the hedge fund World they speak to me they say Tyler interest rates or rather bond
prices are a bubble because right now the low rate of course is at zero it's not going to go down much below that it could go slightly negative uh and there's a fear that right now we're living in the world's biggest Bond bubble now personally I don't think this at all but what's your opinion I have to I'm going to be real
careful again I do not think the word bubble is is Justified so that's not careful that's that's overly bold uh actually uh having said that that you got I got I got to be clear when I say I don't think it's a bubble it doesn't mean I'm I'm saying this thing is great I'm saying when I talked about bonds I said they're more expensive than about
90% of recorded history actually the low 90s now that is not a commercial for forward-looking Bond returns that is saying I reserve the word bubble for something that cannot work out and I I sit down and I go well how we how would it work out for a bond investor it's very hard to work out for a cash investor you got me there but cash is
largely it's a it's a government set rate it's it's not a market rate has other services right but bonds how would it work out for a bond investor from here we look at these ridiculous you know two percentage kind of kind kind of nominal yields and for me to come up with a scenario not a prediction not
something I think is a good bet but a reasonable scenario that could happen in the next 20 years for instance for workout I need one word Japan wasn't that hard fair I I I I if if your standarded like mine is a bubble is something where you can't really come up with a plausible scenario with this investment might work out it's proof by
contradiction we just ended it I think it's an expensive asset I think equities are actually shockingly similarly expensive I think people focus on bonds for a bunch of reasons they focus on bonds because the yields seem much more measurable I think Equity valuations things like Schiller's cape and many
other measures are actually about as good for forecasting Equity returns as bond yields are long-term for forecasting bonds um I I think uh the last 20 30 years equities look better versus bonds than they have in a while but that's cu the tech bubble dominates a lot of the last 20 30 years over the last 100 years we actually find
we're picking on bonds we're we're nervous because multiple asset classes look not bubish but pretty darn expensive at the same time that's what worries me and that also leads into if a lot of the world be they institutions that need formal forecasts of what they're going to make in their portfolio
or my dad my dad is planning the his retirement 30 20 30 years ago always had the same sheet of paper um and he never showed it to me but it was how much I need to retire and I'm pretty sure it was off by a factor of 10 I don't know which direction it was off on my dad was a trial lawyer I don't it skips a generation I was not math he's not not a
math guy but I'm sure he had how much I need to live on what I think I can make on my money and the number that fell out was how much he needed to retire people still do that institutions do it very formally they make forecast of what they're going to make in their portfolio and I'm sure there are a lot of my dads
out there they probably use a spreadsheet now if they're using anything like history and if we're right that high prices on both stocks and bonds lead to lower than normal returns doesn't have to be a bubble we don't need to see it crash we don't need to see it fix but they're they're using too high of an
assumption it's a problem going forward and it makes the whole retirement uh problem a bigger problem we're going to come back to finance but there's a segment of these conversations always where we do overrated and underrated so I toss that something and you give me a short answer is it overrated or underrated um you we already have a
problem I'm not good at short answers but okay Bitcoin correctly rated correctly rated in science fiction the author Robert heinan Early stuff underrated later stuff overrated and what's your favorite that is a really Methuselah's children ah good pick I could have gone with the obvious I'm a bit of a Libertarian I could have gone with with
the mooners the Harsh Mistress is his most famously libertarian book doesn't age so no I like I like methus children Ben banki fairly rated fairly rated actually overrated by half the world dramatically and underrated by half the world dramatically reality it might be partisan reality TV I I know I'm modifying it every time
I'm I'm destroying the SP of your question no no I used to think horribly overrated I never watched any reality TV I have 11 and 12 year olds and we've watched Shark Tank a reality TV business show we watch the old survivors which is basically teaching Game Theory to 11year olds in a sneaky way this guy's doing
this so this guy does it's um so I I now I I I will say fairly rated and much better rated than I than I gave it credit for in the past now you've told me you're a hockey fan Wayne Gretzky overrated or underrated oh he's massively highly rated and still underrated and what do people miss people miss I think hockey fans don't miss this but
the general public misses that he was a guy who was undersized less fast uh slower as we have a word for Less fast than than than other people um and this is cliché sounding but he the people always used to say he was a humble guy people would say this about him he skated where the puck was going to be where everyone else was skating
skating where the puck was and having watched him I just think it was true I don't know how he got that ability it's a mutant ability but he had it a bit like a momentum investor yes now I'm interested in this issue as I think you are extreme performances or performers and it's measured most readily in sport
so Gretzky is a kind of extreme outlier in basketball you could say Kareem Abdul Jabar who will be in the series as an outlier maybe Michael Jordan in sports or some other area of your choosing which is the extreme outlier which strikes you as the most amazing and you just say oh my God I can't believe
there's a Wayne Gretzky or fill in the blank there for me other than gry I have no sense if this is if this is actually accurate but I'm going to go actually no one could measure this it can't be accurate you're not going to believe what I'm going to say cir to solle when I sit there and watch cir to solle which both my wife and I like I
literally walk out and go nobody can do this and I don't think cheating they're not cheating right and what is it go watch it again it's it's like it's like a Looney Tune show where Daffy Duck dives from up there into a little thing of water down here and he doesn't die I don't know how they do it um everything
else the crash of 87 was a 20 standard deviation event nothing um Wayne Gretzky pretty good the Cirus Olay people I once theart I once this is this this this story was from Vegas and it's not staying in Vegas uh but I was in Vegas um and I was exercising um and I know you find that hard to believe but I was and the cirto people were in the gym and
you don't want to ever do that it is one of the most demeaning humbling experiences they exercise exactly as you they did this thing um where they just keep leaping over each other and they go around in a circle and they did it for like half an hour and I'm sitting there on the StairMaster on a
three spider best I got Spider-Man versus Batman who wins why Batman wins every time because unlike most superheroes He Cheats [Laughter] violently Superman races with flash they both travel at the speed of light yet Einstein tells us there are no simultaneous events who wins I I'm going to ignore the physics much as the comic
books do there there a great this this is actually a pet peeve of mine I'm more of a Marvel comics than a DC Comics I know everyone wanted to know that uh in the audience DC is much better now but um when I was a kid they exaggerated all the powers much more Marvel had realistic superpowers you could run at
500 miles an hour not the speed of light DC would go with the speed of light you have no idea you might actually you might um but this is one of the things comic Geeks will fight about um and they've had this by five times in the comics they've had races between them and of course they they try to cheat and make them a tie I know why you tried to
to come up with that I subscribe to a theory that is on the internet it has a name I forgotten the name but it's a documented Theory but it says the flash should win because the special ized power should win and I agree and it but but what I I like to portfolio theory in fact right in equilibrium portfolio Theory comparative advantage absolutely
um though it has a little bit of a the world must work out fairly notion to it work out fairly right longterm longterm very long term mutual funds overrated or underrated oh we run mutual funds this is a hard one all right I'm going to be I can't be fired so I will go overrated active management I think is over I'm I
I believe certain things can win I've talked about a few of them but on average I think people try too hard to beat the market and pay too much for it I'm I love if people listen to me I believe in what I'm saying but if you if you go spend your life listening to a man named Jack Bogle you won't do terribly super practical question you're
sitting in this room or listening on YouTube and let's say your income is two or three times the national media and so you can save some money but you cannot operate investment at a significant scale what what's the mistake those people are most likely to make and what should they do to stop making it um
there there this most likely is a hard one you already said it uh in expected value terms over trading and I don't mean not everyone very in fact I'd say minority are daily stock Pickers watching the market um but there is this phenomenon that I still want to look into more because it's a method somebody has to be making this money no one's
ever this is going to sound stupid no one's figured out who's making the money but uh Jack Bogle quotes these numbers a lot there are all these paradoxes where the average mutual fund investor seems to get out and in at the wrong times they're they're remember how I talked about value and momentum of course I
like to call them to geeky phrase maybe I'm the only one who likes it they are momentum investors at a value time Horizon remember I told you value Works longterm you have to hold three five 10 years momentum is a 6 to 12 month Horizon if you're going to be momentum you got to really do it you got to be
disciplined you got to come in every day and you got to count on these under and overreaction things if you wait five years and buy what's worked for five years you are not you are you can call that a negative value investor or a momentum investor working at the wrong with the wrong numbers and I do think that is one of the things people do too
much out there it's probably the biggest somebody's making that money maybe we're making some of that money maybe that's the flip side of our it's very hard to track so I don't think anyone's done a great job of nailing where that money lands uh but I think if people came up with good strategies and somehow disciplined themselves to do far far
less and the worst case is if someone I don't think many I don't think many professional Traders can make money trading in and out constantly I think pretty much nobody in an expected sense of course some will get lucky should do that casually uh so if you're doing that you're making a giant era uh but if you
are if you're even looking at and going I used to like this but the three to five it's been tough I get me out out if you're getting out cuz you feel sick to your stomach about it you're making a mistake what should we do and here I'm leaving the Wii deliberately ambiguous to make Securities trading more just more
fair um and you can pick the way you want well Justin fair this is a loaded terms of course deliberately loaded um you know a finance guy comes in here and starts being wishy-washy about the terms just and fair I'm worried already um I don't know if I'd call this just or Fair the fact that people make this this era
they're hurting themselves I don't I don't really attribute a value judgment I wish they didn't it would probably cost us some money I think the world would be better off um but I don't know if that's just or fair I think the world has got gotten more just and fair and I'm going to say something potentially
controversial um something that is is often attacked high frequency trading has made the world more just and fair particularly for small investors highfrequency Traders and have I I watched the the Republican debates last night so I know to change the topic to something I'm comfortable with they they do a lot of different things but the
core trading strategy is just to do the other side of whatever you want to do so if you want to trade sell X they'll buy it from you and they charge a little thing called the bit ass sprad they will buy it from you for a little less than they'll sell it to you for and it's very competitive they fight with each other
to do your trade so they can't just charge any bit ass spread they want that is always but they get they get attacked because they charge a bit ass spread and and when you ask them to do a lot they start moving the prices because they're getting scared that you might know something they don't know but we've always had to trade with someone else
we've always needed market makers out there used to be much more expensive worse bit ass spreads worse execution particularly for the small person there's some controversy with high frequency I mean small investors not literally small people you know that right for very large investors who trading large amounts of
money there I believe high frequency has made our trading costs cheaper but there's at least an argument for the other side some will say Market impact what's what the price moving on you when you try to execute and buy and and and and buy or sell a lot of a stock is is bigger now I don't think so but that's a
fair argument there is no argument for the little guy what you worry about in trading is something called front running someone figuring out what you're doing it and doing it before you there's the illegal version where someone actually gets a Peak at your what you're doing which they're not supposed to get and then
there's the completely legal version people notice trades occurring and prices moving and and think oh I I better get in front of maybe this is a wave that's that's there nothing uh illegal about that but it still costs you money you no one bothers no one no one front runs a small dollar investor and it's not because people are nice and
kind and care about there's no money you want to rob banks not people no so there's no money in it so the small investor I think unambiguously has a fairer cheaper world now I'll dig myself a hole I don't think they should trade very much that was our earlier question so just because it's cheaper doesn't necessarily make them better off
if cheaper induces more trading that's an entire different but they're getting cut a fairer deal by Wall Street whether they use that to harm or help themselves open question but I think they're getting cut a fairer deal than they used to and high frequency trading it's getting us back to Superman versus Flash
right you like that question no well I I have made this observation many times is literally the only part of my field where the speed of light is relevant that's right hedge funds your company is much more than a hedge fund you've written a lot on hedge funds you know them very well for most people is it worth it the
data on hedge fund returns I've put a lot of time in trying to find out what is actually the net return forget about the risk adjusted return but just the net return how much comes from linear nonlinear strategies that makes my head spin it confuses me in the kind of way where as a naive Outsider I get a little scared what should I think of hedge
funds and how good they are overall again not a question about what you're doing sure in the I will try to separate those two it's hard sometimes I I think if you have to go buy one of every hedge fund that will that will take your money which is a subset of of of hedge fund some of them are closed you'd probably
be better off figuring out what their average exposure to the stock market is and go buying an index fund that's it's going to get me into I live in grenwich Connecticut where in some parts of the world if you said my daddy runs a hedge fund they say what's a hedge fund in grenwich Connecticut they the kids say what kind of hedge
fund does your daddy run um so is he is he event Arbitrage or Trend following what does what does Dad do so I'm I'm going to be Persona n gr um but I think hedge funds and this is a there a lot of complexity to this answer they're a universe are very smart people they are doing some good strategies some I've
mentioned to you already they seem to have grasped the momentum strategy not so much value oddly enough uh but they seem to definitely incorporate the momentum strategy there are so-called Arbitrage strategies they don't use the word like academics academics or or almost academics like me use it to mean riskless profits they mean a trade they
that has reliably worked over time where they go long and short fairly similar things they are clearly not riskless but something like a merger a is buying B if the deal closes it's going to go to here a is going to fall and B's going to rise the day it's announced only goes to he because there's some chance this deal
doesn't happen antitrust the market uh shareholder uh activism somebody else so what the what the merger Arbitrage your and my finest achievement today is saying that word in front of you that's a hard word to say buys B and sells a and if it if it if it happens they make a little money and if it fails they lose a lot of money now I'm dying to do this
I've not done it yet I've talked about it for about two years I'm about ready to try it I want to ask one of my one of my two older kids their set of twins or 12 years old does this sound like a good idea to you I'd have to hold their attention throughout this whole thing and I think there's about a 98% chance they say no that sounds like a
terrible idea to me you can lose a lot you can make a little who wants to do that I'd be the proudest pop on Earth if either of them kind of paused and said how often do both of those two things happen dad because that's the proper question right it turns out if if you do this rather with zero skill you just do
every merger that ever comes along maybe you can do better maybe not but you just do this every time you've made a lot of money over time you get killed occasionally you're basically selling Insurance when they when the deals don't happen you lose a lot hedge funds have figured that out there are a lot of other things they figured out like this
that's the good part the bad part is they do not as a group and keep in mind it's a self- serving but we run things people would call hedge funds not not all of our business by any means we think we're not doing this I we don't think we're the we we don't think we're the only ones giving clients a fair deal
I'm talking about the industry as a whole doesn't hedge enough I know that sounds stupid given the name um but if anyone likes geek numbers like correlation for the last seven years an index of hedge funds has been about 08 correlated with the S&P 500 that means if you tell me what happened to the S&P 500 I got a pretty good idea what's
happening to hedge funds the the word hedging almost by definition refers to removing that risk trying to create return returns that go up on average but at different times than stocks because you can get that again from Mr Bogle for about 11 basis points you know near 10th of a percent they don't hedge enough and they
charge a lot I if I I will never you have a shot Tyler I I don't have a shot I will never get an economic law named after me I I gave that up when I went to to to try to make money but if I got one I want it to be there is no investment process so good that there's not a fee high enough that can make it bad
and I do think hedge funds don't hedge away a lot of the risk that a lot of the risk in return you can get much cheaper elsewhere and then simply on average broad Strokes I'm insulting some people unfairly including myself but they charge too much here's a historical question but it can be about recent history who is the individual who has
done the most to promote Liberty who is undervalued in this regard oo has to be someone fairly terrible in my mind because it has to be a counter example I'm going to go with Joe Stalin please explain it's a pretty good example of what happens when you don't have it um some of us might think it's a more
relevant example than others I'm I'm not revealing anything that you might not know sure um but I think counter examples are probably more more more powerful than anything than anything else that that counter example of what happens when you take Liberty away I think we'll be with us for a really long time and I don't think we're
near there yet I might be a raving lunatic but I'm not that much of a raving lunatic but I I I think I wouldn't have wished it you know it wasn't worth the cost uh but he's helped the cause of Liberty thank you Joe the contrarian answer what's the side of Iran's philosophy that you feel is weakest um uh economics I don't mean
I I'm going to get so I'm going to get yelled at by every libertarian friend I have on Earth I I've never been a very big gold standard uh person um I I respect it I respect I have friends who are fanatic Believers in it I don't think it would be the disaster that a lot of people but I don't think it cures
all ills I have a lot of friends who who I agree with will'll say we have too much regulation I'll go check I go we have a Byzantine crazy tax code that often not just that they're high they create a lot of of odd incentives for trade-offs that shouldn't exist I'll go check um we should have a hard money no check and they think that would
fix everything I don't I don't fully get it and Iran um she basically her name of her philosophy was objectivism and she just told you it was objectively right that that gold is the standard of value I I think she's kind of unkind to Silver frankly um and uh you have succeeded in getting me make getting me making fun of
ir Rand that's very impressive uh but I when I read when she Ventures into economics um like that makes very bold strong statements um I don't agree with them all and what's her most underappreciated side or aspect or angle you know let me let me turn try to make uh uh again I'm GNA try to flip it around I'm gonna I'm I don't think she
was as anti-h helping people as she sometimes comes off um if you read her talk about it she certainly I disagree with her on this by the way um she didn't consider charity a primary virtue but she didn't have a problem with it whatsoever she it's your she considered the individual Sovereign uh and and if
that's important to you do it I think it's I think it's a larger virtue benevolence charity um is one of the things in in her world and I my favorite thing which you didn't ask about her is just you own your own life it's one line I I in love with that but the a of a virtue being the desire to help other people not someone forcing you to which
he was dead set against but but wanting to help other people I I disagree with her on but I think people come off think that she's snarling against it I don't think she was for it enough but I think she was rather passive and said it you know if you care about it she she talked about examples giving up your own life
to save someone else if you value that person more than yourself it's rational do it so I don't think she was quite as nasty about that nasty last year than I think she should have been but not quite as nasty I know you just a bit and she could have used an editor I admit that absolutely come on come on that speech oh my
Lord for this conversation I read all of these papers of yours right which is the tradition uh I've read your Wikipedia page I know you not well but some modest amount what is there in your life that's influenced you that I would have no idea about from what I've read by you and about you what's the hidden influence on Cliff
Aus that I don't see maybe others don't see that's that's a hard one I I was probably wrong about this and my parents are going to get mad at me um but we weren't we were by no means I'm not telling a poverty story I I love Marco Rubio um but if I hear one more time about the freaking bartender um his dad is a bartender It's
a Wonderful story but it's in every answer um but we grew up decidedly middle class and and my dad had he was a trial attorney and he had a job where some years he made a fair amount of money some years he made no money and my parents shared that way too much with me I've told him that I had a sense of
impending doom as a child that I think was oddly a positive for achievement it made me very um uh uh uh focused on on on not being nervous about those kind of things but does make you a happy relaxed person and it's impossible to turn off after it's no longer useful there's a literature byri Mander you may know these papers which try to argue that the
risk premium in a given generation depends on exactly what economic conditions they grew up with do you think this is generally true or just about you um I've I've written probably a a much more empirical paper uh on precisely this idea I I'm I promise I'll get there I'm going to get I'm going to get to the point
there's this idea something called the FED model for valuing stocks that says when interest rates and inflation are low you should pay a higher PE for for stocks in theory it's a very weak model because it deals with what are called nominal interest rates not real interest rates and unlike bonds when when
inflation's low you expect earnings to grow slower forget all the math there's this puzzle that the world seems to follow the FED model they price stocks according to it and it's a very strong empirical regularity when interest rates are low those pees are higher and vice versa though they do vary one thing we found I wrote this is
a financial analyst Journal articles Circa I wrote One in 2001 and a follow-up in4 that how much how much more they demand in return or how much cheaper they need stocks to be when they're cheaper they return more how much excess return they need on stocks versus bonds is a function very strong strongly of the last 20 years
relative relative volatility of stocks and bonds in English if I called 20 years a generation I didn't monkey around with that too much I checked it works for 10 years it works for 30 years it's not cherry-picked but if the last 20 years had experienced a wild ride on stocks versus bonds they demanded a very
high return going forward see I I got there if you didn't notice um I've written on this I believe it you can't make a lot of money by the way trading on 20y year phenomenon um you know clients don't really enjoy the whole well I've been wrong for 19 years but give me one more year uh but I do the I never give the
short answer but the short answer is I found the same thing myself I think it's directly reflected in the numbers uh and I think people are somewhat a prisoner of their experience last question from me before we get to questions from the group if policy makers could understand one thing better about financial markets that they don't understand
now what would you want that thing to be and why I'd want them to understand that that any form of near certainty without certainty anytime you convince the world that something is a certainty but it's not is the most dangerous time humanly possible I look back at the financial crisis and the key moments in it lot of
arguments I'm not even going to get into the partisan arguments the right says government did it the left says Wall Street did it great shocks you know what did it if I had to pick one thing that that that that one primary cause of the financial uh crisis the assumption that real estate prices can't go down the government made this
assumption the so-called mod people will say these terrible quantitative models were way off at the end of the day somewhere in this giant model in a thousand lines of computer code there was what's the worst case 10year return for Real Estate if that worst case was not losing money that's garbage in garbage out you can have the best mall
in the world that's a problem when Leman failed we went into a huge spiral because people were pretty much convinced that the government wouldn't let anyone fail when money markets when when the famous uh Reserve fund broke the buck uh this is a money market is supposed to return you a dollar for a dollar uh it's
always been a fiction by the way you've been lied to for years money markets own portfolios of short-term bonds that move in value they allow them to round to only I think two I could be off by a decimal place to only two decimal places that's not a lot two decimal places for short-term Securities means most of the
time almost all the time it rounds to a dollar therefore there's an illusion but they're risky that is to me a very dangerous asset because it tells people there's no risk when there actually is risk I'm not saying you have to go out a billion no one's wants an nav what's your nav piie no one wants that but it's
it's it's so short it's artificially looks stable and when you tell the world there's risking something and then bad things happen it's not it's not fun still bad things but they tend to deal with it much better a famous um many people have observed the internet Tech bubble that I keep talking about when
that came down The Economic Consequences the threats to our system were far more benign uh and I think that's because no matter how crazy they might have gone and nobody thought they were utterly wrestless they didn't act as a as a group as if there was no Poss problem Equity losses are expected Bond losses are not expected so I will I will say
this if you truly can take all the risk out great if you tell everyone it's risky and it's risky great I think the people thing people don't appreciate is how dangerous things are you think protect you but only mostly protect you we're having a forum here Monday with Greg IP on the very the illusion of safety we're going to have a whole
session just on this some people argue I don't know what the data is that football players would be safer if they didn't wear helmets because they would know this was dangerous they point to sports that are very very violent like rugby and whatnot and that might be true you can take this logic too far right
maybe we all drive more aggressively because we're wearing a seat belt and we know we can hit the brakes and we won't go through the windshield I'm not going to sit here and say that's a bad idea the effect exists still by the way you probably drive a little too much too aggressively and you probably have an
extra accident to do because of the seat belt my logic doesn't mean it's always bad to take preventive action but if you thought as we sometimes do in finance like money market funds that you could do anything in a car because you're wearing a seat belt that's kind of the money market analogy I'm making and I think those are the most dangerous
things thank you very much Cliff for those remarks we do have time for questions there are two mics on each side of the room please get behind a mic and I will alternate calling left and right mics uh please do not make statements these are questions uh for the focus to be on our guest anyway over here your question sir
please introduce yourself uh thank you John grahe from the national Center for policy analysis and I hate to name drop but I was at a last week uh with Mr Rubenstein of Carlile and he was asked a question about retail distribution of alternative assets and he said well it doesn't matter to us a Carlo group
because we can raise money quite readily but uh it'll probably go that way now aqr you've LED with mutual funds um do you think in the next few years due to changes in regulation that the Alternatives industry will do more distribution to non- accredited investors and how will the industry handle that opportunity the
short answer is I think I think yes um remember I I I think these strategies can be used very usefully but I don't think the hedge fund industry has broadly delivered them on Fair terms to investors when you look at the mutual fund industry and the the they're often called liquid alts the the the the the hedge fund like strategies that have
started to appear in the mutual fund world and we do some of these I think they've largely been replicating some of the same problems um I think they're not fully as a group um and we're in there and I clearly like ours but as a group uh I think they're not uh fully hedged and are probably still too expensive so I I do think that
same intellectual battle will go on uh but I think there are still reasonable strategies at the core doing reasonable things and not everyone uh is in the same position as as Mr Rubenstein a lot of people actually do want more assets uh so I do think that will that will get bigger next question hello um Ed Bartholomew
representing myself um I wanted to just sort of ask you to reconcile momentum or any of these strategies with sort of the the the related to sort of the passive versus active debate if you consider that all active strategies summed up effectively are passive so any active strategy including say something like
momentum or value investing requires not just that someone not do it but that they actually be on the opposite end of the trade so who who's on the opposite ends of the trade I mean is it individual investors they're trying to stock pick are they other sort of stupider professional managers and how can you will you explicitly use that word
okay and when you how how confident can you be that there will continue to be the steady supply of stupider investors on the other side of the trade so that you can continue to make money that's that's that's a great set of questions um backing up you're not going to believe me you're going to think I'm just copying you but myself and a
colleague Auntie elmanin um he's finished it's not just he didn't just have Odd Parents have been planning we haven't written it yet to write a paper with the literal title who was on the other side it's a little shorter version of of what you said because we do think that is a very disciplining question I've written I I
wrote uh something in the financial analyst journal on 10 different things uh in finance that I thought were kind of interesting um short observations and one of them was your point precisely where I said people think if they follow systematic strategies like we do even low turnover systematic value happens to
be what's called a low turnover strategy momentum changes its mind you have to trade momentum more than value so systematic and low turnover they'll call passive it's mainly a fight about semantics but I don't like that term because to me like for I think for you passive should be something we can all do and for any if we all try to do value
we can't all do it value even if it's systematic simple to explain works on average still requires exactly what this man just said somebody if if you're overweight cheap stocks somebody has to be overweight expensive stocks I will say a lot of it gets back to the exact conversation we started out with Tyler
uh I started out with Tyler there are two possible reasons someone can choose to be on the other side of you so you have to start out right there thinking about both of them one is they is what you're talking about Works my use of the word works for risk reasons again same thing cheap stocks are inherently riskier there's some
scenario where they get killed in a depression and that's that's risk um you are willing to bear that risk someone else is not they willingly andc consciously maybe implicitly we do a lot of things in economics it just kind of happens right even though we don't say it but they they in some sense willingly take a lower return because they don't
want that risk right there might might be true might not be but it's a very perfectly logically valid story for who is on the other side the other is Hope Springs Eternal for Value there are a number of people who simply whatever's been going on who's been beating earnings for the last few years uh whose products have been
popular that company probably should be worth more they go too far they overe extrapolate the behavioral story the other version besides risk both those stories you're exactly right do require someone on The Other Side by no means and I'm glad you asked do I think these things could be used for everyone to
outperform this is not like wagon we can't all beat the index it's it's actually a precise mathematical identity having said that I think there are risk premiums and there are behavioral biases that lead some to willingly or accidentally underperform and you have to have the story for each one and your other question about why would it
persist is also um Tyler asked a version of it too um if they were I think they can persist because they're pretty good but not extremely good um we look at this you know the value uh effect it's been a bad it's been a good five years or so for the set of these these three or four anomalies I've talked about value low risk momentum profitability
it's been a bad five years for value and the pricing of cheap versus expensive stocks it's not egregiously weird but it's about historically normal when they've on average probably looked a little too cheap if you're a behavior there is what happened of all these three or four I've talked about that's the the longest one
that's been around the longest it's very hard to Arbitrage this away somebody is on the other side value goes through some horrible periods and Hope Springs Eternal so I do think you're it's a great question because you must always ask that question I put it even Starker sometimes it's not a good title for
paper but whose money are you taking you know the old joke if you're at a poker table for five minutes and you haven't figured out who the sucker is it's you same answer if you cannot say whose money am I whose money is taking me maybe again it's perfectly rational and they don't feel taken they feel like their risk is being reduced it's fair
but why am I making this extra money if you don't ask your question and you're not doing your job and and assuming assuming it's behavioral and not risk right do you have a sense that the other side is individual stock Pickers or other professionals that are stupid some of some of both um I I I think it's I
think it's some of both there there is some evidence uh for instance I mentioned remember I I snuck this in that hedge funds seem to have figured out and and incorporate this is just empirically if you look at their returns look at which strategies are correlated to and not they seem to show that they figured out some of the momentum
strategy they don't seem seem to buy more expensive not cheap stocks maybe they buy the right ones maybe they figure it out but they have they are fighting the value effect so I think at least some of it is coming even from the very quote smart investors other restrictions like remember we talked
about lowrisk uh investing for the Fisher black reason being effective because people are restricted from Leverage professional mutual fund managers have that restriction left and right uh whether they do it consciously or they just led to it they get pushed into higher beta stocks they get pushed into taking more risk and probably
overpay for them um so I like that ex I like that example better than we're taking Mom and Pop's money uh but that's probably in there too to to some extent but keep in mind I'm being nice I'm advising mom and pop not to trade they should go to Jack next question oh sorry this side yes I have a question um specifically
about the biotech and Healthcare sector it's uh traditionally outperformed the broader Market over the past decade or so um what are your thoughts uh both as a momentum uh Trader and uh from a fundamental standpoint does that Trend continue or is it time to get out just to calibrate here we have two more questions in 10 minutes so everyone
please time your answers and questions to make it all fit perfectly to the Split Second Cliff yeah I I'll do this one quickly then I have no idea um these techniques not only do they work on average over the long term but they but you need a broad cross-section all the time they're really really bad at things
like what do you think of this sector I could literally I don't know the answer first of all I I'm going to tell this will be the third I told you active management it's too expensive hedge funds are are are not a good idea and now I'm going to tell you I don't know if we're overweight or underweight biotech everyone write that down so I
actually like telling people this when I go on something I don't do it too often but like TV we coach them don't ask me about individual stocks we're long and short thousands of things based on these quantitative measures and we're doing that intentionally because what you can be cheap good momentum profitable low beta and and the
CEO can have a scandal tomorrow right these are statistical averages you want to spread your bet so you want to make a lot of them so a quantitative systematic manager like me shouldn't know a lot I mean I could go memorize all 5,000 positions but biotech I have no idea but I think it's instructive why I have no idea if I have
an idea worse if I have a very strong opinion I'm just doing my stuff wrong there are people who may or may not be good at that but you do not come to a systematic Quant manager and and if if your systematic manager says and here's what you do put it all on biotech Run next question um my name is Evan dunks um I'm
wondering who's your favorite superhero and has your has like you studying economics changed how you felt about certain superheroes oh my god um I I've always this might be sappy patriotic but I've always liked Captain America um I I the whole he was he fought in World War II suspended animation for 20 years which by the way
happens to anyone who falls into cold [Laughter] water um that's just a throwaway I could sing You the song if you'd like when Captain America throws his anyone old enough to remember that all those who chose to oppose his shield must yield it's great rhyme um yeah even the most insane billionaire cannot afford a hundredth of what
fraking Tony Stark or Bruce Wayne have it's infuriating I I'm I I've done well I'm not the most insane out there but if I wanted to go build a batcave at my house it would take approximately 600 times my wealth and everyone would know about it so it's a shockingly good question which actually has been an annoyance of
mine yeah I have I have a a skyscraper that's also a missile silo your least favorite superhero if I may interject it you know what it used to be before the um before the movie I would have said Ant-Man but the movie was kind of funny I like the but it there was a character named Hank Pim one of the original Avengers Avengers were of
course as you all know Thor Hulk Iron Man giant man which is hpim and the WASP he is a loser giant man was just a big guy he wasn't even stronger than a regular guy he was just big everyone beat up giant man then he used the same powers to shrink and control ants of course because those go together and
then he became an alcoholic and and then he hit his wife in the comic books and that's easy to to hate but I hated him even before the spousal abuse last question here here Chris Kyer I'm a master student with the marada center uh question on uh advising people to get into the the passive lowcost Vanguard kind of funds we've seen people
heating this advice and flowing in do you think that in and of itself uh more people going to passive strategies could open up more uh potential for active managers and more uh anomalies that is a great question I'm going to fuse that question with with the one over here not the superhero one my favorite question I
might add but it cannot be fused with this question instinctively you want to say it's going to be easier to beat the market if fewer people are are trying the amount if you're a PhD student in finance this is what you do at 3:00 a.m. in your bull session is what happens if everyone indexed no one who's gone through a PhD program in finance or
probably economics has not done that we really don't know a very uh people will actually argue over this and then you try to get a little more realistic what if almost everyone indexed feels very obvious that it would be easier to win on the other hand this constraint that that that was brought up already that
the average can't beat the average whose money are you taking if everyone else is passive how do you induce them to take a bed away from passive my sense and I I I think you can literally mathematically disprove this so it's a sense of what would happen if we got close not all the way is it would be easier and you could
fool people if you were the one with some information information would be easier to get and the informationless trader you could push away more by just bidding more for their stock and short term you could capture some of their profits still hard to make the math work because if you really push them away they're no they have to tilt away and
they're trying to be passive if everyone else is trying to be be fully market cap weighted whom do you trade with no one is willing to underweight so you've actually brought up a paradox that people are still fighting about I think in a more realistic scenario I do know this more people chasing my strategy is
not good for me um but in general it's really hard to figure out but but a question everyone talks about so I'm I'm glad you asked so I could fail at it also cliff in one of your papers you cite an old Slovenian proverb which I quite like and it goes speak the truth but leave immediately after did I do think you'll be here for
just a few more minutes if we have not been able to get to your question uh but but not for hours but anyway Cliff we thank you heartily this is a lot of fun thank you all discussion was fun you read [Music] that and just for all of you our next event conversations with Tyler will be January 26th we are honored to have as
our guest Kareem Abdul Jabar and uh we will cover a wide variety of topics so please put that on your calendar and you will have an answer to a trivia question what do cliff aens and kareim Abdul Jabar have in common because this will be the only thing supern normal returns right super normal thank you again that was great thank you