Tyler and investment strategist Cliff Asness discuss momentum and value investing strategies, disagreeing with Eugene Fama, Marvel vs. DC, the inscrutability of risk, high frequency trading, the economics of Ayn Rand, bubble logic, and why never to share a gym with Cirque du Soleil.
TYLER COWEN: Cliff is one of the most influential figures in global finance. He has a PhD from the University of Chicago, he studied there with Gene Fama. And he is a founder and principal of AQR Capital Management in Connecticut.
On momentum and value investing
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 a momentum trading strategy is?
[drizzle]Cliff Asness: Sure. 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 6 to 12 months, and you beat the market. Unfortunately for sanity, that seems to be true.
COWEN: 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 supernormal returns might you possibly earn through a momentum trading strategy?
Cliff Asness: As one example, if you were running against large?cap US equity, something like the Russell 1000, and you bought the one?third of stocks with the superior 6 to 12 months returns, you’d probably make 100, 125 basis points extra long?term, on average. You do that in small stocks. It’s more like 250 to 300.
COWEN: Why is it larger for small stocks?
Cliff Asness: Almost anything we find in investing, almost any regularity, “this tends to beat this,” seems to be smaller?—?seems to be larger, excuse me?—?for small stocks. That is 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. Analysts’ coverage, Wall Street doesn’t cover them as much, perhaps whatever degree of inefficiency in the market is larger for small?caps. But it’s a nearly ubiquitous finding. Anything you find works in large?caps tends to work somewhat better in small.
COWEN: If you have, in terms of excess return, 100, 125 basis points compounded over 20, 30 years, obviously that’s going to be a lot of money, correct?
Cliff Asness: Correct.
COWEN: What’s the catch? What’s the qualification? Why doesn’t everyone here run out? They don’t even wait until the talk is over —
Remember the movie Highlander? You and I talk about sci?fi.
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