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Cliff Asness: Hedge Fund Strategies are Failing, Here’s Why

Cliff Asness of AQR Capital Management, joined Stephanie Ruhle, David Westin and Erik Schatzker on Bloomberg TV’s new flagship morning program, Bloomberg <GO>. He discussed market reaction to the Paris terror attacks and the use of long-term investing to overcome risks.

Cliff Asness

Cliff Asness on why hedge fund returns are down:

“They don’t hedge enough and they charge too much. Over time what they are supposed to do is hedge out the market risk, provide a return that’s independent of the market, these famous uncorrelated diversifying returns. And they’re supposed to do it at a reasonable price.”

Cliff Asness on the market reaction to the terrorist attacks in Paris:

“As a person you weep, but as a long-term investor you do your best to ignore. term I would say the markets are reacting very rationally. And I’m probably more of a contrarian. Medium to long-term, this doesn’t drive markets. This is a human tragedy, but it doesn’t drive markets. “

Cliff Asness: Markets Reacting to Paris Attack ‘Rationally’

Risk Parity and a Long-Term Investment Portfolio

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Hedge Fund Strategies are Failing, Here’s Why

Cliff Asness: Hedge Funds Charge Too Much, Returns Down

ERIK SCHATZKER: As I mentioned moments ago, Cliff Asness of AQR is here. Cliff, if we could begin with a little bit on the way investors tend to think about events like the terrorist attacks in Paris on Friday, Matt showed us that things haven’t really moved that much. And frankly if you look at the historic record, things don’t move that much over time after these horrible incidents. So, again, as the investor, as a man who sits on top of $135 billion and, granted, not all of your strategies would speak to this, why is that the case?

Cliff Asness: Well as a person you weep, but as a long-term investor you do your best to ignore. I don’t think it matters very much. As a medium or short-term investor, it’s not our strong suit. We’re not timing these things, but if I had to, I’m probably a more contrarian than anything else, the whole — the old Rothschild quote, what is it, buy on the cannon, sell on the trumpets. I’m not the guy to give short-term advice, but if I had any inclination short term I would say the markets are reacting very rationally. And I’m probably more of a contrarian. Medium to long-term, this doesn’t drive markets. This is a human tragedy, but it doesn’t drive markets.

STEPHANIE RUHLE: The demands they put on you, the time horizons that they’ve created, the fact that they change things so much, how can one be a long-term investor when the people who are giving you the big bucks won’t allow it?

Cliff Asness: I think a lot of the people giving us or others the big bucks are better than you think. I think there is this trend. I’m not denying it, but I think good investing is about exactly that. If it’s harder today, I’m going to go crazy and say the rewards will be bigger to doing it. I used to think being great at investing long-term was about genius. Genius is still good, but more and more I think it’s about doing something reasonable that makes sense, and then sticking to it with incredible fortitude through tough times.

RUHLE: But how do you do that? Think about who — what we’ve seen grow in the hedge fund community in the last few years. It’s these hedge fund platforms. It’s hedge funds that have vertical after vertical. And the minute you go outside your range, a secretary you’ve never seen before shows up with an empty box at your desk, saying get the hell out of here.

Cliff Asness: Yes.

RUHLE: Well that’s what the investment climate has turned into. How do you invest in a time like this, and how do you explain, well we’ve got to give more credit to these people? How?

Cliff Asness: You get fired by those people. You find other people that are out there. They invest with you, and then you do well. You try to stay away from these people as much as possible. The short-term is your enemy. I think what I call the short-term is sometimes years. I think people look at multiple years at times and infer too much.

So if we’re talking about quarters and months that’s crazy. I agree with that. But I do think my method — my message of optimism here is I think there are more investors, there are more institutions, there are more individuals through their — either on their own or through advisers who have a longer time horizon. The shift you’re talking about is real, but they are not the whole market.

SCHATZKER: Cliff, we’re going to have plenty of time over the course of this hour to beat up on hedge fund managers, but for the moment let’s talk about some of the macro managers who are paying geopolitical risk consultants all kinds of money, right, for advice that doesn’t seem to matter. If we go back to the chart that we looked at that Matt showed us with these terrorist incidents, the relentless, more or less relentless march upward of the market during times of geopolitical stress, it just leaves me wondering.

RUHLE: Why people like Cliff pay geopolitical analysts so much money?

Cliff Asness: I have never paid a geopolitical analyst, to my knowledge. It’s a big firm. I’m going to wake up and find out actually you gave one $7.00 12 years ago. Look, you’re talking to a disciplined systematic manager. You’re throwing me a hanging curve ball. I don’t believe that kind of stuff works very well.

I also have to live and work in Greenwich, Connecticut and my kids have to go to school there. So if I’m too nasty I’m not sure I can go home again. There are people who believe in it more. There are people who are more short-term. Some have good track record. Distinguishing that randomness versus skill is very hard. If you ask me my honest opinion that stuff is not very worthwhile to make money.

DAVID WESTIN, BLOOMBERG NEWS: So, Cliff, it makes sense to me, and I’ve heard from other people, you need to figure out a good plan, stay with the plan, don’t get thrown off your plan with little vagaries that come up sometimes. But at what point are there data that come and says I got to rethink the plan?

Cliff Asness: Well there are things, like I don’t think the global financial crisis was a just ignore it, stick with it. And even there you don’t sell all your stocks in a panic. But that was something that I don’t think could just say I’m not going to pay attention and ignore it. Most of the time you focus on why you’re doing what you’re doing, what the historical evidence is. And you stick with it.

I was not an author of this, but three guys from my firm wrote a paper on Warren Buffett’s return over time, 35, 40 years of returns. Of course they found he was fantastic, but not quite as fantastic — his track record was phenomenal, but human phenomenal. What was beyond human was him sticking with it for 35 years and rarely, if ever, really retreating from it. And that was a nice little lesson that you have to be good, even very good, but sticking with it and not getting distracted is much more the job.

RUHLE: But you can’t invest in a vacuum. One of the mistakes we saw investors make in 2007, 2008, they weren’t looking at the global economy. They weren’t paying — you could be an investor in a tech company in Texas, but if you didn’t know where Portugal was on a map, you were about to get smoked come 2008. At what point do you have to focus on more than just your strategy and really take a global perspective?

Cliff Asness: Yes. Well strategies, disciplined strategies tend to take a global perspective. When — I’ll just talk about ours because it’s the only one I really am very familiar with, but looking around the world, the things like valuations, trends, both price and fundamental, quality of firms, profitability, risk. We prefer low risk to high risk.

RUHLE: What does that mean, quality of firms, quality of companies?

Cliff Asness: All else equal, low-risk firms, in geek speak low volatility, low beta firms in fundamentals, high profitability firms have tended to outperform their opposites. It’s a bit of a puzzle. Efficient markets struggles with this one a bit, but it has. That kind of thing works very well in conjunction with the value strategy because value strategies often want lower quality firms. Put the two together you’re looking for a nice combination.

We try to use those globally when it comes to countries and asset classes. None of this stuff it works like regular people use the word works. I’ve been joking for years, when I saw works I mean two out of three years for 100 years. If your mechanic used the word works like this you would fire him, your car. Two out of three is not good on your car, but these things have tended to work. So you want to look globally.

You want to incorporate all of this, but if you have a process that already does that, and you have a process for risk control, and by no means saying that estimating risk and saying how much risk you should take doesn’t take into account events. You have to ask yourself a different question. I’m saying do you deviate from your process when you see these things? And those situations are far, far rarer if they exist.

SCHATZKER: Why are hedge funds sucking it so badly?

RUHLE: Get technical.

Cliff Asness: That’s pretty technical.

SCHATZKER: What’s going on, Cliff?

Cliff Asness: Can I take the rest of the hour?

RUHLE: You got it.

SCHATZKER: That’s why you’re here.

WESTIN: We want you to.

Cliff Asness: We’ve written a lot about this. We started in the year 2000 with a paper called “Do Hedge Funds Hedge” that was — I mean it’s very unpopular in the hedge fund world, talked about they don’t hedge enough. And I’ll get to that because right now the opposite is showing up.

They don’t hedge enough and they charge too much. Over time what they are supposed to do is hedge out the market risk, provide a return that’s independent of the market, these famous uncorrelated diversifying returns. And they’re supposed to do it at a reasonable price.

SCHATZKER: Those look like pretty uncorrelated returns.

Cliff Asness: Well it has been, with some exceptions recently, certainly, a bull market. The flip side, when I criticize them, and I have criticized them for those two things for not hedging enough, the flip side is when the market goes up they are not unhedged. They are not 100 percent long.

If you want the numbers, they’ve been about 35, 40 percent net long over time. I don’t like that part because the observation was right. You should get that from Jack Bogle for near zero. If you want to be net long, Jack will give it to you for five basis points, and you can get it there. You don’t need hedge funds to take two and 20 out of 40 percent net long.

The flipside though, they’re not 100 percent net long. So when people criticize them like me long-term for not being hedged, short-term in a bull market they’re not fully invested. So I think that is too short of a period. I think, by the way, I know I get boring. I think everything is too short of a period. I wrote a blog —

SCHATZKER: We’re going to go back to 1900 little bit later.

Cliff Asness: I wrote a blog piece taking issue with someone praising our short-term performance this year, because it’s too short term. I don’t like that. I don’t like that either. I think in a bull market hedge funds should lag. In a bear market they should outperform.

SCHATZKER: Right.

Cliff Asness: Over time I do think the criticism that they do this partially hedged odd thing, they’re not fully hedged, they’re not fully invested, and they do charge too much for what they do. They’re good stuff there, but they charge too much. Those are fair criticisms.

RUHLE: You’ve also criticized hedge fund trades being too crowded. Is the reason we’ve seen this overcrowding, in just a few names, in just a few trades, the cause of short-term investing?

Cliff Asness: It’s hard to disentangle the short-term investing because crowding, does crowding cause short-term investing? I like to say I’m not involved in this world. I’m a quant who doesn’t talk to people, and I have no friends. So we just — we — that’s an exaggeration. I got one or two. You guys brought one on once.

RUHLE: We did.

Cliff Asness: But, yes, it’s an industry that has grown tremendously. It is — no financial asset is immune to bigger, being harder to make money. Short-term is another problem. Anyone under short-term pressure is going to find it more difficult. I think those come together and make it harder. I simply won’t look at one or two years of lagging a bull market as the evidence. I tend to be a critic.

SCHATZKER: I know.

Cliff Asness: I just don’t want to base it on a couple years of lagging in a market I think they’re supposed to lag in.

SCHATZKER: Are these strategies still working? Let’s get more basic.

Cliff Asness: I think there’s a lot of good stuff underlying what hedge fund managers do.

RUHLE: What does that mean?

Cliff Asness: They provide arbitrage capital and mergers in the converts world that no one else provides. I think there are trends that exist on average. Trends keep going. Systematic trend followers have added, forget fees for a second, with which we could forget them forever, but forget them for a second, I think the strategies work.

I think individual stock picking, if it’s based on things like value, quality that I talked about before, low risk, works. And hedge funds have figured out a lot of these individual strategies. The package they put it together for investors as an industry, clearly I wouldn’t want someone to say this to me. It’s not fair to say this to any one manager, but as an industry the package they put it together is not fully hedged, not very transparent and too expensive.

I like to joke we know all this data that it’s hard to beat the market, and mutual funds have found it very difficult to beat the market. When you go to hedge funds, it’s like we figured out how we can beat the market. We just weren’t charging enough before. That’s not going to help. So I am a critic, but I wouldn’t base it on the really short period. I think there’s good stuff. It should be packaged better for investors.

RUHLE: I’d actually like to follow up on the point you last made. We actually got a question coming from Instant Bloomberg. Is one of the reasons we’ve seen really poor hedge fund performance is because this is a moment where we’re seeing a regime change of low volatility, steady gains to more choppy uncertainty in these markets?

Cliff Asness: See now I’ll flip the other side. I’ll be mean to hedge funds.

RUHLE: Bring it.

Cliff Asness: I think that’s a pretty poor excuse. I’m the first — I hope I’m the first to say the short-term is tough. Sometimes you make money, sometimes you lose money. If you make money more than you lose money long-term you’re doing a great job. I don’t want to infer too much from it.

But you remember for a couple of years beforehand hedge funds complained there wasn’t enough volatility. They did. They talked about it’s a boring market, there’s not enough going on. How do you make money? So that excuse, I wouldn’t buy that excuse. There is no perfect market. You can make or lose money in any market. I don’t think anyone will make money all the time. I’m not being that guy. But I don’t think you can just always point to the current environment and go, well, who can make money now?

RUHLE: Then what’s the excuse for poor macro performance? Luke Ellis of the Man Group was here, and they were getting out of macro trading. Macro hedge fund investors were the original titans. And it was at a time when we had a whole lot less data. Now given all of the information we have real time around the world, has it made it significantly harder to be a macro investor?

Cliff Asness: Anything is harder than it used to be when a lot of people know about it. I like —

RUHLE: Isn’t that perverse? Doesn’t that say when only a few people had all the information, it was a much better time to trade. One would think if you have more information you would be more equipped to trade.

Cliff Asness: Well you have two things going on. More information, all else equal, is good. More information that everyone else knows at the same level you know doesn’t particularly give you an edge.

RUHLE: More information is good if you’re a consumer looking to buy a TV. It’s not good if you’re looking for a ARB opportunity.

Cliff Asness: Well I also think that there is also a confusion between getting information and processing information well. And this is not a statement on current macro managers, but I remember back in the technology bubble, it’s ’99, 2000, we were getting killed. It worked out okay. I’m still here, but we were on the wrong side of that. We thought it was crazy, not horribly early, but a year or two early is excruciating.

And one of the things we heard was, well, how can you say this is irrational? People have every piece of information in the world at their fingertips. They were actually using the internet to justify the internet bubble. And I think what we learned there is people can get it right or wrong, but more information does not necessarily lead to better decisions. With zero information it’s pretty tough to make a decision.

But a constant flood of — you talked about being short-term. Information overload, too much information, I don’t think it should make us into idiots. But at some point it doesn’t keep adding to our value.

SCHATZKER: But isn’t that what you’re trying to filter out at AQR with sort of quantitative and systematic strategies to strip out the noise from the signal?

Cliff Asness: Well I’m trying desperately not to brag. It’s not been a particularly tough time for us, but we will have tough times when other people don’t. That’s — and that happens. I think what we try to do is actually pretty uncorrelated. It’s the goal. So it’s hard for me to address this. I don’t want to talk about what is going on with other people, and I don’t want to be too short-term about it, but a lot of people are trying to do the same things with the same information. It gets harder.

SCHATZKER: How much of this is a function of zero interest rates, and how much of it is a function, particularly in equities, but we could also start talking about fixed income, of market structure?

Cliff Asness: I think I’m going to be mean again. I keep flipping back and forth, defensive or mean, either one. I think zero interest rates tends to be somewhat of an excuse. The way almost any hedge fund strategy works, the way almost any long-only strategy works is you own — you earn the cash rate plus a premium.

SCHATZKER: Yes.

Cliff Asness: With long/short strategies it’s very explicit, your longs minus your shorts plus cash. Total returns will be lower when cash is lower because you start from a lower base rate, and that is not an excuse. That’s just valid. If you start from a five percent lower cash rate, and are just as smart as you used to be, you’re adding to a smaller number.

SCHATZKER: But everybody is affected equally.

Cliff Asness: But everybody is affected equally, and I think markets are affected by the short rate also. So I don’t think it necessarily leads to fewer opportunities. There’s where it’s an excuse. If someone is yelling you’re making five percent less because cash used to be five and now it’s zero, that’s a good excuse. Sorry, cash is lower. We make five percent less. If you’re adding less on top of cash, I don’t think that’s a fair excuse.

WESTIN: So, Cliff, let me ask how much of your criticism of hedge funds is inherent in the structure of hedge funds, an it’s particular on the way you’re compensated, because when you get two percent, you get two percent no matter what happens, as I understand it. You’re sharing 20 percent of the upside, right? As I understand it, you don’t write a check to people if it goes down, and cover 20 percent of their losses. So doesn’t that inherently create almost a conflict of interest between managers and investors?

Cliff Asness: Well, yes. And I am a yes. I never end with —

WESTIN: Yes. That’s great. I love simple answers.

Cliff Asness: I think the problem with the fees are not so much their structure, but their level. And there are strategies out there, and I’m not talking particularly about us where you can justify quite a high fee. If you truly have an edge no one else has, you should charge much more for it.

If you’re very aggressive, you can consider whether you want a very aggressive investor, but an investor who wants to invest very aggressively will have to pay a higher fee because that manager will have much less capacity. They’re taking bigger positions. So larger fees can be justified.

The performance fees a lot of investors prefer, but if you add up these two in the expected fees, very large versus the potential value added, and if a lot of that return is coming from being 0.4 exposed, 40 percent exposed to the market going up over time, they can be simply too high versus what I call the good stuff, these strategies that are underlying.

So there is no perfect fee structure. A perfect fee structure would be very, very long term, be a performance fee that was very long term. You need investors who are then willing to stick very long term, and it has to be two-sided. That would be better. But in the world we have I think the problem is more about the level for what’s being done than the particular structure.

RUHLE: Well those who saw you speak at the Market Most Influential Summit walked away saying investors don’t have a lot to look forward to. You had said both stocks and bonds are not usually expensive at the same time, but they are today. Why?

Cliff Asness: Why? And let’s start with what. Stocks on the measures that we like to look at, we look at many of them, but the most famous these days is the Shiller CAPE cyclically adjusted PE. You go back a little over 100 years. It’s in the high and high 80th percentile, low 90th percentile expensive, bounces around of course precisely where it is, call it more expensive than 8.5 or nine out of 10 times throughout history.

It looks cheap versus the technology bubble. If you do the graph you can get fooled and thinks it looks reasonable. It’s the old — I like this. I use this in my life, the Rodney Dangerfield comment, —

RUHLE: One of my favorites.

Cliff Asness: — if you want to look — if you look — if you want to look thin, stand next to fat people. That works for me. The tech bubble does that for stocks today. If you look throughout history, not good. Bonds are call it mildly, but not extremely worse. Real yields, yields — yield on the 10-year minus economists’ forecasts of inflation, look over the very long-term, it’s higher than about low 90th percentile of times.

Both of those are not the tech bubble. The tech bubble stocks were 1.5 times prior highs. That was not — percentiles are tricky numbers. You can’t get higher than the 100th percentile, but you can keep getting more expensive. So neither are what I would call a bubble, provably insane. And the world is nuts.

They’re simply very expensive assets. To Stephanie’s point, if you take a portfolio of the two and put them together, we think it’s — that portfolio is more expensive than just about 100 percent of the time. I say just about because, again, the end point jumps around. It’s not two times the last high, but it’s just about the worst it’s ever been because, to Stephanie’s point, they’re not usually expensive. They’re not usually in the 90 percentile at the same time. Go back again to the tech bubble. Stocks were way worse than today, but bonds will give you four percent over inflation just for showing up.

SCHATZKER: What is changing though in the investors’ mindset because, as you wrote in “Institutional Investor Magazine,” if you look at the Shiller CAPE, the adjusted PE over time, you see that in the first half of the 20th century, right, the average was 13.5. In the second half of the 20th century it was 17. And in the first half of this century, we’re only 15 years in, it’s 25 plus. Now, yes, some of that is elevated by the technology bubble, but that’s where we are right now, approximately 25. But what it shows is that over time, regardless, people are willing to pay more for earnings. Why is that?

Cliff Asness: There’s been a steady drift up. If you’re going to read my stuff this is just not going to be fair. First of all, there are no certainties here. There are a lot of theories as to why —

RUHLE: There shouldn’t be certainties.

Cliff Asness: Of course there shouldn’t. If they were certainties this would be easy. But why do people pay, and to rephrase Erik’s question, why do people pay higher multiples today pretty steadily? And obviously we’ve had dips and moves, but pretty steady move over the last 50, 60 years that people will consistently pay higher multiples on stocks.

One theory is you don’t really care about what you pay. You care about what you make of course. In the past you didn’t earn all the returns on stocks. There wasn’t Jack Bogle out there. And I don’t want to overuse him, and he’s a hero of mine, but you couldn’t go buy the whole market for a very low fee. So people had more concentrated portfolios at higher fees. So they didn’t earn as much, and they had to take more risk. So it could be rational to pay more, because paying more leads to a lower return. Maybe it’s rational. Here’s what you can’t do though.

You can’t use that logic to say so I think everything is ok and we’re going to make historical returns. That’s circular logic. You try to trick — maybe you trick yourself. You have to actually use the lower numbers.

SCHATZKER: So here’s the thing that I don’t quite understand. Why, if what you say —

RUHLE: What, that Cliff said the market existed before Jack Bogle?

SCHATZKER: No, no, no, no.

RUHLE: And really Jack’s been investing for how many years, yes.

SCHATZKER: I think and if Cliff believes what he says, and I know he does, why are you also saying at the same time that a little momentum or trend following right now isn’t such a bad idea?

RUHLE: Ding, ding.

SCHATZKER: And in your words, sinning a little bit is okay, right?

Cliff Asness: Well now you’re reading another — you’re going — did you spend the weekend reading my stuff? That’s scary.

RUHLE: This is not the weekend, all the time, Cliff.

Cliff Asness: Myself and a colleague, Antti Ilmanen, wrote a paper about market timing, that the world has often considered it a sin. Actually there are two sets of people, people who consider it a total sin, and people who oversell it. And we do think we’re somewhere in the middle. We — our tag phrase is and sin, but sin a little, two ways. We look at the two classic strategies, the most tested things in finance, —

RUHLE: Which are?

Cliff Asness: — yes, trend following, which Erik mentioned, but also valuation. Where do we stand today versus history? We find over the very long term for both stocks and bonds both add a little bit of value if you do them in moderation, two-sided. Trend following is not a 25-year trend. It’s six to 12 months. It’s something I wrote my dissertation on in the Stone Age. It’s one of the harder things for market efficiency to deal with. It’s the tendency that assets tend to keep going. Right now the trend on the market, Erik, it’s funny, it’s not a bullish trend. It’s, if anything, a neutral, bouncing around a neutral to (INAUDIBLE) negative.

SCHATZKER: Unless you’re in five stocks, right, unless you’re in Amazon, unless you’re in Microsoft, unless you’re in Facebook.

Cliff Asness: Yes. I’m talking about the market.

RUHLE: But if you choose five stocks, being an investment follower that’s when you end up in a hedge fund hotel, and you’re screwed.

SCHATZKER: That’s what I want to know. I mean you may have seen the research. Your once upon a time employer, Goldman Sachs, crunched the numbers and found out that these five stocks, right, it’s Facebook, it’s Google, or Alphabet if you prefer, —

RUHLE: Apple.

SCHATZKER: — and it’s GE. No, in fact, Apple isn’t even in there.

RUHLE: Really?

SCHATZKER: And no, Amazon and Facebook. So there’s five in total are responsible for more than all of the S&P 500’s year-to-date gain. In fact, if you stripped them out the market is down 2.2 percent. But that is a trend that has only emerged, that incredibly narrow breadth of the market, in the past month. And on average these very narrow breadth trends tend to last at least four months. So would you ride that wave?

Cliff Asness: Let’s talk about two different things. There’s the market as a whole. The market as a whole, we’re saying if you’re going to sin a little and try to time it, I find the in depth, the breadth numbers and whatnot, we’ve never gotten much out of them. We tend to look at the market as a whole over six to 12 months, how it’s been doing, and where is its value versus the past.

Now let’s talk about something else, choosing what stocks to be in. I’ll never pick five stocks. I want to be overweight or long 500, and underweight or short 500 and bet on the averages. Quant geeks have strong opinions about averages, and know very little about individual names.

Having said that, it’s been a strong year for momentum investing in stock selection, not in the trend. And so this relative. And it’s been a relatively weak year for value investing. We still believe in both. We don’t think we can time which of these. We want to build a portfolio that does some of the other things I mentioned, and these two things in the relative world, but I can report that we find very similar to them. Them finding that a few have led and it’s been consistent, it’s fairly consistent with our finding that it’s been a better year for momentum than value.

RUHLE: We’ve got an Instant Bloomberg that has just come in from Edison Nyzyka, asking do you believe that a risk parity weighting approach may yield positive results?

Cliff Asness: To be specific, he says when to I believe it. So I will say two things. I believe it will long terms. Risk parity, and people say a lot of crazy things about it. It gets exaggerated. It’s the general notion that being more balanced by risk, traditional portfolios if you’re 60/40 stocks/bonds are dominated by equities, is at much more than 60 percent of your return and your risk comes from equities.

And we and many others think a diversified geographic portfolio across stocks and bonds, other asset classes like commodities and credit at risk weightings that matter, but not too much, will long term outperform. But is the completely strategic argument. It is a long-term argument. It is not about what will outperform tomorrow. Everything else we’re talking about, again I’m not a very big market timer, sin a little, but everything else we’re talking about, value, trend, carry, quality in terms of low risk and profitability, nothing is great, but those are better short term.

Risk parity is about the next 10 or 20 years. Do I think a diversified by risk portfolio will outperform an equity-dominated portfolio at the same level of risk? And this is a much longer talk to talk about how to make those the same. Yes, I do. As to when, I have no idea, because that’s what a strategic allocation means.

SCHATZKER: Why would anybody with a long-term view, Cliff, invest in public markets? If you have the money, if you qualify, and you don’t — you’re not subject to some kind of call on your dough, why not just invest in private equity?

Cliff Asness: A few reasons. First of all, I think big institutions that can do it should put some in private assets, so it’s not anti, but the proposition that you should do that instead of public, let me take it on in a few ways. I don’t think it’s all proven that you generally long term do better in private, particularly when it comes — again, I know I’m a broken record, after fees, and terms and conditions.

You’re worried about your net, not gross. A lot of the investors who talk about private throw in a little comment all the time. It’s an odd little parenthetical comment if you could be first quartile. And let me just tell you there’s not a thing in the world you’re not going to do really well out long-term if you can be first quartile.

RUHLE: What does that mean, first quartile?

Cliff Asness: Take all the private equity managers and be in the top quarter of long-term performance. Take all of the widget managers. If you’re in the top quartile of widget performance, I think you’re going to do well. So if you can do it, maybe there’s a case that savvy investors have a better shot at being first quartile in private. If you can make that argument, fine.

Third, private tends to be subject to the same forces. And it’s not my field. I don’t go looking for private companies, but I’m going to guess they’re paying higher prices because their end game is to go public. You got to remember, a lot of these things have to end in the public market. If it’s a bad 10 years for the public market, if valuations regress to the mean, if they’re paying anywhere near elevator prices now, which I’m guess they are, they’re linked to the public market.

So I think to the extent you think have an edge, it’s up to you as the investor instead and you think you can find good managers, you should have part of your allocation — long-term investors, what are they — what can they do that other people can’t? They’re long term. They don’t need their money tomorrow.

Being a little illiquid probably should have a return for you. But I don’t think it’s very different today than at other times. I think it is subject to the same forces that public markets are, and you should look at them, but you should always be looking at them if you have that capability.

RUHLE: All right. Then all the magic and love we have given to private equity in the last few years, and all the funds that have flown there, is it because they’re doing such smart investing, or is the benefit that they don’t have to mark-to-market?

Cliff Asness: That’s — I have a long history of complaining about this, as someone who does have to mark-to-market. And I go back to my Goldman Sachs days. This is about a 20-year-old story.

RUHLE: When you had risk manager standing over you saying, sell today, sell.

Cliff Asness: Well there was a day, the S&P was down about seven percent. It was October of

97. It was the Asian debt crisis where I was very proud that our market neutral fund was flat that day.

And then our private equity manager comes over, and he ways, how you guys doing? I say, flat. And he says, me too. And I go, no, you’re not.

RUHLE: You’re not. How could you possibly be?

Cliff Asness: I said aren’t you kind of leveraged small and midcap? And he says, yes. And I said, well if you had to sell today versus yesterday, wouldn’t you be down a lot? And to his credit, he said, a ton, but I don’t have to sell today, which is of course the little bit of cheating in my mind.

I’d go for years if investors want to invest with us, not check every 10 years, and we just won’t tell them how we’re doing. We can reproduce private equity also. With all that said, I’m a little less cynical today. I used to think investors didn’t get it, that they thought this was diversifying just because it wasn’t mark-to-market. I think most of the investors are smarter than that.

I think they get it, and there’s a Ulysses tied to the mast concept that many investors, I’m not saying you should need this, it would better to be disciplined without it, it would be better to have all your options open, but if you have the option to get out every day, you might at the wrong time. So, believe it or not, not my field, not what I do, but I think many investors are almost consciously tying themselves to the mast.

WESTIN: But isn’t the theory of private equity that there are certain market imperfections with respect to some companies that really smart people can look for an identify, fix them up and then take them back out? And that probably is right.

Cliff Asness: It probably is right and it should be right economically, right? Imagine a world without this. You’d have to create it. Small and medium-sized companies that need help with the next step, they need capital, they can’t get it from the public —

RUHLE: You know what? We’ve got to interrupt you for a moment, because President Obama has actually taken the stage.

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