An interview with billionaire quantitative investor and co-founder of AQR Capital Management, Cliff Asness. In this interview, Cliff discusses his momentum trading strategy and how to exploit other investors psychology. Cliff also talks about the worth of Hedge Funds, Bubbles and Liberty.
Billionaire Cliff Asness: Momentum Trading, Investor Psychology And Hedge Funds
Sure as one example if you were running and Large Cap U.S. equities something like the Russell 1000 and you bought the one third of stocks with this superior six to 12 month returns you probably make 100 125 basis points extra long term on average 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 and it seems to be larger excuse me for small stocks 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. Analyst coverage Wall Street doesn't cover them as much. Perhaps if there's whatever degree of inefficiencies 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 a few of it in terms of excess return 100 hundred and 25 basis points compounded over 20 30 years. Obviously that's going to be a lot of money. Correct. Correct. So 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 there.
There are a number of them. One hypothesis is I'm really not very convincing at all. Another is that more people do it these days 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. 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 off to say to someone who studies markets particularly for Eugene Fama like I did the idea that you can beat markets and we do more than just momentum. Tyler I promise. He's promised me he'll get to that. But it's a very unintuitive idea if you think markets are anywhere near a highly efficient. And I think that dissuades some. And no one really works all the time. One thing 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 100 years. We get small p values large statistics if anyone likes those kinds of numbers out there. So we think we're reasonably sure the average return is positive. It has horrible streaks within that of not working. If your car worked like this you'd fire your mechanic for work on the word. If it worked like I used 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 a 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 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 in momentum will work. What's wrong with us as people. What more human imperfection.
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 argue over. I will give you the two most prominent explanations for the efficacy of momentum. The first is called underreact that.