 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 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 a momentum investing strategy is the rather insane proposition of That you can buy a portfolio of what's been going up for the last six to twelve months sell a portfolio of what's been going down for the last six to Twelve 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 lunchway, but what kinds of? Supernormal returns might you possibly earn through a momentum trading strategy? Sure as one example If you're we're running against large cap US equity something like the Russell 1000 and you bought the one-third of stocks With the superior six to twelve month returns you probably make a hundred hundred twenty five basis points extra long term on average If you do that in small stocks, it's more like two fifty to three hundred 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 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 a hundred hundred and twenty five basis points Compounded over twenty thirty 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? Um, there are a number of them One hypothesis is I'm really not very convincing at all Another is More people do it these days and and I'll I'll admit I think the strategy is gonna 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 gonna 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 just to someone who studies markets particularly for Gene Fama 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 but It's a very unintuitive idea if you think markets are or anywhere near highly efficient And I think that dissuades some and it nowhere nearly 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 a hundred 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 not working if your car work 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 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'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 three to twelve month time window? Sorry investing on momentum will work What's wrong with us as people what's the core 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 of momentum. The first is called under reaction Simple idea comes from from behavioral psychology the phenomena there called anchoring and adjustment news comes out price moves but not all the way 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's some statistical tendency to continue take a while 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 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 an empirical finance is Though those might be the right explanations, but they're not mutually exclusive Remember the movie Highlander you and I talk about soft files 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 two thousand people laughs That's not true in in in these things. There could be multiple Explanations both of these things can be true. There can be underreaction and ultimately People can go too far Very often in finance. There are two other let me give you two other possible explanations also Every empirical Regularity meaning something that works 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 datamined, you know, I sat there in my dissertation in 1990 I found this empirical relationship with a big t-stat, but I really checked 63 things So the t-stat is a bit of a lie and it never works again Momentum in my opinion. This is editorial has survived 200 out of sample tests Through time different asset classes. I don't believe that one but to be intellectually 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 the 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 era 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 short term six to twelve 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. They do show 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 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 overinterpret 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 gonna go with that from now. No, I'm kidding. Yes It does I think you're articulating a version of the overreaction idea and one thing Tyler just referred to is is if anything Pride of place came before momentum and is a super important strategy to us 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 and pretty much anyway price divided by something reasonable price divided by earnings books sales Just buying five-year losers five-year Stocks that have suffered and and selling or or underweighting the opposite is also a very good strategy Very much the opposite in spirit to momentum now in the value world. They have the same fight dude Does cheap eat expensive because it's riskier? 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 Then a much more short-term Phenomenon like like momentum and then there could also be overreacting of course the second big one is behavioral People make errors of any kind literally almost of any kind value is going to work because 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 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 are other One thing nice about the overreaction Reason for why momentum has worked over time is it is consistent with the behavioral version of value to 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 markets stay imperfectly I'm very pleased to get a promotion and metaphysical. That's much deeper than I've ever thought of it But I Started I was never a pure efficient marketer I was never a person of thought markets price things perfectly nor is anyone by the way The Paragon's might one of my investing heroes of academic here is Jean Fama likes to shock the class at Chicago Only 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 efficient markets So you get a Any anywhere else you guys did not do that you might you might notice that And he's making a point that that's in a very extreme hypothesis that all the information is there People individually 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 over Confidence and over extrapolation Are you two of us over confident? Let's say someone on Twitter. I can't answer for you I am react or overreact. I am I I overreact and therefore I'm over Confident if you tell your kids they can't watch their favorite you're you're destroying my entire self-image right here or overreact My kids are probably more grown up than I am yeah, yeah, but they overreact they overreact I can't find a lot of examples of people who under react 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 you know, let let me take this in another way I think when it comes I think we are mixing over confidence 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 we come to processing new information I do think there isn't 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 on 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 good But at academic seminars this idea that there can be multiple explanations I push at times because they'll always be you know two people they want to win right somebody has an overreaction Someone 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 It doesn't have to be the same at all points in time and let me give you an example I'm I didn't start out a perfect efficient marketer I wrote 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 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 one of my partners told me I look like Lincoln before and after the Civil War from the technology bubble to which I was like We got a lot 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 ten years it might get you nowhere or even underperforms 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 low risk investing So Fisher black of the black Scholl's option pricing model discovered in 1970 and then everyone everyone forgot for 35 years It's another effective systematic form of investing if everyone did them. Yes, 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 in 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 have keep your market franchise I recognize intellectually you need those times while I will whine and cry horribly During those I'm not I'm not pretending. I'm above that but momentum investing still works. I believe it a day Stochastically. Yes. Now if the momentum anomaly and the value anomaly Those to me seem like the two biggest anomalies pricing theory does Eugene Fama 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, we'll he's just trying to get me in trouble. I will tell you I'm I'm in public here. 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 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 Jean Fama fishing markets dissertation Look with these crazy people on Wall Street do they make all these indicators and they're thrown away their money to his credit He immediately said if it's in the data, right the paper Now we don't agree fully on it. We don't agree on two things 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 might be a big part of it I think Jean would say it's mostly are all risk. I don't think he's very positive on the behavioral explanation Momentum Jean's a risk guy. He's an efficient markets guy. I I think Jean is still cynical about it I know his latest paper he and Ken French right him 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 moment sizes return house the small firm Effect it's gold and how small you are they've added to that over time They've added an investment effect of firms that that that for instance Reduce their share account 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 profitable firms and again That's a very strong effect that holds up. I wrote a piece on our blog Saying something our factor model goes to six and yet for those of you who are curious It was a reference to spinal tap where our amps go to 11 I take the other side from them. I love these guys. We agree on on nine out of ten things I I don't see how momentum is not their sixth factor It adds a tremendous amount of return to versus their model the numbers I gave you versus that you can add versus say the Russell 1,000 125 kind of basis points understates the power greatly because momentum's also In geek speak negatively correlated with value 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 Jean 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 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 skewness 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 Ptolemaic epicycles and within a pretty broad range of asset classes Is it possible risk doesn't really explain anything about asset prices true or false? What do you 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. I don't think the fifth moment I'm gonna insult someone I care about now by accident. I don't remember who wrote this I don't think the fifth moment is a good measure. I don't even think skewness is a skewness is bad stuff Really even if something works 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 cost skewness at least makes sense to me as a real risk factor What that means is not only does very 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 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 open your time, right? Yeah, and in exact I use this example something in a very different way of some someone says what if we get something five times as bad How do you invest if we get something five times as bad? It's the global financial crisis and I and I say ammunition in canned goods And I don't think there's a better answer for for for that But I but I do think something like cost skewness. 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 The geeks call that a bad left tail and the seem to live 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 Jean have never embraced this story. 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 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 the terrible English sentence, and I apologize in advance. Does it hurt you when it hurts to be hurt? It is is an English language version of risk and any good quantity no matter how geeky you 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? Think I'm gonna take a guess that there aren't that many more But some I won't rule it out because you know once you're horribly wrong about this You hopefully you learn from that. I would have told you ten years ago I would not have guessed that low-risk anomaly and and this is the idea that that Stocks and by the way, I use stocks as a shorthand one kind of wonderful thing and if we've done anything There's something I can brag about a lot of these things. We've participated in the research We've written the leapfrogging papers. We have been early in saying let's go look outside of stocks Let's go look at bonds. Let's 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 risk like low leverage Outperform in a fairly strong way Fisher 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 risk outperforms another one is profitability. This is a real anomaly Stocks out there 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 the scale by their sales outperform You mentioned Fisher black on leverage just to pursue that a little bit So Fisher thought and maybe you seem to be agreeing with him It's another human imperfection that at least some of us are too afraid of leverage 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 dead aversion we were brought up don't get into debt I think it is some dead aversion. It also might be less irrational and more constrained There may be people who just can't Mutual 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 gonna draw on my hand in a fishing frontier I promise you it is a perfect artistic rendering Many of you I know I've seen it before if you haven't On the x-axis you have risk on the wire 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 or 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 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 fishers showed is imagine leverage was very costly or just no one would do it He points out that low-risk assets are orphans now Low-risk assets function in a portfolio in an important way to make your return for risk better But they often don't make your top line 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 fishers 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 they're 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 moon if you're very aggressive But neither is concentration either is moving your money into fewer and fewer assets We don't tell people leverages riskless. 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 It's risk aversion. It's more I think people do miss appropriate the risk of one of one thing against another Maybe it's neither a boron or a lender be your idea that people just taught leverage is bad Right, 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 Sumner 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 you ask 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 are but there's always a winner in any or loser in all right If I had to pick one 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 Rolling average of earnings for the S&P 500 You like low prices. You don't like high prices. That number is more expensive In roughly 90% of a hundred 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 ten years nothing's perfect even over ten 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 pee for stocks is the yield on on a government bond minus Economist forecast of inflation People call that a real yield. It's what you should care about the nominal yield doesn't really matter It's what you it's what you consume 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 gonna be a coward We get to about the worst ever we've hit this level before for the portfolio I used to think hundredth percentile is pretty impressive in my career Now you never go past the hundredth percentile. I know you're you're a math guy You know how it works math guy, but I will tell you not all hundred percentiles are equal If you are the hundred percentile today, but you're higher than but you're 150 percent of The of the prior hundred percentile excluding the last couple years That means you've shot off to the moon in the technology bubble the Shiller Cape Probably 50% higher than it had ever been if you excluded the period right around that Japanese stocks in 89 90 got to levels Like that in my 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 subjective measure, but my my measure for the using the word bubble Remember, I'm a gene Fama student. He hates the word bubble to bubble is an 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 hundredth percentile us stocks and bonds So you invest half your money in stocks half your money in bonds historically you've made about five percent over inflation We think it's priced now at this level to make about two and a half percent over inflation rather than five All right, 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 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 They'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 are 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 but Emerging markets on that same measure just looking at the local stock market. It's not the carry trade per se 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 Shiller Cape numbers are considerably cheaper than US or even Western Europe. So you might You might very well be right, but again 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 are rather bond prices or a bubble because right now the low rate of course is at zero It's not going to go down much below that could go slightly negative 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 justified. So that's not careful That's that's overly bold Actually having said 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 saying this thing is great. I'm saying when I talked about bonds I said they were more expensive about 90% of recorded sure 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 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 and it has other services Yes, 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 of nominal yields and for me to come up with a scenario not a prediction not something I think it's 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 sure? If your standard like mine is a bubble of something where you can't really come up with a plausible scenario where 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 yield 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 a long-term forecasting bonds. I I think The last 20 30 years Equities look better versus bonds than they have in a while But that's because the tech bubble dominates a lot of the last 20 30 years over the last hundred years We actually find we're picking on bonds We're we're nervous because multiple asset classes look not published 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 the institutions that need formal Forecasts of what they're going to make in their portfolio or my dad my dad is planning 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 a math guy, but I'm sure he had how much I need to live on What I think I could 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 forecasts 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 a crash We don't need to see it fix But they're using too high of an assumption. It's a problem going forward and it makes the whole retirement problem a bigger problem We're gonna come back to finance But there's a segment of these conversations always where we do overrated and underrated So I toss out something and you give me a short answer. Is it overrated or underrated? You're 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 Heinlein Early stuff underrated old 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 moon is the harsh Mistress is his most famously libertarian book. It doesn't age so well. No, I like I like Methuselah's children Ben Bernanke Fairly rated fairly rated actually overrated by half the world dramatically and underrated by half the world dramatically Real might be partisan reality TV I Know I'm modifying it every time. I'm destroying the spirit 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 watch shark tank or reality TV business show We watch the old survivors just basically teaching game theory to 11 year olds in a sneaky way This guy's doing this so this guy does it's so I now 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 Slower as we have a word for less fast Then then then other people and this is cliche sounding but the people always used to say He was a humble guy people would say this about him He skated where the puck was gonna 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 to 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 sports So Gretzky is a kind of extreme outlier and basketball You could say Kareem Abdul-Jabbar 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 Gretzky the I have no sense if this is if this is actually Accurate But I'm gonna go actually no one could measure this it can't be accurate You're not gonna believe what I'm gonna say Cirque de Soleil Please when I sit there and watch Cirque de Soleil Both my wife and I like I literally walk out and go nobody can do this and I don't think they're cheating. They're not cheating, right? And what is go watch it again? It's it's like it's like a Looney Tunes show or daffy duck dies from up there into a little thing of water down here And he doesn't die. I Don't know how they do it Everything else the crash of 87 was a 20 standard deviation event nothing Wayne Gretzky pretty good the Cirque de Soleil people I want the chart I want this is this this this story was from Vegas, and it's not staying in Vegas, but I was in Vegas And I was exercising and I know you find that hard to believe but I was and the Cirque de Soleil 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 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 that Batman wins every time because unlike most superheroes He cheats violently I Superman races with flash they both travel at the speed of light yet Einstein tells us there are no simultaneous events Who wins I'm gonna ignore the physics much as the comic books do there is a great This this is actually a pet peeve of mine I'm more of a Marvel comics than a DC comics and everyone wanted to know that in the audience DC It's much better now But 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 at the speed of light You have no idea you might actually you might but this is one of the things comic geeks will fight about 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 make them a tie I know why you tried to come up with that I subscribe to a theory that is on the Internet It has a name. I've forgotten the name, but it's a documented theory But it says the flash should win because the specialized power should win and I agree and it but but what I I like It's a portfolio theory in fact right in equilibrium portfolio theory comparative advantage absolutely Though it has a little bit of a the world must work out fairly Which is fairly right long term long term very long term Mutual funds overrated or underrated. Oh, we run mutual funds. This is a hard one All right, I'm gonna be other people. I can't be fired so I will go overrated active management I think is overrated. I'm 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's the mistake those people are most likely to make and what should they do to stop making it? There there this most likely is a hard one you already said it affected value terms Over-trading and I don't mean not everyone very in fact, I'd say a minority are daily stock pickers watching the market But there is this phenomenon that I still want to look into more because it's a method It's somebody has to be making this money with no one's ever this is gonna sound stupid No one's figured out who's making the money, but 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 I talked about value and momentum, of course I Like to call them to geeky phrase. I'm maybe a little likes it They are momentum investors at a value time horizon remember I told you value works long term you have to hold three five ten years momentum is a six to twelve month horizon If you're gonna 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 over reaction 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 art It's very hard to track. So I don't think anyone's done a great job of nailing where that money lands But I think if people came up with good strategies and somehow discipline themselves to do far far less and The worst cases 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 So if you're doing that you're making a giant era 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 could get me out if you're getting out because you feel sick to your stomach about it. You're making a mistake What should we do and here I'm leaving the weed deliberately ambiguous to make securities trading more just more fair Um and you can pick the way you want Well, just and fair. This is a loaded terms of course We loaded, 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 error. 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, 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 gonna say something potentially controversial Something that is is often attacked the high-frequency trading has made the world more just and fair particularly for small Investors high-frequency traders and have I watched 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 bid-ass spread 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 bid-ass spread they want That is always but they get they get attacked because they charge a bid-ass spread 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 bid-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 you're 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 cool with the price moving on you when you try to execute and buy and buy or sell a lot of a stock? Is bigger now? I don't think so, but that's a fair argument. There's 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 peek 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 better get in front. Maybe this is a wave. That's that's nothing Illegal about that but it still costs you money You know 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 I was our earlier question over 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 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 and 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, but in the I will try to separate those two. It's hard sometimes. 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 hedge funds 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 that's Gonna get me into I live in Greenwich, Connecticut Where in some parts of the world if you said my daddy runs a hedge fund Let's say what's a hedge fund in Greenwich, Connecticut. They the kids say what kind of hedge fund does your daddy run? So is he is he event arbitrage or trend following what is what does dad do? so I'm gonna be persona non grata but I Think hedge funds and this is a lot of complexity to this answer. They're a universe of 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 But they seem to definitely incorporate the momentum strategy. There are so-called arbitrage strategies They don't use the word like academics Academics are at or almost academics like me use it to mean riskless profit They mean a trade they that has reliably worked over time where they go long and short fairly similar things They're clearly not riskless But something like a merger a is buying be if the deal closes It's gonna go to here a is gonna fall bees gonna rise The day it's announced it only goes to here because there's some chance the steel doesn't happen Antitrust the market Shareholder activism somebody else so what the What the merger arbitrage or and my finest achievement today is saying that word in front of you That's a hard word to say buys be in cells 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 dead? That's the proper question Right, it turns out 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 It's not a not all of our business by any means we think we're not doing this I'm we don't think with it. 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 But if anyone likes geek numbers like correlation for the last seven years an index of hedge funds has been about point eight Correlated with the S&P 500. That means if you tell me what happened in the S&P 500 I got a pretty good idea. What's happening to hedge funds the word hedging almost by definition refers to removing that risk Trying to create returns that go up on average, but at different times Then stocks because you can get that again for mr. Bogle for about 11 basis points, you know near a tenth 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 don't have a shot. I will never get an economic law named after me I gave that up when I went 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? ooh Has to be someone fairly terrible in my mind because there's to be a counter-example. I'm gonna go with Joe Stalin Please explain It's a pretty good example. What happens when you don't have it Some of us might think it's a more relevant example than others I'm not revealing anything that you might not know sure 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 think I wouldn't have wished it, you know, it wasn't worth the cost But he's helped the cause of liberty. Mm-hmm. Thank you Joe The Contrarian answer, what's the side of Inran's philosophy that you feel is weakest? Economics I don't mean I I'm gonna get a song. I'm gonna yelled up by every libertarian friend I have on earth. I've never been a very big gold standard Person I respect it. I respect to my friends who are fanatic believers in it I don't think it would be the disaster that a lot of people but I only get cures all I'll have a lot of friends who I agree with. He'll say we have too much regulation. I'll go check I know 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 We should have hard money No check and they think that would fix everything. I don't I don't fully get it and I ran She basically her name for philosophy was objectivism and she just told you it was objectively right that that Gold is the standard of value. I think she's kind of unkind to silver frankly and You have succeeded in getting me make getting me making fun of I ran that's very impressive But I when I read when she ventures into economics like that makes very bold strong statements, 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 Again, I'm gonna try to flip it around I'm gonna I'm I don't think she was as anti helping people as she sometimes comes off If you read her talk about it, she certainly I disagree with her on this by the way She didn't consider a charity a primary virtue But she didn't have a problem with it whatsoever. She says you're she considered the individual sovereign And and if that's important do you do it? I think it's I think it's a larger virtue benevolence charity 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 in love with that But the idea of a virtue being the desire to help other people not someone forcing you to Which she was dead set against but but wanting to help other people I I disagree with her on but I think people come off and think that she's snarlingly 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 nastier 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 for you. Come on that speech. Oh my lord For this conversation, I read all of these papers of yours, right, which is the tradition 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 as in us 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 gonna get mad at me But we weren't we were by no means. I'm not telling a poverty story. I love Marco Rubio But if I hear one more time about the friggin bartender His dad is a bartender. It's a wonderful story, but it's in every answer But we grew up decidedly middle-class and and my dad had well 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 focused on on on not being nervous about those kind of things but Doesn't make you a happy relaxed person and it's impossible to turn off after it's no longer useful There's a literature by Ulrich on mom and dear 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? I've Written probably a much more empirical paper on precisely this idea and I Promise I'll get there. I'm gonna get I'm gonna 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 P 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 it when inflation is 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 It's a very strong empirical regularity when interest rates are low those P's are higher and vice versa though They do vary one thing we found I wrote this as a financial analyst journal articles circa a row one in 2001 and a follow-up in 2004 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 strongly of the last 20 years relative relative volatility of stocks and bonds in English if I called 20 years of a generation I didn't monkey around 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 got there if you didn't notice I've written on this I believe it you can't make a lot of money by the way trading on 20 year Phenomenon, you know clients don't really enjoy the whole well. I've been wrong for 19 years, but Give me one more year But I do 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 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'd look back at the financial crisis and the key moments in it a lot of arguments I'm not even gonna 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 one primary cause of the financial Crisis the assumption that real estate prices can't go down The government made this assumption the so-called mob 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 ten-year return for real estate if that worst case was not losing money That's garbage in garbage out. You can have the best model in the world. That's a problem when Lehman failed We went into a huge spiral because people were pretty much convinced that the government won't let anyone fail When money markets when when the famous reserve fund broke the book This is a money marks is supposed to return you a dollar for a dollar 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 to I could be off by a decimal place 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 got wants a NAV. What's your NAV pie? 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 risk in something and Then bad things happen. It's not it's not fun It's still bad things, but they tend to deal with it much better the famous 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 And I think that's because no matter how crazy they might have gone Nobody thought there was utterly restless They didn't act as a as a group as if there was no possible problem equity losses are expected bond losses are not Expected so I will I will say this if you truly could take all the risk out great If you tell everyone it's risky and it's risky great I think the people think 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 Yip on the very great example the illusion of safety We're gonna 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 gonna 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 Please do not make statements. These are questions For the focus to be on our guest anyway over here your question, sir Please introduce yourself. Thank you. John Graham from the National Center for Policy Analysis And I hate to name drop but I was at a last week with mr. Rubenstein of Carlisle And he was asked a question about retail distribution of alternative assets And he said well, it doesn't matter to us a car law group because we can raise money quite readily But it'll probably go that way now a qr. You've led with mutual funds 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 Remember 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 they're often called liquid alts They 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. I think they're not fully as a group And we're in there and I clearly like ours, but as a group I think they're not fully hedged and are probably still too expensive So I do think that same intellectual battle will go on But I think they are still reasonable strategies at the core doing Reasonable things and not everyone is in the same position as as mr. Rubenstein a lot of people actually do want more assets So I do think that will that will get bigger Next question Hello, Ed Bartholomew representing myself I Wanted to just sort of ask you to reconcile Momentum or any of these strategies with sort of 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 it's an individual investors They're trying to stockpick are they other sort of stupider professional managers and how can we explicitly use that word? And When do you 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 Back you know you're not gonna believe me you're gonna think I'm just copying you but myself and a colleague auntie Elman in 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? So it's a little shorter version of what you said because we do think that is a very disciplining question I've written I wrote something in the financial analyst journal on ten different things in finance that I thought were kind of interesting 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 Mainly a fight about semantics, but I don't like that term because to me like free I think for you passive should be something we can all do and For it 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 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 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 You are willing to bear that risk. Someone else is not they willingly and 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's on the other side The other is hope springs eternal for value. There are a number of people who simply see Whatever's been going on who's been beating earnings for the last few years Whose products have been popular? That company probably should be worth more They go too far they over extrapolate the behavioral story the other version besides risk both those stories You're exactly right do require someone on the other side, but no means and I'm glad you asked Do I think these things can be used for everyone to outperform? This is not Lake Wobegon. 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 Tyler asked a version of it too if they were I think they can persist because they're pretty good, but not extremely good We look at this, you know the value effect. It's been a bit. 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 longest one'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 stark or sometimes it's not a good title for paper, but who's 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 who's money am I whose money is taking me? Maybe again, it's perfectly rational and they don't feel taken they feel like the risk is being reduced It's fair, but why am I making this extra money if you don't ask your question You're not doing your job and assuming assuming it's behavioral and not risk, right? Do you have a sense that the other side is? Individual stock pickers or others professionals that are stupid Some of some of both I think it's I think it's some of both there There is some evidence for instance I mentioned remember I snuck this in that hedge fund seemed to have figured out and incorporate This is just empirically if you look at their returns look at what strategies are correlated to and not They seem to show that they figured out some of the momentum strategy They don't seem they seem to buy it 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 low risk Investing for the fish of black reason being effective because people are restricted from leverage Professional mutual fund managers have that restriction left and right 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 so I Like that is I like that example better than we're taking mom-and-pop money, but that's probably in there too 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, you have a question specifically about the biotech and healthcare sector It's traditionally outperformed the broader market over the past decade or so What are your thoughts both as a momentum? Trader and 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 ten minutes So everyone please time your answers and questions to make it all fit perfectly to the split second cliff Yeah, I'll do this one quickly then I have no idea 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 gonna tell it. It'll be the third. I told you active management It's too expensive hedge funds are not a good idea and now I'm gonna 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 you 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 your systematic manager says and here's what you do Put it all on biotech run Next question My name is Evan dunks. I'm wondering who's your favorite superhero and Has just as like you studying economics change how you felt about certain superheroes. Oh my god. Um, I've always this might be sappy patriotic, but I've always liked Captain America. I I the whole he was fought in World War two suspended animation for 20 years, which by the way Happens to anyone who falls into cold water That's just a throwaway I could sing you the song if you'd like when Captain America throws his money 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 friggin Tony Stark or Bruce Wayne have It's infuriating I'm I've done well. I'm not the most insane out there But if I wanted to go build a back cave 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 skyscraper. That's also a missile silo Your least favorite superhero if I may interject Hmm 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 even but it there was a character named Hank Pym one of the original Avengers Avengers were of course as you all know Thor Hulk iron man giant man, which is Hank Pym and the wasp He is a loser giant man was just a big guy He wasn't even stronger than a regular guy who's 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 then he hit his wife in the comic books And that's easy to today, but I hated him even before the spousal abuse Last question here Chris Kuiper. I'm a master's student with the Mercatus Center question on Advising people to get into the the passive low-cost Vanguard kind of funds. We've seen people heating this advice and flowing in. Do you think that in and of itself? More people going to passive strategies could open up more potential for active managers and more Anomalies that's a great question I'm gonna fuse that question with with the one over here not the super hero one my favorite question I might add but it cannot be fused with this question Instinctively you want to say it's gonna be easier to beat the market if fewer people are trying The amount if you're a PhD student in finance This is what you do at 3 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 it's a very 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'll 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 bet away from passive my sense and 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 information list trader you could push away More by just bidding more for their stock in 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 But in general it's really hard to figure out but but a question everyone talks about so 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 But but not for hours. But anyway Cliff. We thank you hardly. This is a lot of fun. Thank you all Read 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 Karim Abdul Jabbar and 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 as this and Karim Abdul Jabbar have in common because this will be the only thing Supernormal returns Thank you again