Out of the School of University of
Chicago under Eugene Fama, studying efficient market theory.
The question is, do you think the markets are still efficient?
M. I took teens class and then I was the
teaching assistant for two years and I was terrified to get something wrong.
So I sat through it for three years. About the third week of class.
He looks and he tells the students the market is almost certainly not perfectly
efficient and you get a big gasp. Now, only at the University of Chicago
and only Jean's class, you get a gasp with that.
Everywhere else in the world, people either go, Yeah, we know markets aren't
perfectly efficient or they have no idea what you're talking about, which is
often quite common. What he meant.
He's an honest guy. He believes they're more efficient
probably than I do now. But perfect efficiency is silly and
nothing is is perfect. The question becomes, how efficient are
they? I think it's fair to say someone like
Jeanne thinks they're pretty darn efficient.
Efficient is this idea that prices are accurately reflecting fundamentals.
This can get really geeky on how to define that, but let's let's just be
colloquial. I do have a view.
It's not a short term view. It's not a market call that.
Again. Markets are never perfectly efficient.
But over my career, which is annoyingly about 32 years now, I guess the opposite
will be even more annoying. But it's a long time.
I'm a little obsessed these days with those internet memes of when they show
you like an actor like Ed Asner and in Mary Tyler Moore was ten years younger
than me when he did, the role is very upsetting.
But over my career, I actually think markets have gotten somewhat less
efficient, meaning prices are a little bit more disconnected from reality.
It ebbs and flows. It's never the same at each point in
time. But I find that an odd view because one
tends to think as technology in particular advances, that things should
march towards better with better. I think being efficiency in this case.
And I actually. I actually think maybe I'm biased by
having a front row seat, but I think over the last 30 or so years, I'd say
the market is somewhat less efficient than when I started.
So why do you say that is? What is causing it to be that way?
It's, um. Well, first I start out by just
observing a few facts, and I. And I am, of course, biased by what I've
lived through. But I love Gina's presentation.
The dot com bubble stuff was bringing, you know, PTSD, like memories for me.
We try to very formally measure how disconnected from reality or not or how
or how reasonable our stock price is in particular, not the price of the whole
market, but within the stock market are cheap versus expensive stocks.
You could define that very narrowly in a can sense in terms of just multiples.
You could define it more broadly in terms of a Graham and Dodd sense.
Yeah, you want to pay a low multiple, but what's the quality of the stock?
What's the risk of the stock? But either way, measured very formally.
The dot com bubble saw by far the largest disparity between cheap and
expensive we had ever seen in about 50 years of data.
We survived that. It was a little ugly for a while, but we
said we actually thrive through it if you take the whole round trip.
But when you almost die in the first half, you you tend to remember that.
If you had asked me in, say, 2002 when all of that access was pretty much
worked off, are you going to see something more extreme than that in your
career? I think I'm smart enough even back then.
To never say never. We don't live in a business where any of
us should say never. It's a dangerous word.
But I think I would have said it's highly unlikely.
That was the craziest thing we'd seen in 50 years.
I would have said, Well, in 20 years people like me will still be around, I
hope. Who?
It's a memory. It's not 100 years where everyone is
forgotten. And then pre-COVID it was close.
And then after COVID hitting, we saw things measured, very similarly priced
in price multiples or even price multiples scaled by quality to go to
levels well beyond the tech bubble and lasting about as long as the tech
bubble. If you ever have the misfortune to have
an investment that ever goes down for any amount of time.
You will learn something that they don't teach you in a Ph.D.
program. Severity is bad, but duration is
underrated when it comes to pain. Three years of pain, even if it's
cumulatively not worse than a year and a half of pain is a ton worse.
The first year you go back to your clients and go, We think we're right.
Look what's going on here. And you go, okay, okay.
The second year, they're like. That's the same thing you said a year
ago. And you go.
Yeah, but it's still going on and we're still going to be right the third year.
I mean, I'm. I'm still invested.
But it's getting tougher. So duration counts.
So we've seen both the severity and the duration of those.
So I start out just observing facts. And then in trying to fill in why
admittedly, this is a lot of op ed, this is very hard to prove.
And I love to you know, I'm a card carrying quant.
I love to, you know, produce tables. I can show you these spreads, but y and
I tend to have I think it's a multitude of things.
I think the number one thing is probably the thing we all love to blame the
Internet and social media. I think a lot of people naturally assume
such a thing would bring us information so quickly and so ubiquitously, knowing
everything that prices would be very efficient.
But. That's never been the hard part.
When I started in this industry, we got earnings within it, and within 20
minutes they're missing 20 minutes and a nanosecond matters to an HFT.
It doesn't matter to almost every other investor.
We didn't really materially get more. And I do think that level of information
overload gives people a lot of illusion of control.
I you know, I don't want to go into this deeply because I know you'd like to get
me going on this, but I think the meme stock examples,
I don't think they're the norm by any means, but I think they're the ultimate
example of a little bit of information making you think you really know
something very deeply. And I think that gets into market
prices. I'll be careful to keep this a little
reined in, but on the meme stock issue, I knew I'd get that started.
How much are the retail traders that are bidding up prices of stocks like
GameStop contributing to this idea that markets are less efficient to you?
I think they. Our very small part in dollars.
They may be poster children in some sense for the effect.
The whole idea that that this disconnect in in prices can come in a world where
we have all the information at our fingertips.
I think we're all raised at some point. We've all read about the, quote, wisdom
of crowds the way, you know, if you take a crowd that on average people have 51%
information. But your poll, we
hope many of us here are old enough to remember Regis Philbin.
And you know, Who Wants to be a millionaire?
The absolute best lifeline was always poll the crowd.
Right? Because if they ask the question, you
know, what does it say on the back of a quarter?
Now, 85% of the people don't know, but they're evenly split.
And the 15% who do know all go one way. But there was always a little unspoken
footnote to the wisdom of crowds to have a wise crowd.
It's got to be fairly independent. If everyone got to talk about the
quarter, not look at a quarter, that's cheating, but talk about it.
The people who are wrong convinced the people who are right and whatnot on a
crowd where everyone is coordinated and not independent has the risk of becoming
a dangerous mob. And I don't know about you guys, but I
can't think of anything better at turning a wise, independent crowd into a
dangerous mob than the Internet and social media.
So I do think they're kind of the poster child.
I don't think economically they are. They are that important.
They you know, I don't want to disparage either side of it, but it's $9 in terms
of, you know, in video said that on a daily basis, the entire meme stock
phenomenon is like a little part of a day of and video.
But I think it is a poster child for the concept I'm talking about.
There are other candidates. People talk about the role of passive.
That's really complicated. I'm not one who just looks at passive
and goes that that's causing all kinds of havoc.
What is it causing? Okay.
I'll disappoint you here, people. I don't think we really quite know yet.
First of all, here are the things we know about passive.
Not everyone can be passive. The whole world breaks down.
Even back when I was a Ph.D. student.
So this is the early nineties, a kind of stand.
This is what happens when students in finance get drunk late at night.
They they sit around going, What if everybody tried to be passive?
And that's a black hole. That's a singularity in finance.
Nobody's looking at individual stocks, and that just can't work.
A passive risk free rider. There's a free rider on active managers
making sure prices are somewhat reasonable.
But the question of how many people can be passive?
Nobody really knows. Do you think it's contributing to
efficiency? And is efficiency frankly another way of
saying wild swings in markets? I think I would guess, yes.
But I think it's pretty small versus the social media, the illusion of control,
the data overload, things I'm talking about.
It's not clear. Theoretically, imagine you had a world
where you had a certain amount of passive and active and suddenly a lot of
active move to passive. Whether active is now easier or harder,
whether it's more or less efficient depends on who moved.
Let me be really obnoxious and go. There were sharks and minnows.
There were people who were good at it and people were bad.
If all the minnows move, markets get really efficient.
Because sharks are trading with sharks. They all are pretty good at valuing
these things. And the sharks don't make a lot of
money. We don't really know who moved.
I tend my reasoning here is really just correlation, not causation.
This has occurred at the same time that massive price disparities have grown and
lasted longer. So as a pure guess, I would have to go.
It's probably contributed something. It's very hard to sign.
Another one is, you know, I'm probably the billions person who mentioned this,
but over the same period we've had ten years prior to a couple of years ago of
of ultra low, nominal and real interest rates.
I am not a person who thinks that means growth stocks should go to the moon.
I've written papers on the math of that's kind of wrong.
They're not actually that much longer duration, but the market disagrees with
me. The market thinks when interest rates
fall, growth stocks should go to the moon.
And so ultra low interest rates have probably contributed to a fair amount of
that also. So I think it's a witch's brew.
But if I had to put the three, I think the the maybe I'm just an old man
ranting at tick tock. But but I think the the feeling that you
own all the information and are on a level playing field and therefore you
can own two stocks and be very confident about it.
Is probably my number one thing to point out.
So let's step back for a minute, because you are concerned about the efficiency
of markets here. And we ask, has the market gone awry?
Has something about the market broken to you.
Broken? Such an ugly word.
These are points on a spectrum. For me, broken is very a I'm going to
define that is as are we in a bubble or the opposite of a bubble, an irrational
depression where people won't pay any fair amount for stronger companies or
whatnot. A bubble is when we look at the
companies people like and they're willing to pay giant excessive amounts.
So let's say bubble and broken are equivalent.
I, I use the word bubble, I think less than a lot in the industry.
I once wrote a sarcastic piece really doesn't narrow it down amongst the
pieces I've written, but it making fun of the term bubble
that on, you know, the extended use of the word Wall Street people who a lot of
people will see bubbles everywhere and they translate it a little too weakly as
a bubble means a stock I kind of don't like.
No, that's not a bubble. A bubble to me is a vastly diversified
set of things that. I cannot come up with any reasonable
assumptions that could possibly make these valuations work.
I have seen two in my career that I think we identified before the fact and
one I was a passive watcher of the dotcom bubble, which
again the PTSD from the earlier presentation and then really 19 and 20
when stocks surpassed that. I would use the word bubble for that.
Since then, the way we measure value and everybody who measures it's one of the
hard parts of communication in this world is everyone's going to measure it
a little differently. But the way we measure value, we've come
in from the new hundredth percentile, which was set in the late 2020 period.
Sometimes I jokingly call that the 130th percentile, and I wait to see if people
think that's reasonable. Then I can.
I like to gauge the math level of the audience in those sneaky ways.
So the new hundredth percentile, which is about 30% more than the old one.
That I would certainly call a bubble. I don't think there are any assumptions
you could have come up with. We define value as relatively strong,
pretty strongly. Industry hedge very apples to apples.
Epic differences in valuations. Right now after.
About three and a half, four years of the three and a half strong years for
the way we define value. That spread is down to the 80th
percentile. I don't call 80th percentile of bubble
in 80th can go back to 90th in a heartbeat.
There's nothing that means it's going to be a smooth path.
I have downgraded. Value investing in general.
You look surprised. Well, actually, I'm not a value guy.
We're going to bring the audience in actually here, because that's our
polling question. And while we have Cliff answers, the
value of your teasing it already. Well, I've downgraded it.
Value investing still have room to run. Well, the answer is still going to be
yes, because I've downgraded it to something we like on average when it's
50th percentile. We want that as part of what we do,
meaning we all equal. We prefer to pay a lower multiple.
I don't know when we ever wouldn't. At 80 it's percentile, we do think it's
more attractive than normal. So yeah, by that definition we do think
there's more room to run, but it's not an arbitrage.
You can drive a truck through in late 2020.
If I may be bold, the challenge was not being right.
That was relatively easy. What was going on, I think was crazy.
The challenge was surviving, being right.
That can be hard, I think right now at the 80th percentile.
Yeah. You want this as part of your portfolio?
Maybe you want a little more than normal, but it's not the opportunity of
a lifetime, which it was three years ago.
If someone is constantly telling you the same, trade is the opportunity of a
lifetime, you probably want to run. So speaking of opportunities of
lifetime, a couple of years ago it was very recently you've been hitting
records at AQR. A number of your funds have just been
performing like they've never performed before.
Part of that was the value trade, actually less than you would think, but
a decent part of it. But well, what's contributing to it?
Because even through the first quarter of this year, many of our major funds
were up double digit percentage points. And what is it exactly that you're doing
differently at AQR now than you were before?
There are definitely some things they're doing differently, and I will answer
you. Some of it is the fact that if you do
the same thing consistently over time and it is a good thing that works over
the long term, sometimes it works for a years and sometimes it really doesn't.
So you can have those kind of streaks without doing something differently.
We have. I get very leery of talking about this
because the very rough 19 and 20 was a very small contributor to changes we
made to the process. We're always trying to make change.
We're always trying to get better. Who in the industry is not trying to get
better? I think we got a lot better
at how we allocate among these key equity factors.
We've gotten a lot more systematic for our first 20 or so years.
It was probably me and a handful of people saying what's a reasonable long
term allocation? And we stuck to it.
Not to get into it in a kind of theme, but we we let the machine decide more.
And it took me a while. I probably slowed us down two years on
this because I think it's my job as an old man at the firm to kind of say,
you're going to change the what? But I'm reasonably convinced it's just
at least a little bit better than us. So I think that's better.
Some of the things we do that we haven't discussed in the world of trend
following, I think we've taken a huge leap and we did price trends since I
wrote my dissertation in the late eighties and early nineties, 1990, not
1980, the 1880s, but a while ago. But in the last five years, a tremendous
weight, not just the price which it was historically, but the fundamental
trends, tremendous exposure to more esoteric trends than just your famous
stocks, bonds, currencies and commodities.
What are. Suddenly I'm walking around and somebody
is talking about trading milk and somebody is talking about trading sugar
and somebody is talking about trading my favorite Malaysian palm oil.
Please don't ask me for long or short Malaysian palm oil.
I don't take an interest to that level. But but I do take an interest in the
fact that we tried it and we found the sweat equity of pushing into new markets
that are smaller capacity, you know, in basic value investing around the world
and value in a broader sense than just quant multiples considering quality more
of a Graham and Dodd sense. You can run an awful lot of money in
that. And I think it works.
The challenge is it will have its very rough periods and sticking with it.
Esoteric commodities much more limited. There is a certain amount of Malaysian
palm oil and you can take $100 billion and say, I'm going to be mainly
Malaysian palm oil. But can you add a little bit at the
margin and do that in 50 other commodities?
Yeah. So we've you know, again, I don't think
this was a response to that tough two years,
but it did coincide at the same time. So I do think we got better at a whole
bunch of things. I have to ask you about some of the hot
topics of the day because you play in so many liquid markets.
What do you think about this massive fascination behind private markets?
We all know that you think a lot of it is volatility laundering, but what a
great phrase. Who came up with that phrase, I wonder?
I think people exaggerate my med, my medicine for privates.
I invest in privates. I think they're a very reasonable thing.
I think a lot of people do privates, probably the best investors I've ever
met in terms of understanding of a company.
There are people who argue, you know, any investment you can think of is top
line. What do you make the average return and
what is the risk? And you can argue about how to measure
risk, but just think of those concepts. The top line is argued about, you know,
do you have to be in the top quartile of private investors if you buy one of
each? What do you make?
Is it better? Is it worse?
And people fight about IRAs and how to measure that.
It's not my fight. The numerator.
How risky they are is where I have gotten my back up a few times.
And a lot of people in the private world get this entirely right and are entirely
honest about it. They'll tell you we don't market to
market, but we're 1.3 times levered equities and it's equity like risk in
the in any medium to long term that matters and zero problem with that.
Every once in a while and people now send these to me just to rile me up
which by the way, is an exceedingly easy task.
But they will send me things like a tear sheet for a private fund.
Then at the at the bottom has Sharpe ratio realized.
Sharpe ratio 10.0. And this is this actually happened then
was actually ze point zero. I thought that was a nice touch.
Right now, 10.2. 10.0.
And that'll create smoke out of my ears and my Unfortunately, anyone can tell if
I'm angry because my entire head turns red.
Sadly, just passed credible man. But Jim Simons, he didn't have a ten
sharp ratio on his best day and was probably the greatest money machine
we've seen ever. So when I see a ten Sharpe ratio, I
think you're doing something wrong here. So I have zero problem with them as
investments. I do think it is very dangerous to mis
estimate the risk because some people get it and will allocate an amount
saying, Yeah, we know what they are, they say ten, but it's risky and we
think they're levered and we know what credit does.
And if we have a five year bad period, we know we're going to get creamed.
Fine. But for the people out there and I think
there is a subset, I don't want to you know who you are out there.
People draw a fish in frontiers and put private credit.
Way on the left at like like one and a half percent vol.
If you're actually building your portfolio believing that.
I think you build in a bad portfolio. So yeah, I have a problem with some
subset of the market that grossly understates the risk and kind of
believes it or acts like they believe it.
