Expected returns, AQR, inflation hedges, war, psychology and sorcerers
Two years ago, one of the world’s most influential fund managers found itself defending its investment approach because its performance was so dismal. At a time when the best profits could be had just from owning the large-cap index, some were asking whether time was up for the firm’s sophisticated quant models.
But that was a bad take.
The firm was AQR Capital Management and this year its major funds are among the best performing (delivering impressive returns) in a market that is proving to be a nightmare for most money managers.
Source: Citywire
Now, AQR has its detractors like everybody else. It’s a multi-billion dollar firm with forthright views on what works in markets. Its boss, Cliff Asness, is smart, and he doesn’t mind calling out spurious claims (or indeed falling out with people) on Twitter, and that irritates some. He’s a billionaire, he probably doesn’t care.
But what makes AQR interesting is that it’s not really just another fund firm. Neither is it a poster child for value investing (even though ‘value’ is what partly caused its recent trouble). What makes it different is that its years of academic research into return drivers have actually shaped the way many in the industry think.
Asness was a student of Eugene Fama (who won the Nobel prize for his work on asset pricing). And Asness managed to take that academic curiosity and build a business from it. In particular, he and his team worked up a set of ‘style premia’, or ‘factors’ which they apply in various ways in their funds. In broad terms, they go after:
Value (buy cheap)
Momentum (buy last year’s winners)
Carry (buy high yields)
Defensive (buy boring, non-speculative things)
AQR isn’t the only one that does this; studies of long-run stock market return data consistently reach similar conclusions about what tends to work best. But of course, like everything, those styles don’t always work, and a decade of conditions that lit the touch paper under go-go growth in the US has been especially painful.
Now if you wanted a military-grade examination of different style premia in just about every conceivable investing dimension, Expected Returns by Antti Ilmanen is the book for you. It was written in 2011 and late last year Ilmanen published what looks like a remarkably prescient follow-up called Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least.
Ilmanen studied with Asness and is a principal and global co-head of AQR’s Portfolio Solutions Group. There isn’t really much this guy doesn’t know about what works in investing - he’s humble and it’s interesting to hear his perspective on what we’re experiencing at the moment. There have been a few interviews with him following the latest book. Here are a few to choose from:
If you want a really deep dive into some of these style ideas, then this Youtube interview (1 hour 40 minutes) with Illmanen by Adam Butler, CIO of ReSolve Global is the one to go for.
More recently Barry Ritholtz had Ilmanen on his Masters in Business podcast, and that picks through the book and spends time on issues like ESG and alternatives like private equity. You can find that here.
Probably the best balance and the most practically useful (and definitely the most fun) is this Youtube interview with Ilmanen by Meb Faber (or the Podcast version here). That conversation explores the styles in the context of recent market moves and goes in some interesting directions.
Six posts from the past week
Joe Wiggins, Behavioural Investment: How To Identify Behavioural Investment Opportunities and Risks
I don’t think we talk enough about the importance of psychology in investing. If anything, I reckon technical traders are probably the most aware of how behaviour can make all the difference in the market. But for regular investors, it doesn’t get the same attention. The good news is that the Behavioural Investment blog is excellent on this stuff. In this post, Joe sets out a matrix for thinking about where an investment might sit when you assess the evidence supporting it, and the return you might expect from it. It’s an interesting lens to understand decision-making and perhaps flush out a few biases.
Nick Maggiulli, Of Dollars and Data: There Will Always Be Sorcerers
Talking of biases, this post by Nick Maggiulli is a timely reminder why, in periods of fear, humans tend to gravitate to presumed sources of expertise. In the market, of course, these so-called experts are the pundits and analysts, but it’s easy to forget that these people may not be all that useful to you.
Morgan Housel, Collaborative Fund: Little Ways The World Works
Apparently Morgan Housel has sold two million copies of his book, The Psychology of Money (here), and it’s easy to see why. I can’t think of anything that he’s written that’s not worth reading and this post from him is another thought-provoking, slightly diverting piece.
Nicolas Rabener, Factor Research: Evaluating Inflation Hedges
They say that TINA - there is no alternative - is a good summary of investing over the past decade. By which I mean that with so few attractive alternatives, stocks were the only game in town. The landscape has changed now, of course, but are we still stuck with TINA? After all, equities and bonds are both down. The only hope is to find some kind of inflation hedge, but even then commodities (at a push) might be the only real alternative. This post from Nicholas Rabener is a useful look at the subject if you want to see what’s working in these conditions.
Money Maze Podcast: General Sir Nick Carter: How The Ukraine War May End (Update Episode)
Russia’s invasion of Ukraine has not only been desperately sad at a human level, it’s also exacerbated a lot of the global economic issues that were already becoming a problem. Energy and fuel supply, commodity shortages, the effects of sanctions… all these things are now a melting pot of problems that are quite hard to process. So I was quite pleased to hear this Money Maze podcast between Simon Brewer and General Sir Nick Carter. No-one knows where this war is going to go, but amid all the guesswork, this conversation sets out some reasonable sounding likely scenarios.
Twin Petes Investing Podcast: With special guest @GoLeftMassa
Peter (@conkers3) and Peter (@WheelieDealer) have been doing the Twin Petes Investing Podcast for quite some time now. And for sheer enthusiasm, expertise and education (largely focusing on the UK market) it’s hard to beat. I’ve bumped into Pete Higgins a few times over the years and he’s a super guy. Over the past few months they’ve been doing more conversations on video, and when you mix that in with special guests, it’s a good watch. This week, among other things, they talked to Ben (@GoLeftMassa), a private investor who’s gone from a speculative approach to stock picking to a much more portfolio-oriented one. But he’s still a massive fan of resource stocks, so it’s an interesting story. Definitely one to watch.
Have a great weekend,
Ben
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A couple of highlights here… One is this video on investing in tech funds by Ian Shadrack. Ian runs a Youtube channel (subscribe here) and has done lots of videos, largely focusing on funds and trusts. This one looks at some of the diversification challenges of investing in regular tech funds, and pulls together some alternative ideas into an overall strategy.
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