Capital Allocators – Inside the Institutional Investment Industry
Episode 385: Top 5 of 2024 – Cliff Asness
Release Date: January 1, 2025

Introduction

In Episode 385 of Capital Allocators – Inside the Institutional Investment Industry, host Ted Seides engages in a compelling conversation with Cliff Asness, the founder and Chief Investment Officer at AQR Capital Management. Recognized as both a brilliant quant and a stand-up comic, Asness brings a unique blend of intellect and humor to discussions on institutional investing. This episode delves into Asness's journey, his perspectives on market efficiency, the challenges faced during tumultuous market periods, and the evolving role of machine learning in investment strategies.

Early Life and Education

Cliff Asness begins by sharing insights into his early years. Contrary to his current reputation, Asness describes himself as an "underachiever" during his high school days, often receiving B's and C's despite high standardized test scores. Reflecting on his freshman year in college, he recounts experiencing significant anxiety, which led him to consult a university counselor—a rare event for him.

Notable Quote:
“At some point mid freshman semester, first semester, I went to the university's counselor and just said I'm really tense... It was a cathartic experience.”
[05:45]

Asness pursued a dual degree in computer science from the engineering school and finance from Wharton, influenced heavily by his father's emphasis on diversification. His academic path led him to the University of Chicago for his PhD under the mentorship of Eugene Fama and Kenneth French, where he first began to explore market inefficiencies.

Path to AQR

Asness's transition from academia to the financial industry was marked by his stint at Goldman Sachs, where he became instrumental in establishing their quant group. This experience laid the foundation for his later endeavors at AQR, where he has overseen the management of $100 billion in assets. His initial foray into asset management was not without challenges, including significant drawdowns that tested his resolve and the firm's strategies.

Notable Quote:
"We had a pretty horrible period from inception first year and a half... It was poor business design to only have that."
[19:30]

Market Efficiency and Gene Fama

A significant portion of the discussion centers around market efficiency, a concept championed by Eugene Fama. Asness discusses his divergence from the notion of perfect market efficiency, arguing that markets exhibit inefficiencies that can be capitalized upon. He references the Grossman-Stiglitz paradox and Gene Fama's own studies that acknowledge the impossibility of perfectly efficient markets.

Notable Quote:
"Gene will tell you it's a little silly. Then we can all debate exactly how inefficient they are."
[10:13]

Asness emphasizes the importance of data-driven research, stating, "If it's in the data, write the paper," highlighting his commitment to empirical evidence over theoretical postulation.

Challenges During Market Downturns

Asness reflects on the tumultuous periods AQR has navigated, including the tech bubble of 1999-2000 and the Global Financial Crisis (GFC) of 2008. He discusses how value strategies can underperform during certain market regimes and the psychological and business pressures that come with sustaining long-term investment strategies amidst persistent drawdowns.

Notable Quote:
"No matter who you are, you're not that confident that you're right that you'll be able to do that."
[07:05]

He introduces Corey Hofstein's adage, "No pain, no premium," encapsulating the necessity of enduring challenging periods to achieve superior long-term returns.

Machine Learning and Investment Strategies

The conversation shifts to the integration of machine learning (ML) in investment processes. Asness outlines AQR's cautious yet progressive approach to ML, emphasizing the importance of combining strong economic narratives with robust, out-of-sample data to avoid overfitting. He credits Brian Kelly, AQR's Head of Machine Learning, for pioneering the "Virtue of Complexity," advocating for sophisticated models that respect foundational investment principles.

Notable Quote:
"We still believe that. One key insight... turns out it can be a pretty powerful way to choose the best combination that endogenizes correlations."
[31:21]

Asness discusses the potential and limitations of ML, noting areas where it enhances factor selection and creation, while also acknowledging its constraints in solving "small data" problems like determining the equity risk premium.

Cognitive Dissonance in Investing

Asness addresses cognitive dissonance in the investment realm, particularly how investors reconcile conflicting beliefs. He critiques common misconceptions about private equity, international diversification, and performance chasing, arguing that holding contradictory beliefs undermines investment effectiveness.

Notable Quote:
"You can't have everyone index. Everyone agrees with that."
[38:53]

He offers a nuanced view on private equity, acknowledging its benefits while challenging the assumption that it consistently outperforms public markets with lower volatility.

Manager Evaluation and Investment Committees

Drawing from his extensive experience on investment committees, Asness shares insights into effective manager evaluation. He highlights the challenges committee members face, such as limited time horizons and the tendency to focus on underperforming assets rather than holistic portfolio performance.

Notable Quote:
"If you have to let someone go who's a good person... that's a no bone to pick with that is some cognitive dissonance."
[25:33]

Asness advocates for a balanced approach, suggesting that committees should evaluate both top and bottom performers to understand underlying mechanisms and investment philosophies better.

Future Outlook and Research Excitement

Looking ahead, Asness expresses enthusiasm about AQR's research trajectory. He discusses advancements in trend following, machine learning applications, and the continuous improvement of their investment models. Despite past challenges, he remains optimistic about the firm's ability to innovate and adapt in a rapidly evolving financial landscape.

Notable Quote:
"I have never been more excited about our research than I am now."
[61:41]

Personal Insights and Closing Thoughts

In the final segment, Asness shares personal anecdotes, including his hobby of collecting comic books and his pet peeves, such as encountering intellectually dishonest debates on social media. He reflects on the invaluable influence of his father and academic mentors, underscoring the blend of personal and professional experiences that have shaped his investment philosophy.

Notable Quote:
"I truly don't mind being disagreed with and having a good debate when I get the sense someone's not debating fairly avoiding the question."
[64:38]

Asness concludes with a life lesson emphasizing the importance of maintaining a long-term perspective, acknowledging his own journey towards embodying the principles he preaches.

Notable Quote:
"A bad day is not gonna kill you. And to take that longer term perspective, I did think I can be a hypocrite about I've gotten a third better about having the long term perspective."
[68:31]

Conclusion

Episode 385 offers a profound exploration of Cliff Asness's insights into institutional investing, market dynamics, and the psychological facets of investment decision-making. His candid reflections on personal challenges, coupled with his strategic acumen, provide listeners with a comprehensive understanding of what drives success in the complex world of capital allocation. As Asness continues to steer AQR towards innovative frontiers, his blend of quantitative rigor and humanistic understanding remains a cornerstone of his investment ethos.