Cliff Asness: ‘The Problem Was Never Beta. The Problem Was Paying Alpha Fees for Beta’

Summary

The Long View: Cliff Asness on Beta, Alpha Fees, and Investment Strategies

Episode Title: Cliff Asness: ‘The Problem Was Never Beta. The Problem Was Paying Alpha Fees for Beta’
Host: Christine Benz, Dan Lefkovitz, and Amy C. Arnott
Release Date: July 29, 2025

In this insightful episode of The Long View, hosts Christine Benz and Dan Lefkovitz engage in a deep conversation with Cliff Asness, the founder, Managing Principal, and Chief Investment Officer at AQR Capital Management. Asness, a renowned financial economist and prolific researcher, delves into various investment strategies, macroeconomic issues, and the intricacies of asset allocation. Here's a detailed summary of their discussion.

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1. Macroeconomic Implications of Tariff Policies

Discussion Overview:
The conversation kicks off with a discussion on the impact of Trump's tariff policies on economic growth and inflation. Asness provides a critical perspective on tariffs, equating them to taxes and highlighting their detrimental effects on global prosperity.

Key Points:

• Tariffs as Taxes: Asness asserts, “Tariffs are taxes. I don't care how many people say they're not. They're taxes on the buyer. They're just effectively think of them as a sales tax” (02:07).
• Global Prosperity: He emphasizes that tariffs “reduce the global pie and global prosperity,” making the world collectively poorer.
• Political Winners and Losers: While acknowledging the political dynamics, Asness remains against tariffs, regardless of potential negotiation tactics to lower them.

Notable Quote:

"Tariffs are taxes. I don't care how many people say they're not. They're taxes on the buyer."
— Cliff Asness (02:07)

2. Market Timing and Its Critique

Discussion Overview:
Dan Lefkovitz raises concerns about stagflation stemming from tariffs and transitions into the debate on market timing. Asness challenges the conventional wisdom that missing the market's best days erodes long-term returns.

Key Points:

• Misconception of Market Timing: Asness criticizes the argument that missing the market’s peak days significantly harms returns, labeling it as a "terrible way" to argue against market timing (08:32).
• Extreme Hypotheticals: He illustrates the flaw by describing an extreme scenario where missing the 10 worst market days would be akin to constantly shorting the market, which is impractical (10:07).
• Symmetry in Missing Worst Days: He mentions that missing the worst days might even slightly benefit investors due to the negative skewness of markets (10:32).

Notable Quote:

"Market timing is the Lord's work, in my opinion, but this is a terrible way to do it and it's ubiquitous and it's been around forever."
— Cliff Asness (08:32)

3. Asset Allocation: 60/40 Portfolio vs. 100% Equities

Discussion Overview:
The hosts shift focus to asset allocation, particularly the debate on holding 100% equity portfolios. Asness defends the traditional 60/40 equity-bond allocation, advocating for diversification to achieve higher risk-adjusted returns.

Key Points:

• Efficient Frontier and Diversification: He explains the basic investment theory that a diversified portfolio like 60/40 equities-bonds generally offers a higher Sharpe ratio compared to 100% equities (12:45).
• Leverage and Risk Management: Asness discusses leveraging a 60/40 portfolio to match risk levels without significantly increasing the chances of bankruptcy (14:31).
• Historical Performance: He highlights that a mildly leveraged 60/40 portfolio has historically outperformed 100% equities, even in markets dominated by high-growth stocks like the "Magnificent Seven" (15:04).

Notable Quote:

"Long term we think the risk adjusted return is better to do it in the more quantitative way. And in any period that's not near a panic or a bubble, how you do it starts to matter a lot more."
— Cliff Asness (16:18)

4. AQR’s Fusion Strategies: Enhancing Capital Efficiency

Discussion Overview:
Asness introduces AQR's innovative fusion strategies aimed at improving capital efficiency by making uncorrelated alternative investments more impactful within a portfolio.

Key Points:

• Capital Efficiency: He explains that fusion strategies allow investors to achieve the same exposure with less capital by combining uncorrelated assets with traditional equity positions (31:38).
• Avoiding Overexposure to Beta: Asness emphasizes the importance of pure alpha exposure without inadvertently increasing market beta, cautioning against the high fees associated with traditional hedge funds (33:56).
• Fusion Concept Benefits: These strategies are designed to help investors move the dial more effectively by adding uncorrelated exposures without significant increases in portfolio volatility (36:02).

Notable Quote:

"The problem was never beta. The problem was paying alpha fees for beta."
— Cliff Asness (34:42)

5. Factor Investing and Machine Learning

Discussion Overview:
The conversation delves into how AQR leverages factor investing combined with machine learning to enhance investment decisions. Asness elaborates on the balance between empirical data and economic intuition in weighting different investment factors.

Key Points:

• Rule-Based Investing: Asness describes factor investing as developing rule-based strategies that identify characteristics leading to outperformance, such as value, momentum, and low volatility (40:11).
• Bayesian Techniques and ML: He discusses the use of Bayesian approaches and machine learning to update factor weights based on new data, aiming to reduce overfitting and improve consistency (42:16).
• Balancing Intuition and Data: While embracing mechanical methods, Asness acknowledges the continued role of economic intuition in setting initial factor beliefs (43:48).

Notable Quote:

"There are people in the ML world that are more pure math people, but a little more data than intuition than we used to be because the techniques have gotten better."
— Cliff Asness (43:56)

6. Private Equity and Credit: Skepticism on Democratization

Discussion Overview:
Asness expresses skepticism about the push to democratize access to private equity and credit for smaller investors. He questions the purported benefits and highlights the challenges associated with including these asset classes in diversified portfolios.

Key Points:

• Accounting vs. True Diversifiers: Asness argues that private equity and credit are more of an accounting diversifier rather than providing true diversification benefits (45:53).
• Valuation Challenges: He shares an anecdote illustrating the difficulties in valuing private equities accurately during market downturns, emphasizing that these are fundamentally long equity positions (46:07).
• High Fees and Limited Returns: Asness criticizes the high fees associated with private investments and doubts the promised diversification and excess returns after fees (50:12).

Notable Quote:

"They're long equities. They know and we all know that they move in value every day. I don't even see why it's any different."
— Cliff Asness (46:07)

7. Closing Insights and Inspiration Sources

Discussion Overview:
Concluding the episode, Asness shares his sources of inspiration and acknowledges the contributions of fellow quants and researchers in shaping his investment philosophies.

Key Points:

• Learning from Competitors: Asness credits other quantitative researchers and competitors for providing valuable insights and inspiration (52:02).
• Continuous Learning: He emphasizes the importance of staying updated with macroeconomic developments and embracing both data-driven and intuitive approaches in investing (53:14).

Notable Quote:

"I learned something from them and others who I'm probably forgetting."
— Cliff Asness (53:14)

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Conclusion

Cliff Asness offers a compelling perspective on various investment strategies, emphasizing the importance of diversification, the flaws in conventional market timing arguments, and the potential pitfalls of democratizing access to complex asset classes like private equity. His insights into AQR’s fusion strategies and the integration of machine learning in factor investing provide valuable takeaways for both individual and institutional investors aiming to optimize their portfolios for long-term success.

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Notable Quotes with Timestamps:

• Cliff Asness ([02:07]): "Tariffs are taxes. I don't care how many people say they're not. They're taxes on the buyer."
• Cliff Asness ([08:32]): "Market timing is the Lord's work, in my opinion, but this is a terrible way to do it and it's ubiquitous and it's been around forever."
• Cliff Asness ([34:42]): "The problem was never beta. The problem was paying alpha fees for beta."
• Cliff Asness ([46:07]): "They're long equities. They know and we all know that they move in value every day. I don't even see why it's any different."
• Cliff Asness ([53:14]): "I learned something from them and others who I'm probably forgetting."

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This summary provides a comprehensive overview of the key discussions and insights shared by Cliff Asness on The Long View podcast. For those interested in investment strategies, macroeconomic factors, and the nuances of asset allocation, this episode offers valuable perspectives from one of the industry's leading financial economists.

Transcript

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Please stay tuned for important disclosure information at the conclusion of this episode.

[Christine Benz]

Hi and welcome to the Longview. I'm Christine Benz, Director of Personal Finance and Retirement Planning for Morningstar.

[Dan Lefkovitz]

And I'm Dan Lefkovitz, Strategist for Morningstar Indexes.

[Christine Benz]

Today on the podcast we welcome back Cliff Asness. Cliff is a founder, Managing Principal and Chief Investment Officer at AQR Capital Management. Cliff writes often about investing in financial matters on AQR's website and has been a prolific researcher throughout his career, with his contributions appearing in many of the leading scholarly journals including the Journal of Portfolio Management, Financial Analyst Journal, the Journal of Finance, and the Journal of Financial Economics. Before co founding aqr, Cliff was a Managing Director and Director of Quantitative Research for the Asset Management Division of Goldman Sachs. Cliff Asness, welcome back to the Longview.

[Cliff Asness]

Thank you for having me.

[Christine Benz]

Well, thanks for being here. We want to start by talking about macroeconomic issues. You have been a vocal criteria critic of the Trump tariff policy. Of course it's been dialed back quite a bit, but do you think it will have short or long term implications for economic growth, inflation? Anything else?

[Cliff Asness]

Well, first, I am a critic. I'm a critic of anyone's tariff. Obviously it just happens to be Trump right now. I was critical when Biden kept a whole bunch of the Trump tariffs from the first go around. I am, I am in the traditional economist. This is virtually settled economics to steal that term from science. Tariffs are taxes. I don't care how many people say they're not. They're taxes on the buyer. They're just effectively think of them as a sales tax. They reduce the global pie and global prosperity. They do cause some winners and losers and that's a political issue. And I have no great genius how to solve that. But they make us all collectively poorer. If the strategy, and some claim this, if the Trump strategy is ultimately to get lower tariffs by threatening higher tariffs. I'm not an expert on the gamesmanship there. If that worked out, at the end of the day I'd tip my cap and say thank you for making trade freer. But it doesn't seem like where we're going. You are right, they've cut back. But I think this is a little classic. Propose something truly beyond the pale and then make rather large increases that will have an impact seem moderate is kind of where we are now. So I guess I'd say the impact to the global pie, to prosperity around the world will be a lot smaller than the initial, you know, kind of off the charts proposals. But I think the world will be collectively somewhat poorer for these hikes and I'm kind of against that. I should tell you. You guys know I'm a financial economist. I largely deal with is this stock better than this stock? I make no claims to be an expert macroeconomist, though I don't think one needs to be in this case. This is, this is, you know, this is first three weeks macro class.

[Dan Lefkovitz]

A lot of investors out there are concerned about stagflation as a result of the tariffs. Won't ask you for macro forecasting on the likelihood, but I guess.

[Cliff Asness]

Hey Dan, I didn't say I won't pontificate about it. I just said I'm not an expert.

[Dan Lefkovitz]

Well, feel free to pontificate. But I guess I was going to ask you from an investment standpoint if you have a view on what types of assets or what types of strategies that you'd expect to fare well in such an environment.

[Cliff Asness]

Sure. So if we get stagflation and I won't take a strong stance on that, I think tariffs, ultimately they haven't shown up yet, but they almost have to add somewhat to inflation. They almost have to slow down growth somewhat. I don't know if that'll ever qualify for full stagflation. I'll let other people worry about that. But you've basically very early in our conversation threw me a hanging curveball. This is a question I can only answer in a deeply self serving manner because traditional assets, stocks and bonds, the one thing they agree on is they do not like stagflation. Stagflation is obviously bad for bonds because it's all about the inflation part and is quite obviously bad for stocks. Picking up inflation with slowing growth is nobody's favorite environment. I Do think in that case. Again, I'm talking my pocketbook. But I always believe in an allocation to relatively uncorrelated alternatives. I think they would particularly be important in a world where every type of traditional asset is being impacted. That doesn't mean they make money like gangbusters. An uncorrelated alternative is sometimes mistakenly oversold as a hedge. A hedge is something that's short the traditional. A diversifier is something that's simply uncorrelated with it. So if you have a well constructed uncorrelated source of return, you have your normal chance of doing well. If that's two out of three years, you have your same chance, which is wonderful when everything else has no chance of doing well in that environment. But I wouldn't want to oversell it. Maybe the one case where I would get fairly confident, never perfectly confident, but fairly confident, is in the alts world. On the trend following side, bolts from the blue stagflation that started that massively happened in a day would not be good for trend following because you have no trend to follow. But that is just not what we've ever seen. We've seen slow buildups in these things and it's no guarantee going forward. But trend following has done particularly well in longer painful periods for traditional assets. So I appreciate that as the second.

[Unnamed Participant]

Question because you need alts in that.

[Cliff Asness]

World or at least alts are your one shot.

[Christine Benz]

So I should note we're taping this in mid June. Cliff, just to follow up on that, Would you say that the trend following type products would be, you would think, the most effective sort of product in terms of an uncorrelated asset in such an environment, the stagflationary environment.

[Unnamed Participant]

In a.

[Cliff Asness]

Long drawdown, you know, a painful year, 2022, even longer.

[Unnamed Participant]

Yeah, I would say that it's not.

[Cliff Asness]

The only one I would allocate to.

[Unnamed Participant]

You get into trade offs. Trend following has historically had this property.

[Cliff Asness]

Of doing well in very tough markets.

[Unnamed Participant]

The geeky phrase for that is having.

[Cliff Asness]

Some positive convexity to it.

[Unnamed Participant]

But I don't think it's steady state.

[Cliff Asness]

Risk adjusted returned Sharpe ratio is an imperfect measure.

[Unnamed Participant]

We use it as just a stand.

[Cliff Asness]

In for whatever you think of return over risk. I think you could build a considerably higher Sharpe ratio portfolio of volts if you extend beyond trend following. So I would look at a portfolio of both. But the simplest answer to your question.

[Unnamed Participant]

Is yes, if we see an extended period of stagflation, the thing I'd have the most confidence in is probably trend following.

[Dan Lefkovitz]

Cliff, you recently wrote a piece on the common assertion that market timing is a bad idea because if you miss out on several of the market's good days that you erode your long term return. What do you think are the flaws in that argument?

[Cliff Asness]

Okay, well, let's start off with I am not making a pro market timing concept. People sometimes make very bad arguments and I'll explain why. I think this is a very bad argument in the service of good, you know, convince people not to. Market time is the Lord's work, in my opinion, but this is a terrible way to do it and it's ubiquitous and it's been around forever. I didn't recently write a piece on it. I recently revived a piece that I wrote 26 years ago and couldn't get published. So I had some humble moments in there saying, you know, they didn't say this, but maybe they didn't publish it because the writing was just terrible. You know, I don't know. You guys both right? You look back on something you wrote 26 years ago and you're like, I was really that bad. But the economics, I think were good. So in stages, the typical thing, you know, what if you miss the end best days, let's just say 10 days. I don't want to keep saying N. If you miss the N best days for the market, you lose a lot of the return. Okay, maybe interesting as a mathematical fact, but let me say this to you as a strategy. If 10 times over your investing lifetime, you take all your money, sell all your stocks and put them in cash to buy them back the next day, and those 10 times were the absolute worst 10 times ever to do so, then that would be bad. It doesn't strike me as a particularly interesting statement. That is a radically extreme strategy.

[Unnamed Participant]

And to make it worse, and this.

[Cliff Asness]

Is one thing my paper does, paper is too exaggerated. It's too simple to call it a paper. It deserves to be a blog. But run the exercise well. What if I miss the 10 worst days for the market? The results are fairly symmetric. They're actually slightly better. Because markets are negatively skewed, they tend to go down a little bit more than they go up in the short term.

[Unnamed Participant]

Missing the worst.

[Cliff Asness]

Call it the same. I'm gilding the lily. If I say it's better, has a huge impact.

[Unnamed Participant]

Invest in the market the whole time, but manage to miss the 10 worst.

[Cliff Asness]

Days, the returns blow up.

[Unnamed Participant]

Am I allowed to tell people you definitely should time the market? Because look at these results. If you only miss the 10 worst days, you I don't know, double your return. I'm making up the specific numbers. No, that would be a ridiculous argument. I think most people would see it. It's a symmetrical argument. You should do anything investing in investing proportional to your belief in your skill at doing so. After transactions costs, after effects on risk, when you time the market, you tend.

[Cliff Asness]

To move to a more undiversified portfolio.

[Unnamed Participant]

You know, if by definition your long term strategic portfolio is your best bet at diversifying across good assets, a radical market timing tends to make it undiversified. So if you think your skill overcomes all these, you should do it proportional to your belief in your skills. If anyone believes their skill is so good that they should 10 times get out of the market for a day, then I think they need a lot of help, maybe beyond investing. So I just think this is kind of a silly way to frame the argument. Again, it may do the Lord's work if it convinces people not to time. Because my actual personal belief is most people should not time the market, most professionals should not time the market. It's a very hard thing to do. We do a little bit of it, particularly in trend following. Trend following does take a position, but that's about it.

[Cliff Asness]

I don't think we have great insight into the short term moves of the market. So very good cause to keep the average investor from timing. A very, very bad argument in my opinion.

[Christine Benz]

Another paper that you have been critical of is the one about whether investors should own 100% equity portfolios. And I feel like I'm hearing this drumbeat of an argument that investors should forget everything else and be 100% stocks. You offer an opposing view. Can you talk that?

[Cliff Asness]

Sure. Well, first you always hear these arguments when markets have been strong for a long time. Hey, why don't you only do this? Let's go back to basic theory and when I say theory I'm being complimentary, not disparaging. This is just basic math that if you take an MBA course in investing, it's probably week two. In week two, the professor draws what's called an efficient frontier. He estimates the expected return and the risk. Again, you could use simple models like volatility. You can get more subtle in what you think of as risk. But the expected return and risk for a whole bunch of assets, some assumptions about how they're correlated and then shows you that a combination of diversifying assets generally has a higher risk adjusted return than any single 1. So as 60, 40 equities bonds has had a higher Sharpe ratio than 100% equities lower returned because bonds return less, they're supposed to return less. They're a lower risk asset, but a higher risk adjusted return. So basic theory, and again, this is week two, is an investor who finds, let's pretend 6040 is the best combination you can make. We don't think it is, you know, but 6040 I think is. I think legally we have to use 6040 as the default because everyone has for like 50 years. So imagine 6040 is the best Sharpe ratio. Both stocks and bonds are great, but on their own, the return per unit of risk is lower. An investor who finds 60:40 too risky should add cash to it. And an investor who says, I can tolerate more risk than that should apply leverage.

[Unnamed Participant]

And the L word is scary to some people. I've written on this, the amount of leverage you need to apply to 60:40 to make a kind of equal risk.

[Cliff Asness]

To stocks is like 25%.

[Unnamed Participant]

It is not a particularly scary number.

[Cliff Asness]

In all the history of market drawdowns, crashes, there was no bankruptcy risk to this.

[Unnamed Participant]

It wasn't even close. So lo and behold, investors who do this. And I wrote a paper like a million years ago, this was in the 90s.

[Cliff Asness]

A lot of times when we talk.

[Unnamed Participant]

About my papers, I feel really old because I'm always like, yeah, I wrote this in 1994. That was 31 years ago. Showing that realistically, including some costs, you know, mildly leveraged 6040 portfolio handily beat 100% equities, even in the U.S. a country with the strongest equity returns. Others have extended that out of sample. It's worked out of sample. Others have done products based on this. I'm not supposed to plug a competitor's products, but my friends at WisdomTree have a product that I think does exactly, or maybe I don't know if it's more aggressive, but does basically that paper from 31 years ago, you know, I'm not dissing stocks. Stocks are a huge part of, of a strategic asset allocation. But any single asset class, any even more narrow portfolio is simply leaving the benefits of diversification absolutely on the table. With leverage, you always have to think, if someone tells you this is a great strategy, but you have to lever it 41 times, you have to take your two basis point edge and lever it 41 times. I think you probably should go, yeah, I'm going to pass on that one.

[Cliff Asness]

But mildly levered 60 40, again, I'm assuming, please don't take 6040 that literally. But mildly levered 6040 is exactly what they teach you. Second week of your MBA program and it has worked like a charm long term. So I don't see why someone would leave that on the table.

[Dan Lefkovitz]

Sticking with asset allocation. Cliff, you published a piece coming into 2025. It was very clever. You framed it as looking back from the year 2035, looking back over the past 10 years of returns, wondering if you can talk a little bit about the genesis of that piece and also.

[Cliff Asness]

Sort of how you arrive at the.

[Dan Lefkovitz]

Capital markets assumptions and especially the fart coin allocation. I wanted to ask you about that.

[Cliff Asness]

Well, a few things. First of all, I'm sure you know this, but the structure of how I did the piece was a thinly veiled way to say I was right about everything 10 years from now. It's not even veiled.

[Unnamed Participant]

It's being too nice to the paper.

[Cliff Asness]

To say there were allocations. I only spoke in generalities. This was supposed to be kind of half fun, but also what I actually think in particularly the fart coin thing. And I do find it somewhat amazing that serious people like yourselves and myself actually end up discussing something called Fartcoin on a well respected podcast.

[Unnamed Participant]

So in some sense the creators have.

[Cliff Asness]

Succeeded in getting us to do that. But I was just having fun there. I will admit I'm a crypto cynic. I am least cynical about bitcoin. That doesn't mean I like it. I don't want to go that far.

[Unnamed Participant]

But the leader in the category that.

[Cliff Asness]

Does have at least a cap on how much can be created. Unlike many of the other meme coins, I'm still not a buyer. I don't think we need the arguments against, quote, fiat currency, you know, don't lead you to want someone playing computer games all day to generate this made up thing. You know, I am a cynic about the whole thing, but if anyone's going.

[Unnamed Participant]

To succeed, it's going to be bitcoin. So I just. That was the one thing in the piece that I just flat out lied about. Everything else was my actual opinion, my opinion that bitcoin would do terribly, but Fartcoin would hold up. That was a pure joke. So you have found the one lie in the piece.

[Cliff Asness]

I don't think compliance is going to let me launch a meme coin here, but I want to launch a meme coin, literally called Ponzi scheme. Ponzi coin. It's the same idea. Let's just throw the ridiculousness in people's faces. But I believe, I hope somebody can steal this idea. I'm putting this into the public domain. I think they will still buy it. Half the reason people buy these things is transgressive joy at doing something ridiculous. So why not go all in and call it Ponzi coin?

[Christine Benz]

We'll see if someone picks up on that. Cliff, want to follow up on our last conversation with you, which was three years ago at the Morningstar Investment Conference? Was 2022 bad year for stocks, bad year for bonds. On the equity side, Val, Value did hold up a little better than growth in a tough equity market. I'm curious, what's your perspective on what we've seen from value stock since then?

[Cliff Asness]

Okay, I love this. I appreciate it because it's the second time you're giving me a little license to brag. Value, as a concept we all understand, pay a low price compared to fundamentals. I think the way quants use the term value, it's just price to fundamentals. The way active managers, Graham and Dodd type managers use the word value. It is a more holistic concept. They'll look at how profitable, how risky it is. Quants do the same thing. They just call those other factors. I actually think quants misnamed the value factor. Like 30 years ago, it should have been called the low price to fundamentals factor. It's not as pithy, but it's more accurate. But I am a believer. On average, over the long term, low price to fundamentals largely ending because of behavioral reasons. People go too far. The low price to fundamental stocks deserve to be low, but not as low as they are. And the high ones deserve to be high. So I am a believer in that general strategy, even though that is not all I would do by any means. Now, in 2022, every form of value worked. In other years, it gets much more subtle. For instance, the traditional value indices are cap weighted and we of course focus mostly on the United States. Both of those things have led to extreme outperformance of growth. The Magnificent Seven, if you will. They've had tough periods but have trounced the rest of the market. And the traditional kind of indice y way to do it has a huge bet on that. If you are a quant geek, forming a long, short portfolio with value as one factor. Again, not the whole thing by any means. I won't speak for every quant, but I think I'm speaking of most of them. You're going to have something much closer to a thousand. Not equal weight, but let's make it simple, call them equal weight. A thousand stocks equally weighted long not just in the US where this phenomena of the magnificent seven has been dominant. You're going to do this globally and this may be more specific to some quants than others, but we have always favored not taking a industry bet when it comes to value. We found historically and we wrote a paper on this. I'm going back even further. No, this is 1995, only 30 years ago we wrote a paper showing that value and most other quant strategies outside of momentum don't do a particularly good job at the industry decision. Do better. If you take that out, you do all those things. It still hasn't been a banner period for value since 2022, but it's actually held its own. If you do the traditional ways and the indice ways and you actually went short the magnificent seven, you have not had a very good time as a value manager of any kind since then.

[Unnamed Participant]

In normal times these are very different strategies. This construction matters, I will say during wild blow off, you know, plus or.

[Cliff Asness]

Minus six months around a bubble peak.

[Unnamed Participant]

How you construct these things matter a lot less. You know, when values kind of destruction peaked or nadir. I don't know how you want to view that, but when the value destruction hit maximum in late 2020 didn't matter.

[Cliff Asness]

Well constructed. I could tell you I have scars on my back. Well constructed quant versions that hedge a whole bunch of things out and don't take a huge bet on any seven stocks or don't take a huge industry bet were in pain right along with the more traditional indices. But long term we think the risk adjusted return is better to do it in the more quantitative way. And in any period that's not near a panic or a bubble, how you do it starts to matter a lot more.

[Dan Lefkovitz]

Cliff, do you think that non US equities are sort of an indirect value play?

[Cliff Asness]

Yeah. The rest of the world is cheap compared to the us. Here I'm using cheap like a quant, just considerably lower multiples. Obviously there's a level of US superiority in growth that can justify a higher multiple.

[Unnamed Participant]

But the US has definitely outperformed the.

[Cliff Asness]

World for a long long time. Let's call it a quarter of a century.

[Unnamed Participant]

I like saying that instead of 25.

[Cliff Asness]

Years, I think it has more gravitas.

[Unnamed Participant]

But I've written on this. Anti Ilmanin at AQR has written on this. You can do it different ways and get slightly different answers. But call it 80, 85% of the.

[Cliff Asness]

US's victory has come from multiple expansions.

[Unnamed Participant]

So pick your favorite one. Let's use the Shiller Cape.

[Cliff Asness]

I'm not claiming that's the be all, end all method of valuation.

[Unnamed Participant]

Don't hold me to the specific numbers, but if 25 years ago the US was considerably cheaper than global stocks, it is now considerably more expensive on this.

[Cliff Asness]

Measure that has driven again the Lion's share of US outperformance. Not all of it. Again that 15 to 20% that's unaccounted for. That is the US actually being exceptional over this period, actually growing earnings, whatever cash flow, whatever measure you want to look at better than the rest of the world. So the US's victory is not 100% from revaluation, but it is 80% from revaluation. And now the US is considerably higher priced. So at the very least I prefer a diversified portfolio around the world. Looking at it and saying I assume the US will win by the same margin in the next 25 years as it did in the last, it's basically.

[Unnamed Participant]

Saying we're going to see extreme multiple.

[Cliff Asness]

Expansion on a relative basis, us against the world from here again, which would take us to stratospheric differences that we've never ever seen. And I think any level of growth differential would find it very hard to justify if one is more of a mean reversion believer. Maybe you want a little more global. That is a pretty low sharp ratio bet. Pure value to do country selection is not how I want to make most of my living, but it is something I would take a very small amount of risk on. So sorry, long winded answer to a short question. I do see it as a value bet, but I think there's some interesting aspects. I think people maybe over extrapolate what we've seen the US do in the last 25 years, not realizing how much of it has come from people just willing to pay more and more for the same fundamentals in the US compared to other places.

[Dan Lefkovitz]

Well going back to that Market outlook piece, the 2035 Allocator looks back, it sounds like you are expecting international equities to outperform over the next 10 years.

[Cliff Asness]

Well yeah, again that piece had no subtlety to it. I didn't talk about how much risk I would take in such a position, but because of what we've just talked about, I am a little bit at least of a mean reversion guy. So I probably have a little bit more over the next 10 years than I normally would. Whatever your base case is. And again I was getting to write it, so of course I ended up being correct.

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[Christine Benz]

To switch over to discuss what you're up to at your firm, AQR Capital Management. Before we get into some specific questions about various strategies that you run. Can you talk about the firm generally and maybe talk about the ratio of AQR's assets in retail mutual funds versus hedge funds that are accessible only by higher net worth investors?

[Cliff Asness]

Sure. Just looking at hedge funds, which are typically an LP structure and mutual funds, leaves out a fair amount of our assets that are separately managed accounts. But if you're just going to do that breakdown, we're about 70% mutual funds, 30% LPs. If you want to look more broadly and just talk about strategy types, mutual funds are about a third of the rest of aum. The breakdown, they're both super important. A third versus two thirds. I wouldn't call one, let's round it and call them equal. One thing we do, which I'm proud of, is the mutual fund versions of our strategies use the exact models that the LP versions use in terms of pre tax alpha. So to me it doesn't even matter where they come from. But if that made any sense, call it fairly balanced among the two.

[Christine Benz]

Okay, that's helpful. And then in terms of the strategies that you run, AQR is primarily known for its alternative strategies, which we've discussed a little bit here. But you do also have long only strategies. How would you envision the long only products being used in a portfolio?

[Cliff Asness]

Well, first we have long only largely because there are many investors who simply can't, can't or won't allow shorting in their portfolio. We still think our process, we think our process is frankly better if you allow us to go both long and short. The alpha. On the short side, imagine you have alpha. Let's start with that. We think it's fairly symmetric. We think Our ability to pick stocks that will underperform is roughly similar to outperforming. And if so, in a long only beat the benchmark portfolio, where you're owning just different stocks than the benchmark, there is often a limited amount you can actually move the dial. With negative views, you can only not own something. And unless something is a giant stock, a lot of stocks are small in the index and not owning them is fairly trivial. I would never short a ton of a smaller stock. But to move the dial, you might want to have a bigger bet than simply not owning it. And we do think the risk adjusted return if you're allowed to short, is higher. But simply put, we think the long only beat the benchmark. More constrained versions of the process still has a positive expected outperformance. We wouldn't do it otherwise. We charge a lot less for it than we do for long short. So the net returns are closer than the gross return difference. The gross returns again should be better if we're allowed to short.

[Unnamed Participant]

So we do it because it's a marketplace that exists. It's a very big marketplace and we think we can add value. So the way an investor should think of that is just traditional active management. Instead of equities, will these long only equities on average outperformance. So we don't think we could do quite as much as we can do if an investor allows us to go short.

[Cliff Asness]

But we still are quite happy with it.

[Dan Lefkovitz]

AQR is launching a series of what you call fusion strategies. Maybe you can explain what those are, what the philosophy behind them is, and sort of what you expect from them.

[Cliff Asness]

Sure. There are really two concepts here, and I'll say in advance. Both go to something I'll explain called capital efficiency. One is, imagine you're running an uncorrelated alternative. I mean liquid, true, uncorrelated. You're short and long an equal amount in terms of dollars. Beta, you've really thought about this and nothing ever comes in perfectly uncorrelated. Of course, real life will always throw you curveballs. But imagine you think you've created an uncorrelated source of alpha.

[Unnamed Participant]

Step one is in general, it is.

[Cliff Asness]

More useful to investors if you run this at a fairly aggressive level. In the long short world, that tends to be again the L word, leverage. But there are two choices.

[Unnamed Participant]

I could run this at a 5%.

[Cliff Asness]

Annual volatility, call that about a third of equity volatility, or a 10% annual volatility.

[Unnamed Participant]

Quite simply, investors have to give half.

[Cliff Asness]

The money at 10% volume to get.

[Unnamed Participant]

The same bang as they would at 5. That is capital efficiency. They can do something else with the.

[Cliff Asness]

Rest of their money.

[Unnamed Participant]

They can move the dial more. It is the exact same product and in fact this can cause sticker shock at time but it should be exactly double the fee or if I want to be more positive to aqr, the lower volume should be exactly half the fees. You can't cheat in either direction. But that's a form of capital efficiency. The second is all right, so you've created something uncorrelated. I've spent much of my career complaining, whining, writing about so called alternatives that are really getting a lot of their return from market beta from being long. We wrote a piece on hedge funds in 2001 showing that on average their correlation to long only equities was over 0.8. They had healthy positive betas. I have a feeling you'll ask me about this, but we think much of the return to private investing is really just market beta as markets go up over time. So this is a little bit of an odd position for me because I've spent a lot of a career saying be careful about beta being snuck into your alternatives.

[Cliff Asness]

But I think I actually I even lost sight of this to some extent. The problem was never beta. The problem was paying alpha fees for beta. The problem is if you're charging a 20% performance fee and that is on both your Alpha and a beta 1 exposure to the market, well you can get that beta 1 exposure to the market a heck of a lot cheaper than hedge fund fees. So I think even I lost sight of that. So imagine you did this. You have your higher volatility alternative which already we think is more capital efficient. You have to put fewer dollars in to move the dial. But imagine it's still a lower expected return than equities.

[Unnamed Participant]

So equities you expect to make 10% a year. Maybe on the alt you expect to.

[Cliff Asness]

Make 8% a year uncorrelated. That's wonderful. That improves your Sharpe ratio. If you allocate out of equities, it does not improve your total return. You're still allocating from a higher expected return asset into a lower one. And the old saw, we've all heard it a million times, you can't eat risk adjusted returns would be true in this case.

[Unnamed Participant]

Now earlier we talked about a levering a 6040 portfolio.

[Cliff Asness]

If you apply a little leverage to something, you often can eat risk adjusted returns. But if all you do is allocate from the 10% to the 8% you're.

[Unnamed Participant]

Going to have a lower return won't be quite 2% lower because you get.

[Cliff Asness]

A little benefit from diversification on your compound return. But it's going to go down.

[Unnamed Participant]

Now imagine the alt simply adds a position, say using an S and P futures. $1 in the alt gets you the 10% volume that's uncorrelated plus a dollar in the S and P future. You can't charge alt prices for that dollar in the S and P future. That's the sin. But just adding it can be quite.

[Cliff Asness]

Helpful to an investor constructing a portfolio.

[Unnamed Participant]

Because now if they allocate a dollar out of equities to you, you are replacing that dollar of equity exposure and adding the alt as a pure additional exposure. And if you're good at creating uncorrelated exposure, that has a trivial effect. At real life sizes. 5% allocation to the alt barely changes the volatility or the even more general measures of risk of the overall portfolio. So again, it is just a capital efficient way to do it. It's a way. One criticism of some alts that has.

[Cliff Asness]

Some bite is hey, great risk adjusted returns, but they don't move the dial enough. Both of these things more aggressive on the pure uncorrelated alpha side. And coming with a package deal, some financial engineering actually just adding the equity exposure as long as you don't charge for it, can make that alt far more efficient and make it so if you're right about the alt, you still have to be right. It does move the dial. And that is the fusion concept. I don't know where we came up with the name Fusion. That's one of these. We probably had focus groups for six months and no, we don't do that. But somebody came up with it. I kind of like the name.

[Christine Benz]

Wanted to follow up on the idea of moving the dial because you have written about position sizes with alternative assets that as you said, it's often too small to really make a difference. And it sounds like these fusion strategies aim to address that. But can you talk about how advisors should approach that decision about how much to allocate to alts in portfolios?

[Cliff Asness]

Sure, they should allocate 100% to our alts.

[Christine Benz]

Okay.

[Cliff Asness]

But the real answer is for my compliance area. Just heard that and just, just had a myocardial infarction. I was joking. There's no perfect answer to this. You come up with a set of assumptions, you say, can I live with this? You try to do it in a real world way. Some of the practicalities of if you lose unconventionally, it is harder to stick with than if you lose conventionally. Even if that has annoyed me throughout my career, I don't deny the truth of it. During some of our toughest periods, they've been very positive periods for markets and we've been proven right at the end of them. But it was still a rough ride because it was more of an unconventional loss than a conventional. I'm going to disappoint you if you were looking for an actual number, but it's a process of looking at what your assumptions are and we just think the fusion concept helps you get there better. If your goal is to raise the top line, there is nothing wrong with adding a alt that slightly decreases the top line but has a decent impact on the risk. Risk adjusted returns can be a great thing. Maybe you like that trade off, but the Fusion concept lets us offer something for that investor who's looking to move the top line. Not just the risk adjusted return, but the specific numbers. I don't think aqr, my joke before, I don't think AQR is the only firm that's good at this by any means. So it's not just what you think of us, it's what you think of what you can find out there in general. And then how does that compare to your long term assumptions for your traditional assets? So we help investors, we give them our biased view on what we think these are. But every investor has to make that call on their own.

[Dan Lefkovitz]

Want us to ask about AI and maybe how AQR is using it? You've been quoted recently as saying that AI is annoyingly better than me. Maybe you could explain what you meant by that.

[Cliff Asness]

Yeah, One way to view what a quant does, and this is probably an oversimplification, is come up with rule based things that say this type of stock. And by the way, I keep using stocks as an example. We do this in the macro world. It's not just individual stocks, but I think that's the cleanest example.

[Unnamed Participant]

Come up with a rule based approach.

[Cliff Asness]

That says stocks with these characteristics tend to on average beat stocks with these characteristics.

[Unnamed Participant]

Some of the famous ones in the.

[Cliff Asness]

Factor investing world are again the value factor, the profitability factor, the low volatility factor, the momentum factor.

[Unnamed Participant]

There are more these days and there are many different ways to measure these things. Right? How to measure momentum, how to measure value.

[Cliff Asness]

God doesn't come down and tell us.

[Unnamed Participant]

We have a composite of many different.

[Cliff Asness]

Ways we find reasonable. It has always been the job of kind of the senior researchers, myself included, but not just me of course. To say at the end of the day, how should we weight these different factors? We've never been short term timers on it, so this is a long term decision that we occasionally revisit. It's not like I come in in the morning and go feel really good about the low vol factor today. But in setting these long term weights there was some judgment applied. We would pride ourselves on trying to be roughly 50 50. There's no exact way to say what 5050 even means, but 5050 based on empirical results, both in sample kind of back tests and even better out of sample results. Since you've been trading the factor but also call it 50% on does the Factor make sense? Making sense could be a deep theoretical model. It can just be common sense. And the reason you have the second part is to avoid overfitting, to avoid data mining. You can find plenty of factors if you just let the data go crazy that have worked long term that you just look at and go, yeah, no way. You guys know the famous examples for market timing? Buy when a team from the NFC wins the Super Bowl, Sell when a team from the AFC wins the Super Bowl.

[Unnamed Participant]

I don't care how well you show.

[Cliff Asness]

Me that factor has worked, I'm not betting on it.

[Unnamed Participant]

What it turns out is if you.

[Cliff Asness]

Start with a set of factors that.

[Unnamed Participant]

You already believe in and then use modern techniques, actually they don't even be that modern. The first way we did this and still a big part of what we do are simple what are called Bayesian techniques. That's what you. It's just a mechanical way of updating.

[Cliff Asness]

Prior beliefs based on new information, which is largely the return on the factors. Now we're in the midst of adding.

[Unnamed Participant]

A lot of machine learning methods that.

[Cliff Asness]

Are very similar in spirit.

[Unnamed Participant]

We have these historical results, we believe in these things. How should we weight them?

[Cliff Asness]

Let's update with new data.

[Unnamed Participant]

I often joke that Bayesian techniques are machine learning circa 1670 A.D. there, you know, I'm probably off on my years, but the famous Reverend Bayes with his formula was pure math back then. That was machine learning. If you think about it, just really simple. But by and large we do think these more mechanical ways. If you start with good factors to begin with, if you let a mechanical method make up any factor it wants, it's going to gigantically overfit. It's going to find crazy silly things that make absolutely no sense. But it turns out that if you find a set of factors, you believe in which we've spent pretty much 30 years creating, then these methods seem to be both in back tests and so far in our real life results, somewhat better than us making a judgment call at the top.

[Cliff Asness]

And I believe going forward will be somewhat less streaky. Obviously we've been pretty happy with our now 27 year experience at AQR, but it has been streakier than I'd like with some very good and very bad periods. Luckily the good periods have outweighed the bad in magnitude and length. But we'd still prefer to be somewhat less streaky. And I do believe the mechanical methods will be somewhat less streaky. Largely because no matter how good your intentions are, when you are people applying your own common sense to the allocation, you almost cannot help imposing a little bit of a philosophy, a little bit of a view. The machines are cold hearted, you know, you're seeding it with things you believe in. So there's still some judgment involved. But after that the machines seem to do a better job. So you know, the old joke about a recession is when your neighbor loses his job. A depression is when you lose yours. A worry about machine learning is when other people are losing their jobs. I lost a little bit of mind to the machines. Again, lots of room for human judgment in what goes in. I still think, even for people who use ML and we are extensive users these days, I think we are probably decently more towards still imposing some economic intuition. There are people in the ML world that are more pure math people, but a little more data than intuition than we used to be because the techniques have gotten better.

[Christine Benz]

And ML of course is machine learning there. We wanted to switch over and discuss privates because you have been very vocal in addressing the uptake of private securities in portfolio.

[Cliff Asness]

What am I not very vocal about? Let's narrow this down.

[Christine Benz]

Well, that's true. Before we delve into privates, I was hoping you could get into nomenclature a little bit because you do believe that private equity and credit are equity and credit respectively and not alts. So maybe you can talk about that.

[Cliff Asness]

Yeah.

[Unnamed Participant]

Again, I find it hard to even engage in this argument because I find.

[Cliff Asness]

It so staggeringly obvious. Private equity, the canonical private equity. Different firms won't be exactly. This of course are mildly levered long.

[Unnamed Participant]

Only equities that are simply not publicly traded. The notion that these would be uncorrelated assets is fairly insane.

[Cliff Asness]

I have a story for you. This is, you know, I keep dating myself with these stories. This is 1997. 1997. We had a little thing Called the Asian debt crisis. You know, there are like three people listening to your podcast who ever heard of this one. But I remember I'm still. I wasn't going to say anything, but I was still at Goldman Sachs. We were thrilled that our fund that attempted to be market neutral was our guess was were flat that day. I say our guess. Our P and L system said we were way up, but that's because we were short the US against Europe. We're not always short the US against Europe, by the way. It sounds like we are, but we were back then. And one great way to look like a genius is to be short a crashing market. The S and P was down about 7% the day of this crisis. And long a closed market, right? Short, crashing, long closed. Your P and L system says you're minting money. We said, no, Europe will probably fall a little bit more than the US tomorrow and will be flat. Did turn out to be true. So the head of Goldman Sachs, I will keep the name to myself to protect the guilty now, he was actually a really smart person, but frustrating conversation comes over and says, how you guys doing? And I give. I don't let him look at the screen because I don't want him to see it's up a lot because it's not true. I'm like, I think when it all settles, we're going to be flat. And he looks at me and goes, that's great. Us too. And I'm like, wait, you are levered long equities, right? He goes, yeah. I go, if you had to sell them today. I don't mean a fire sale, obviously that's silly for privates. But if you had to sell them today versus yesterday, they'd be down at least. What? The market would be down? No. And to his credit, he said at least. And I said, so what? He goes, but we don't have to sell them. To which any public manager can say, I don't have to either. There's really no difference if you're in the private world. These people are geniuses at valuing a company. If the market crashed 20% and you said, value my portfolio today, they could give you a damn good estimate of what it's worth today. I don't get why one set of investors, the private versus public, gets to mark their portfolio to what they think it's worth, while the other set has to market to where the market will pay today. I will tell you, in some of our tougher periods, I was more than capable of marking our portfolio to what I think it was worth and I would have turned out to be right had I done so. When this valuation bubble corrects, we're going to be way up. Would have turned out to be right. I don't get to do that. So at its simplest, they're long equities. They know and we all know that they move in value every day. I don't even see why it's any different. That's why I say it may or may not be a good investment. I'm not saying it's a bet on the skill of the private manager. I'm not so cynical. They can do some things we can never do, like make a company better. A quant who's long a thousand stocks and short a thousand stocks ain't making their companies better, they're just making bets. So there's a source of potential alpha that I can only dream about. They charge a heck of a lot for it. I'll let other people argue about where the net comes to when I use the word alternative. I mean a true diversifier, not an accounting diversifier. And I think when it comes to that, they're an accounting diversifier, not a true diversifier.

[Dan Lefkovitz]

Why do you think there's so much zeal towards democratizing access and getting credit and private equity into smaller investors hands their portfolios?

[Cliff Asness]

You're just trying to get me to be mean at the end of the podcast, aren't you? It's actually a high sharp ratio strategy for you. I'm more than willing to oblige. You know, to be honest, they're business people. They're always seeking to expand their business. I think their traditional institutional market is full up to the gills on this stuff. So where else are you going to go? I'll be frank with you. I think it's generally a bad idea. I think a lot of the structures proposed are some weird hybrid where they're somewhat liquid but private's in there. I don't even know how it's going to work. I think they actually risk ruining the magic. A lot of the magic is essentially investors let them get away with saying these things, have very low volatility. They let them go with the reported numbers because it makes everyone's life easier. And once you move towards liquid pricing, towards mark to market even a small way, they may risk popping their own balloon there and having people start to focus on the actual economic movements. But I think on a podcast about economics and investing, I can tell you the reason they're doing it is the same reason, to be honest that we do new products is to make money. I know that's a bold statement, but I will go out on a limb. I don't think it's a great idea for traditional investors. I don't think they're getting the diversification they think they're getting after fees. I don't think they're getting a particularly large excess return. So I'm a seller of this movement, but I don't get a vote.

[Christine Benz]

For our last question, Cliff, we wanted to ask who do you rely on to kind of give you new ideas to inspire different ways of thinking about the economy and the market? Who are your must reads or must listen tos?

[Cliff Asness]

I mostly read and listen to the podcasts of other quants. Like anyone in this business, I read a lot of macro stuff too. But that's just because I should know what's going on in the world, not because, like I said before, I'm a macro economist who's going to add a lot of value. So I read competitors stuff. We have some amazingly good competitors. I'm not afraid to compliment them. I think sometimes people are too scared to do that. I feel bad because this will be non exhaustive. Can't think of everyone on the fly, but the team at Rubico has for a really long time put out really good quant research. We don't always agree, we differ on a few things, but I always learn something. Wes Gray, Corey Hofstein, Owen Lamont. These might not be super well known names to the world, but I think they should be. And you don't have to be a quant to read any of this stuff. You know, a lot of them make comments that are just generally great and useful. And even if I've been doing this for more than 30 years, I learned something from them and others who I'm probably forgetting.

[Christine Benz]

Well, Cliff, thank you so much for taking time out of your schedule to be with us. We really appreciate it.

[Cliff Asness]

Oh, it was a lot of fun. Thank you guys. Thanks for having me.

[Dan Lefkovitz]

Thank you, Cliff.

[Christine Benz]

Thank you for joining us on the Longview. If you could please take a moment to subscribe to and rate the podcast on Apple, Spotify or wherever you get your podcasts. You can follow me on social media at Christine Benz on X or at Christine Benz on LinkedIn and Dan Lefkovitz on LinkedIn. George Cassidy is our engineer for the podcast and Cary Gretschik produces the show Notes each week. Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email [e-mail] until next time. Thanks for joining us.

[Disclosure Announcer]

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[George Cassidy]

SA.