AQR Capital Management Founder and CIO Cliff Asness doesn't see a market bubble but says valuation differences are extreme. He spoke with Bloomberg's Matt Miller, Katie Greifeld, and Sonali Basak.
And joining us now for an exclusive conversation about these markets. Cliff Assness AQR Capital Management, Founder, managing principal and chief investment officer. We've been talking so much about these record highs we've been experiencing, but within those record highs, there's a tremendous amount of stock market concentration.
Here.
There's a few stocks that have benefited so disproportionately.
How do you invest through that?
Well, first, it's a lot easier to be a quant at these times.
We do run some traditional portfolios, but a lot of what we do are.
Long and short, and it's very common for us to be long about seven hundred and fifty stocks around the world and short about seven hundred and fifty balanced by industry.
So we do the courageous thing and run away from this problem we've had.
We've had very good years with the mag seven soaring, even though value strategies are part of what we're doing. The opposite could hadn't happened in a while, the opposite could happen. So concentration is a problem for typical active manager and for us in some places, when you're only allowed to go long against the benchmark because a lot of your information, if you're a good active manager, is about what not tone, and when some things are so concentrated and big, it shrinks the size of everything else and makes that information less relevant. When you're long short or even a traditional portfolio that allows you to do a little bit of shorting, that really goes away and you don't have to think a lot about the mag seven. You just have to think about what you like and don't like. So I mainly run away from this problem.
You know.
Speaking of running away from the problem, you have one fund in particular, we're taking a look out. My colleague Justina lead pointed this out. You have an equity market neutral fund that is up about twenty three percent this year.
You're beating the market. I'll take your word for.
It, and that fund, I'm interested in it because traditional value factor is generic. Ones out there in the market have not performed that well. What do you do differently with value?
I have literally a piece on our website saying we are not all about value, except occasionally when we are when the world goes into absolute bubble mode. Anyone who cares about price is affected by it. But value is only a component of what we do. Some particularly strong things over the last few years have been and this year have been our quality strategies, profitable companies that are.
Stable, low volatility, low beta.
Some of the more proprietary things that people at my firm will kill me if I try to talk to you about, but more mL and alternative data kind of things we have had you quoted it, they get mad at me if I quoted. But we've had a very strong year our versions of value.
When you go global and you don't.
Take big industry bets, probably about flat on the year, It's not been a terrible year.
You get very distorted.
The value indices are cap weighted, and we all focus on the US, so they really are mag seven against everything else real world, particularly quants, but even non quants are often much more subtle in in what they're in what they're doing. So not a terrible year for value as we define it. But that's not been the driver. It's been the other stuff that's made it kind of fun this year. So I don't want to still yeah, a bunch of time.
No, No, I just mean the year is not over.
I hate year to date until December thirty, first four o'clock.
You really want the family do this thing. How you do. I'm a superstitious quant. Okay, there you go.
I will say you can say anything on TV one, so feel free to talk about your returns single stocks. And I do want to get your thoughts on size, because the phenomenon that we've been discussing is the fact that you don't have a lot of small cap IPOs anymore. That companies are waiting in the private markets until they're a little bit bigger, so maybe they bypass the small and the mid cap index. And that's spurred the idea that maybe the small cap premium has disappeared as a factor. I would love to hear your thoughts.
Yeah, well this one again. I'm going to turn the question around on you, like a quant. Okay, we don't think there's ever been a small cap premium.
What does that mean?
Well, certainly sometimes small caps win, but a premium means they win on average, that on average, you make extra money. The early tests of this were in the early nineteen eighties, when the so called small firm.
Effect was discovered.
I arrived at the University of Chicago about five years after this, but it was there, it was being done, and it showed that after adjusting for their beta. Another thing quants do and non quants. If you're making extra money just because you're a one point five beta and markets go up, you will make more money than a one beta, and small cap does tend to be more sensitive to the market. The early tests had to estimate the listing returns the databases just say dlisted, so you have to guess at how much you would have recovered from that, and they overestimated how much you recover, and they didn't adjust enough for the fact that the traditional statistical methods. You know, I love statistics, but they grossly underestimate the market sensitivities.
The beta is the volatilities of things.
That don't trade every day, and a lot of small caps don't trade enough. When you adjust for both those things, there's not been a historical small premium now today it's interesting. I do think this effect of companies waiting longer, it's probably more we don't trade on this. It's just an opinion, but the small world is probably a more distressed value world even than it normally interest is. So I don't think that necessarily means if you believe in the premium, I don't think it necessarily means it's gone. It could just be suffering, and along with value strategies in general, I know a fair amount of people who look at this thing that's spread between cheap and expensive in small is even wider than it is in large cap where it is wide versus history. So it could be a sea change, or it could just be bad things that have happened that lead to good things.
I have a sea change question, please.
So I pay like half of my income to the US government taxes here in the capitalists, you know, free market Cliff wants.
To help you, Taxy of New York. No.
No, but I lived for like ten years in Germany, right socialist Germany, where I paid less in taxes than I do here, and I got free health.
Care and childcare there.
So when I see a story about reducing my tax liability, I'm reading it. Justina Lee wrote a great story about you, guys. Quand Giant AQR cuts income tax bills for wealthy clients.
Yeah.
I hated the title, but okay, well, how can I get in on this?
Like what am I missing that I'm you know, losing half of the money I earn and not getting anything back for it.
I'm well getting even bigger picture, the difference in Germany and the US.
You raise a fair general point.
People don't realize that, at least when it comes to income tax, the US tax code is more far more progressive than a lot of other countries that are thought of as more progressive. So you're not imagining it. You are paying very high rate for us. It probably started about ten years ago.
We always co invested with our with our with.
Our clients, who are almost all tax non taxable institutions, pension funds and Dowmonds foundations, sovereign wealth funds, and we knew this was kind of stupid.
In some ways.
We believe in our strategies, but you shouldn't invest the same for a taxable investor as a non taxable investor.
It always shocks me when people are like you do that for them.
I'm like, yeah, you remember, we're fiduciaries. We have to do what's best for the client. And classic example is if this is stock you loved a year ago, you made a lot of money on it's eleven and a half months later, and your model or your process, or even your active managers.
If you're not a quant, wants to sell it.
If you're a tax free institution, you just sell it. If you're an individual, you're crazy not to wait two weeks. Right, I don't know anything about the next two weeks. I wish I did. I'd be Janet. You just talked about them if I knew about the.
Next two weeks. So you wait two weeks and they're gonna do.
They design some silly things in the tax code, like the difference between selling something after three hundred and sixty four days at again and three und sixty six days is dramatically difference in your tax bill. So we don't do a darn thing different in terms of gross alpha. We are basically you have to do, except for making holding in another.
Two weeks or something.
We are still running mostly about making money before taxes. We're running our standard process. But the major things which turn out to matter a lot if you do them systematically are if we're running your money after tax, you're and you're an institution, and we're running your money pre tax, and we decide we hate a stock we used to love, we'll sell it for you, and we'll wait fifteen days to sell it for you. That doesn't sound so powerful, but when you're long short and you have seven hundred and fifty longs and seven hundred and fifty shorts. And when you're us, which we got kind of lucky on this, our average holding period is just.
Under a year anyway.
So we are making a ton of decisions naturally part of the pre tax alpha process around that key decision point. If you're a high frequency trader, you can't do very much. You're realizing it all every day. If you're Warren Buffett, you already have a good tax plan. It's eventually to hopefully not for a long time, but to die and to pass it on to your airs or charity tax free. One year is a beautiful time because the tax code is kind of silly about it. The tax code I would write is not necessarily the tax code that I will, as a fiduciary manage my clients too well.
I want to talk about the after tax return a little bit more, because of course there's always been a focus on after tax returns, but it feels like there's more and more products that are coming to market that are focused on the after tax return.
I think about what's going on in.
The ETF space where I live, and there's an a tier to make exchange funds in the ETF wrapper and to get a little dystopian. I wonder if that's like the future of asset management after tax return products and leverage single sock ETFs.
I mean, I have strong opinions on what's the best way to do this. Exchange funds. I watched some of them at Goldman Sachs thirty years ago. They always struck me. You know, we like to do really natural things, like we're doing our process anyway, but we're gonna wait two and a half.
Weeks to do this. They you know, those always struck me as a little like in alchemy.
Yeah, I'm not super comfortable with that kind of solution. But what you said in general, a larger focus on after tax I have been waiting for this for my entire career as a as a little kid in this business.
This is not genius.
I think a lot of people did it. I was like, why does everyone? Why do tax will people focus on pre tax returns. I mean, they've been studies that look at mutual funds and say the money flows to the largest pre tax return, which is often for the obvious canonical invest there not the best post tax return.
Rob are not.
Who has been a friend of me of mine for a long time. We've written articles back and forth. He wrote a brilliant piece on this, and I think in the eighties it might be saying, but nobody cared for a long long time. So I think it's a positive development. I think you have to have pre tax alpha. You can't do things that are just about taxes. But once you're doing it, you should money different for your tax will investors.
And that is shockingly new. It should have been a long time ago.
Let's switch back to something you were talking about a little earlier. We were talking about places. Let's talk about it in terms of places to find alpha, because you had went there. Where outside of the stock market are.
You finding it?
You've made a lot of money in recent years on commodities. A lot of people have been talking about bonds. You were weeks away from putting around new capital markets assumptions. How do you think about diversification? What's the new sixty forty?
The new sixty forty still sixty forty. I don't know who on earth has ever invested in sixty forty. Somehow that became you have to do sixty forty if you like write a piece like we do on the perspective returns of fifty to fifty. The world goes I can't, I can't deal with this. This is fifty to fifty. We do think both stocks and bonds, and this will be reflected in our piece that's coming out soon. We do these capital market assumption pieces. They're really are client service. We're interested. We don't trade on them. They're like ten year signals. I've had a couple bad years in a row that I can survive. Things that only work over ten year horizons are not very practical.
And they often give you kind of weird indicators. They'll say things like, we expect to this right now.
We expect to make less on the next ten years on sixty forty, particularly on stocks, than the long term average because they're expensive. You know how hard it is to make money With the phrase make less? What if you underweight or short them, if they go up but less than normal. At the end of ten years, you tell your client, we lost you money, but we lost you less than we would have in the twentieth century. We talk about this a lot, and people don't get very excited about that. Having said that, everyone's got to plan their life, from individuals to pension funds.
How much am I going to make on my assets to cover what I have to cover? So these numbers are very important.
If you're going to make less, it's important, But I want to be clear, it's not a trading signal, but cost. We think less of the markets. We think diversification away from sixty forty, which, to be honest, we always believe in. So I'm singing a song I would sing all the time, but we do think it is somewhat more important when markets are probably offering you less trend following strategies long short equity strategies that are truly short, not long short, because that's just window dressing.
Well, what's the.
Best advice you would give to somebody who is primarily an equity investor. It's kind of like what David Cosson was saying a couple of weeks ago, like Golden Sachs. If you're standing at these valuations and you're worried about long term returns and you're investing today, how do you play just equities?
If you're playing just equities, it's in your question.
You are stuck with just equities, then it's about can you add alpha to it? And we think some of the more publicly known things buying high quality companies at reasonable price, what Warren Buffett does, we think is still going to work going forward. It doesn't fix the equity risk premium. To fix that you have to go outside of equities or be willing to short some equities. So with in equities, we still think there's alpha for active managers who have a discipline, rational process.
But to cheat the question, I think to.
Really move the dial on an all equity exposure, you know, why are you all equities? You've lived through one of several but a golden age for equities, and people tend to look at ten years and extrapolate that forever, when in real life at that horizon there's at least some degree again and it's not a daily tradable strategy, but there at least some degree of mean reversion. So the world on average gets this little backwards. They get all excited and are comfortable with one hundred percent whatever it is, one hundred percent one thing, when that one thing has won same thing for us versus non us.
US has crushed the world.
Most of that has been the US getting more expensive than the world. The fundamentals have come in somewhat better on the US, but as we measure, that's about ten to fifteen percent of the US's victory. Eighty five percent is people being willing to pay more for those multiples. That's not something you want to extrapolate fundamental performance. You can argue maybe there's something better in the US, maybe this is not, but just price multiple moves. So I think the number one thing is to cheat your question and go You've lived through a tremendous period of richening, particularly for a US investor. I'm not saying dump them, but I'm saying to assume that's going to happen again is a little crazy. And doing some other things, be they the things we like or whatever you think can add value. That's not just a great bed on equities. Rising is always important. You always want to build the best portfolio you can. Is more important now than it normally is.
Yeah, this is what Oswa thamzar And was talking about with has Linda, and the fact that we're in a pricing market right now. It's about momentum and vibes more than fundamentals. I want to ask about we have a really cool function on the Bloomberg E can go Eca and go and you can. We have AI now powering a search through companies earnings reports, and I ran a search here to see how often people mentioned machine learning and AI itself, and obviously you know it's blown up in twenty twenty three. And whenever I started thinking about this, at first, I thought a lot about you and AQR.
Because how often do you think about me?
Well with shanology to me, No, I mean I love to think about quants and how they can put this kind of thing to use. And I remember a couple of years ago reading a story about how you were hiring all of these you know, computer science guys from University of Chicago, and how much can you put a use and gain an edge over other people who are I hope, doing the same thing.
Sure, well that's a separate question, and I do think i'll skip to the end on that. I do think the AI world will be far more dynamic than what you might call the quant factor investing world. You do a very good version of Warren Buffett's doing. You'll have bad times, but if you stick with it, I think the whole world can know about it, and you can still make money from.
It, but we don't have to throw away the Benjamin Graham book.
Now AI big data, alternative data sets will be I think a more constant arms race where you have to keep reinventing what you do. I'm actually optimistic we can do that, but it will have more of that element. AI is a really complex topic to even discuss about how a firm like ours is using it. If you guys want to give me a three hour segment and kill your ratings forever. I know it's hard to do AI in three minutes, but at our firm we're using at least three different ways. One is signal generation, literally, you know quant signals.
We've always done that could be done better.
The classic example is using natural language processing to look at written and verbal information and turn that into is this good news or bad news?
Quants have done this forever. They've done it.
Word counts, you see the word increasing, You do a plus one.
That was very course.
If the actual sentence was massive embezzlement is increasing, then plus one was probably not your best call. Quants only have to be right about fifty three percent of the time, so that's okay. Turns out NLP machine learning is better than our old methods at doing that. A second way we're using AI is how to combine our factors, how to weight them. This is a little annoying because you know the old joke or recession is when your neighbor loses your job, or depression.
Is when you lose your job.
AI is coming for me now because I've always been one of the AQO and makes kind of the final call on weights on how much you know, I don't do this every day. We're not traders, but what should be The final weights are not all model driven because you can overfit that way.
AI is taking over some of that role.
It turns out it's annoyingly better than me, So that's another way. Finally, just as a productivity tool, which is the most mundane, but just to code, AI is making everything faster and probably moving where you talked about that innovation cycle itself AI for a to use AI is there the other really kind of cool way to think about AI. And I probably slowed our firm down by a year or two on this. I think sometimes the old man's job at the firm is to slow things down when there's new stuff. But forever we've talked about not overfitting that. A danger of quantitative processes is you see things in the data that were random. You think you can trade them, but they weren't real AI. And the way you combat that, by the way, is to combine data with theory and common sense.
AI, to be honest.
Pushes us a little on the spectrum away from some of the traditional things we've talked about, and I was uncomfortable from me. You are surrending yourself a little bit more to the machine. If there's limited data, you still need some economic priors. If there's a lot of data, you sometimes don't. One of my partners, Brian Kelly, has written a paper with a title I love called the Virtue of Complexity, because everyone always talks about the virtue of simplicity, even I've had to adjust to a world where maybe simplicity isn't always the goal. Complexity can be the goal.
You know, over and over and over, we.
Have one Wall Street executive after another saying AI is not going to take your job. But you've come here and said AI's even coming for me in some respects. What does that mean about a job on Wall Street over the next five, ten, twenty years that's.
The operative question is over what time horizon, Not to get philosophical, but on significantly long enough time horizon.
It's coming after all our.
Jobs, right, which is not necessarily a bad thing depending on the transition, you know, we get to a world of Star Trek with where we have a replicator that can make whatever we want. That's not necessarily terrible news, but it could be a lot of upheaval on the way to that. I think clearly so far at AQR it is certainly we've not shrunk because of AI. It has made our existing people more productive. Forecasting five or ten years down the road is of course a lot harder, and I'm not sure a quonkeeek who lives for diversification is the guy you want doing this.
But increasingly.
You have a job like doing an RFP a client wants questions answered. That's going to get much more AI over time. I doubt even on a ten year horizon, we'll get to a point where no human has to look at it. Right now, we are not at that point. I would not release something that was pure chat GPT to a client, But it's all about time horizing all this is coming, and I'm not the guy to do it, but how society adjusts to it, that's the question. You cannot stop technology. And I always laugh when I hear about people like we're going to stop automation.
I'm like, good luck with that.
You can slow it down at little bit and maybe let some other country beat us at it.
But it's common for all our jobs.
My wife went on a quest for our four children, we're all in the early twenties right at one point saying what jobs should they pursue that are most safe from a from AI and she concluded at the end, you just do what you're interested in.
I can't figure it out, since she's pretty smart. Yeah, yeah, So.
Cliff, we have less than two minutes left with you. I want to talk about market mechanics here, and I want to talk about leverage single stock ETFs. I was speaking with your new friend Mike Green from Simplify on Friday and we were talking about these leverage micro strategy ETFs. His belief is that that's helping to fuel this record premium. That micro strategy has to bitcoin itself, not specifically about that product, but you think about the proliferation of these types of products, what do you think that means for the market structure and the motion of markets.
All right, I'm drifting from quant now. Whenever I give like broad opinions about market psychology, ye, you should weigh my opinion somewhat less than when I'm talking about AI or diversification because I'm a little out of my wheelhouse. But I do think if you look at valuation differences, we're still at a time of extremes. And that's not just the mag seven. You could do it within any industry you want and add them up. I wouldn't call it a bubble four years ago. I would have called it a bubble. But we still are a time of extremes. I think animal spirits are high. Keep hearing that it's you know, that's I don't know how to judge this exactly, but it's partly quantitative, looking at just the spread between what we think are reasonable and unreasonable price stocks, and part of it is qualitative, the part you shouldn't trust me on. But the part you shouldn't trust me on looks at the rise of say, aggressively levered ETFs and says, yeah, nobody needs those, And then you combine it with twenty four to seven trading. You know, if you're waking up at two am and you need a levered bed on, then you might want to reconsider not just your financial plans, but many things in your life. Extremely lebretytfs if you hold them long enough, are almost and I only say almost for legal reasons, are almost certainly going to lose their money. The volatility drag is very large if you rebalance them religiously. It depends on the costs that are embedded in them. If you use them for very short term tactical views, they can make some sense.
And then I ask, why do.
You have very short term tactical views, because very few of us, certainly including me, certainly in concentrated non quan not Jane Street, but you know two stocks. I don't think. I don't think these people have any information on it. So I do think it is a speculative tool, a symptom of some things that are still pretty extreme in markets. And well, this is clearly not investment advice, but I wouldn't use them. And I speaking of by the way, that was investment of ice.
Speaking speaking of speculation outside of your wheelhouse.
My boss does want me to ask this question. I'm like he's a quat.
But how are you investing in Asia with the backdrop of Trump tariffs?
Your bosses are asking me a stupid question. I would never insult you guys, but I'm very comfortable now.
I'm kidding.
We're investing like quant We are relatively actually really close to balanced by country and industry around the world.
We don't. That doesn't make us ristless.
We have bad periods when the styles we like, reasonable companies at good prices that are starting to turn around are not being favored.
Not gonna be a fun time for us. But we have been very.
Good over time at avoiding the big Thematic themes like tariffs are a lot about specific countries and specific industries. That's where they can play havoc. They can make real winners and losers.
Can you use Trump one point zero as a blueprint for Trump two point zero?
Oh? There are a lot of jokes that write themselves here. I think we're at a time it could work out very well. I'm not necessarily a pessimist, but I think we are at a time of elevated uncertainty. We can measure that. That's not just an opinion. You can look at dispersion and forecasts of earnings. Of economic forecasts, you can look at how bad they're missing when the numbers come out up or down. Dispersion is just about the size of the miss. It's elevated and as a soft sense, whether you love it or hate it, the Trump world's going to be very different than the prior world. So I do think economic uncertainty is larger. I'll give a blatant commercial I think things like trend following strategy strategies.
That what are called positively convex.
It's the geek term for they tend to do well in tumult are probably a better time. But mostly when it comes to picking individual stocks, we run away from your question.
It wasn't a stupid question, it was just not the right question for a while.
Another Trump question for you. We do have less than a minute left here, but do you think that the tax cuts, if achieved, will be fuel for the market as certain investors believe.
They usually are in the short term? We do have You don't need me here to tell you we have a bit of a deficit problem that it doesn't appear that either party wants to take. We could talk about government getting more efficient.
We could talk about the DOGE. Do they still pronounce it doze when it's a department?
Still those even when it's the Department of Government Efficiency?
I think, so let's doggy. I'm copying this from Twitter.
Someone else said it, but it cracks me up that we have two guys heading the Department of Government Efficiency. Yes, it's like first thing, fire one guy. That's what either of them would do, and I'm not saying which one. I'm not going there. I do think we are in a world of more uncertainty. I think when it comes to stimulative things, the budget deficits are going to matter at some point. Many of us would have thought they'd matter twenty years ago.
And have been dead wrong.
So I'm not going to do the suckers game of trying to time when that matters. But at what point we consider something stimulative versus oh my god, we've gone too far is something I would be terrified to trade on.
So I'm not trading on that.
But that point does exist, so I won't make any firm forecasts. I just think we're in for an interesting ride in one direction or another coming up.
Cliff, we thank you so much for joining us.