(Bloomberg) -- Cliff Asness says he sounds like an “old man whinging,” but that’s not stopping him from writing 23 pages on his latest thesis: Financial markets these days aren’t what they were.
The often-cantankerous co-founder of AQR Capital Management just published new research that amounts to a detailed exposition of an argument he has repeatedly raised of late, namely that the market has become less efficient over the course of his more than three-decade career.
The paper — prepared for the 50th anniversary issue of The Journal of Portfolio Management — is “as much an op-ed as it is quantitative research,” the billionaire admits. But he says the conclusions have important implications for any investor seeking to win on Wall Street.
“I believe markets have gotten less efficient over the 34 years since the data in my dissertation ended,” writes Asness, 57. “I think the ups and downs will be bigger and last longer, making more money for those who can stick with it long term, but making it harder to do so.”
In one sense, it’s a big call coming from the hedge-fund executive. His PhD adviser at the University of Chicago was Eugene Fama, the godfather of what’s known as the efficient markets hypothesis.
In that world view, trying to outguess markets is a fool’s errand, but it’s possible to eke out extra returns by picking stocks based on so-called factors, or characteristics that compensate their holders for bearing particular risks. It’s the philosophy at the heart of firms like AQR and Dimensional Fund Advisors, another business founded by Fama’s proteges.
If Asness is correct that markets are getting less efficient, it essentially means that factor-investing approach is getting harder. It may take much longer for the type of strategy beloved by AQR to come good.
In terms of what has caused the change, Asness says that index investing, ultra-low interest rates and social media are all potential suspects. He ultimately lands on the latter and a subsequent “gamification” of trading as likely having the biggest effect, as it has ushered many irrational actors into the investment world.
“Whether this lasts forever I can’t say,” Asness writes in the paper, titled The Less-Efficient Market Hypothesis. “It seems that over history new technologies are eventually adapted to, and one day maybe that adaptation renders this piece obsolete. But for now, I think it has raised the stakes of rational active investing.”
Investment Strategies
So what is an investor to do? Some market players should lean into the new normal, Asness says, heeding the advice of the very meme-stock investors he blames for the new inefficiencies: HODL, or hold on for dear life. Investors should push themselves to have the longest possible investment horizon, he says.
Beyond that, he exhorts investors to learn from historic market behaviors. Watch evolving valuations. Don’t get sucked into focusing on every single item in your portfolio, and see the big picture instead. Don’t mistake three-to-five year trends as permanent. Avoid private assets that simply “launder” risks away by obscuring their true volatility. Constantly work to improve your processes.
And ultimately, if you aren’t confident of following his playbook, then turning to indexing is “a perfectly reasonable option.”
“The task is not easy and the advice is straightforward not any new genius!” Asness writes. “But perfection is never the goal and one can get better, perhaps much better, and hopefully these ideas help.”
The bout of self-reflection comes as AQR is riding high, having seen a powerful resurgence in many of its strategies in recent years as higher interest rates drive diverging stock performance. But the revival follows a period of underperformance that lasted so long that some critics speculated its methods were out of date.
According to Asness, less-efficient markets also mean there’s value in newer approaches like machine learning, alternative data and adaptive models that change factor allocations over time. While the firm’s better performance is partly due to market cycles, AQR is also letting machines make more decisions, he said at the Bloomberg Invest conference in June.
“Good investing has always been a challenge combining a) discerning what is right, and b) sticking with what is right,” Asness writes. “If markets are indeed ‘less efficient’ the first task has actually gotten easier and the second harder — and the skills needed to pursue good investing have shifted.”
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