Odd Lots - Inigo Fraser-Jenkins and Aaron Brown Debate The Future Of Quant Investing

Episode Date: November 23, 2020

Traditional quant strategies that try to screen for stocks that are "cheap" have had an extremely rough period. So is this just a temporary setback that will eventually mean revert, or are the existing strategies dead and busted? Earlier this year, Inigo Fraser-Jenkins of Bernstein Research provocatively said he was sticking a fork in the quant world. But not everyone agrees with him that it's a lost cause. So in addition to talking with Fraser-Jenkins, we also brought on Aaron Brown, formerly of AQR Capital Management, for a debate on what works in quant and what the future holdsSee omnystudio.com/listener for privacy information.

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And I'm Tracy All the Way. Tracy, we're going to have a debate today. I know. It's our first ever odd lots debate. It's pretty exciting. I think we had one like a few years ago about like fiscal policy in India or something like that. I feel like we've had at least one before, but maybe not. Maybe I'm hallucinating that.

Yeah. I don't think so. And this one is kind of on a topic that we've touched on a few times this year, but it's the terrible underperformance of quant investing in recent times. Yeah, exactly right. So for people who aren't as familiar, but as we've been talking about a lot, like a lot of traditional quantitative strategies, quantitative signals have only done so-so. So the most sort of obvious example is quantitative strategies. that are built around value investing, identifying stocks that look cheap, buying them, shorting the ones that look expensive, things like that, where you sort of like take a screen

or some sort of method and sift out hundreds or thousands of stocks that always churned them of various sorts. They really have not delivered the performance that they did in the past or that the performance that some of the academic work underpinning them would suggest what happened. Yeah, and I think a big part of this existential crisis for quant investing, if you will, is that a lot of that underperformance could be forgiven in 2020. You know, a lot of things have changed. There's been a lot of unexpected developments this year to say the least. But even before 2020, quant investing or systematic investing or factors such as value,

however you want to put it, they haven't been doing as well. as one might have expected. So this is sort of a long-term decline, and 2020 has really just hammered at home. And I guess the question is, and we'll get to this, but to me the question is, is this like, are we waiting for the mother of all mean reversions? So you have years and years of underperformance for a strategy, and if you just hold out a little longer, then the big swing back towards historical norms happens, or is there something deeper and sustainable. such that maybe if everyone is engaging in the same strategies or the strategies are well known beyond a universe of academics, they just don't work anymore because, you know, we talk about the concept of alpha decay all the time, that if everyone knows a winning strategy, then it doesn't work as well. So there sort of seems to be like two big questions, like which one is it?

Or is it just a matter of like quantitative strategies can still work? They just need to be sort of updated at their approach. Is it different this time? I have a feeling our two guests on this episode are going to have different opinions on that topic. Well, let's bring in our two guests. I'm super excited about having both of them on. We're going to be speaking with Inigo Fraser Jenkins. He's a quantitative strategist at Bernstein.

And last, in October, he actually published a piece, an essay. And in it, he said, I'm no longer a quant. And he kind of had this big rebuke to the industry. So we'll get to his arguments why. And for a different perspective, we'll also be speaking with Aaron Brown. He's a professor at the Math Institute at NYU. He's an author. He's a Bloomberg opinion contributor.

And for a long time, he was the head of financial markets research at AQR, which is a big quant shop. So really delighted to have both of these guests on the show. Inigo, thank you very much for joining us. Thank you for having me. And Aaron, appreciate having you as well. Thank you very much, Joe. So let's get started. Inigo, why don't you just give us, you know, sort of dramatic. And I have to say you're kind of known for your dramatic statements because prior to, prior to blasting the entire quant world, you famously attacked passive investing is worse than Marxism. I think you came on the podcast and said maybe your statements were a little overblown. But you certainly know how to say something provocative. So tell us why the sort of very high level view of why you think. quant as we know it is busted.

Sure, I'd be happy to. And I want to start off by saying that the essay wasn't really intended to be anti-quant funds per se because the market is more systematically driven than it's ever been a year before. But I do want to kind of reject the canonical view of what kind of quant is and how it's used in the market. I think there are a few different levels to this. There's one point that Tracy mentioned just now, which is, yes, has been an underperformance of quant funds.

this year, I think that's actually excusable, given the high correlation of stocks in the market. There's more tricky issue of the underperformance of many quant strategies over the last three years or more. That's frankly harder to explain. And that's even true for some of the more so new approaches have been applied rather than just those exposed traditional factors. And linked to that, there's inevitably the question of the value factor that maybe we can come back to at some point. I mean, the discussion and the wide extent value is dead or not dead. But then there are two deeper questions, too.

So one is around the role of diversification. And the quant strategies tend to be diversified in two different ways. One is at the single security level and the others at the factor level. And there's plenty of really good reasons for this, because most quant models work on average rather than through high conviction and through tight risk control. And so one wants to be diversified. But the problem is that diversification, generally speaking, has counted against fund performance in recent years.

That's true, not just for quants, actually, but for fundamental investors too. Now, some parts of that might well be temporary, but I would argue that in a regime where real rates are held very low for a long time, there might be more a long-run concentration in the market. And the other big issue is this assumption that the future is going to be like the past. passed, and i.e. applying back tests to making future investment decisions. Now, of course, that's a really good way as a process for avoiding simply forming investment views by shooting from the hip, and I wouldn't want to advocate that. But equally at the same time, I think there's

an argument you made that the regime has changed. If COVID doesn't count as a regime change, I'd struggle to see what would counter the regime change. Now, we have you very careful in, you know, constantly overlaying discretionary views on models that are meant to be systematic. That process has a troubled pass in many cases. But equally, you know, I think that there is plenty of evidence that occasionally regimes do change in a very big way. And one particular aspect that now is the policy response to inflation post-COVID and how that affects the performance of things like the value factor. But also just a mechanism of the interaction of macro forces. and policy. I mean, I think we've been very used to a 30-year period where the main job

cushioning the economy of the business cycle, it's been left to technocrat to central banks. That approach has been running out of ammunition for some time. I think the future is very different. It's a blend of fiscal and monetary policy, a blend that inevitably has more politics in it at a long run way, and it's sort of messier and harder to forecast. And so, you're a bit more So in that kind of environment, I think we need to be very careful about applying back tests onto the future. So there's clearly a ton to unpack there. I want to focus for now on the point about narrow leadership by mega caps and that being a negative for quant factors that basically focus on diversification or quant portfolios that focus on diversification. This is something that Aaron actually picked up in his response. to your note, Enigo.

And he argued that, you know, people were saying similar things back in the late 1990s during the tech bubble. They were saying it was different this time. And maybe investors should go out and just buy the really hot tech stocks. And, of course, we all know how that panned out. So, Aaron, maybe just to begin with, could you dig into that mega cap leadership point and how it relates to Qants? Sure.

Thanks, Tracy. See, we may not get as vibrant debate as you want. Most of the stuff I heard in a go so far I agree with. Not all of it. And, you know, it's a little more nuanced than the headline of his research piece. Yes, we have a technical name in Quant Finance for extended periods where the value factor underperforms and we call them bubbles. The overvalued stuff gets more overvalued.

The undervalued stuff gets even more ignored. But I do agree that this particular value drawdown we're seeing really goes back to the financial crisis. We have never in history and hundreds of years seen a value drawdown to this extent. And one of the ways I agree with in a go is that I think the issue here is not in the numerator, but in the denominator. Whenever you look at a price, you're looking at a price, you know, in dollars per share. The stock market hasn't changed fundamentally in 10 years. The dollar has. Quantitative easing near zero interest rates.

Massive Fed purchases, massive fiscal imbalances. I don't think those are, I mean, those are some of the reasons that we're seeing that the dollar has become different. If you do value factors using everything in gold, we find value is doing. much better. I think that there is a fundamental process going on, and it is the market is awakening to the possibility of extended periods of significant negative real rates, and that's causing a lot of repricing in the market, and that makes the dollar a bad thing to value, a bad thing to use to measure value. So that's what I would say going on there. I don't think we're in the mother-of-all bubbles in the sense that you're going to make a huge amount of money

shorting the S&P 500 are buying puts. But I do think we could see a extended period, five years, 10 years longer, a really mediocre equity returns. I think that is the risk to investors more than an immediate crash. So, Inigo, I mean, how much of this really is just a macro question in your view? And, you know, this is, again, another thing that frequently comes up on our discussions with lots of different guests coming at the question from different sort of intellectual frameworks, which is that as long as we are sort of in this mode, where the only like game in town or the only sort of entity that stabilizes the economy is the Fed and the Fed is sensitive to asset prices and doesn't want to see any drawdown, et cetera, how much of this is essentially nothing is going to

work until we get out of this regime, this economically? Yeah, so I think there are a blend of macro issues and micro issues here. I mean, not that I want to in any way claim that quantum investing is just about the value factor, but value does tend to be a large exposure in many quantum approaches and certainly would help if value had a turnaround. And I think there are, you know, in the debate that's gone on in the last 10 years around, is value dead or not dead. And I say it in an interview that, well, it's not dead ultimately. But equally, I can see that there are, you know, headwinds for it, some which are macro, and some which are micro. So, you know, I guess some of the more micro headwinds around the technology change that destroyed moats around certain industries

and the change in the basis by which corporates make investments more on intangible assets rather than tangible assets. And so some of the measurement of value, you know, has been wrong. But one thing, you know, has been clearly missing, I think, and that is inflation. And you can show that over the last five years on daily data, the last 90 years on quarterly data, the period in inflation picks up, tend to be generally kind of good ones for value. And so in a sense, you can say, well, we're waiting for in a policy shift here. And I happen to think that once the immediate dust settles and we're out of our short-term deflationary shock, then actually the policy response to COVID is going to be inflationary.

In a sense, that is part of what a value investor is waiting for in a long time. but with the enormous caveat, that I think there are plenty of good reasons why the policy response to that inflation when it comes will be different. And so there's, I think, a likelihood, as I mentioned, that real rates are held low for a long time.

And what that leads to, I think, is something of a bifurcation in the value factor, where if value is an undervalued sickle company, then fine, it can respond and do very well and rebound and mean revert in that kind of environment, but if value is a financial company, then it's much less likely to.

So if we're relying on simple back tests and what value does in the recreational environments, then I think we might be disappointed, but more nuanced approach actually could potentially find some areas of value that outperform. The problem is that it requires overlaying a regime policy view, which happens to be a subjective discretionary kind of call. And the other thing I'd say link to that is I really, really want to be able to believe in mean reversion. I mean, because without mean aversion, we're left relying on forecasts and human beings not terribly good at making those. And in a world where I would argue that actually all asset classes are pretty expensive, you know, equities, credit, sovereign bonds, private equity, maybe the value factor is the only cheap thing that we can go and buy. The problem is that the way the goals are phrased in the industry and the way that people think about their personal career is,

which can't be hedged away. You could be wrong for a period of time. This would make it almost impossible to hold it. And although the engine of mean reversion might look like it's very strong, we also do know that policy can simply override that for a very long period of time. So I have a follow-up question based on that, which is, I mean, Inigo, you sort of touched on this in your first answer, but one of the reasons people like quant investing or systematic investing is that

you sort of avoid that shoot from the hip style of investing where people can sometimes, I guess, become too reliant on their gut feelings or irrational in one way or another. So should Quants be attempting to factor in these kind of big macro calls into their portfolios? I think we need to be very careful about adding a continuous series of discretionary overlays aren't what are meant to be systematic approaches to investing. And in fact, generally, the shoot from the hip approach to investing, I think is going to struggle in a structural way, frankly, in a world where there's so many cheap, semi-passive ways

to go and buy things used to be thought of as active, and I'm thinking here of sort of so-called smart beta strategies, that it's very hard to have an approach that, you know, that only relies on that. Having said that, occasionally I think there are huge regime shifts that do take place. And I think this is one of them, I guess most obviously, in the policy environment, the way the policy interacts with the market overall. Aaron? Sure. Regime shift is a nice sounding term for this time is different. And quant is really based on the idea that, sure,

things do change, but people overestimate the change. People overreact to the last six months, the last three years, the last 10 years. And if you, look at things over centuries, if you look at the same factor in many different markets and contexts, and you stick to that, you're not right all the time, but you're right 51% of the time. If you go with whatever's popular, you're basically never right. And there are regime shifts in our data. We have the transition from gold standard to Fiat money in 1970. We have the breaking of inflation in 1982, going farther back. We've got World War II, the Depression. World War I.

So we've seen regime changes before. They're in the data. And there's no reason to have a special way to deal with them. Now, really, we've been talking about quantitative factor investing in U.S. large cap equities. And that's one part of quant. There is a whole quant macro strategy that is trying to take advantage of these macro things. You can be macro and still be quant.

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Subscribe today wherever you get your podcasts. You know, speaking of regime shift, Aaron, and Indigo sort of hinted at it. I mean, you know, one of the things that strikes me that I think about sometimes is, you know, a lot of what was once sophisticated strategy is now like I can go into any online broker and quickly with a few keystrokes by some sort of so-called value ETF very cheaply. That used to be something that, you know, powerful people with powerful computers and hold teams. of traders had to do. Now is super simple. Is that a regime shift? And is that a contributor to the alpha decay of some of these strategies, the ease with which sort of anyone can replicate them? You don't need a whole team of geniuses, say, an AQR to do them per se? Yeah, well, I don't know about the geniuses, but we have a lot of degrees at AQR. No, I don't think so.

For one thing, when more people pile in, it tends to strengthen the strategy, right? If everybody's buying value stocks and value stocks will do well. If everybody's doing momentum, then momentum will do well. The problem comes when people change their minds. But also, this is just a natural way of financial markets. You know, you start building a hedge fund strategy, you know, with new assets, with new ways of doing things. But then as you get better at it, as more people learn about it, as liquidity improves, it becomes a beta product that every retail investor can buy an ETF F-forms. We should all be very happy about this. It is true. One of the downsides of doing cutting-edge financial research is, you know, you don't get rich forever. You have to come up with a new

idea every, well, frequent, basically constantly. You have to keep improving your ideas and coming up with something new because the basic product becomes generic very quickly. Because I'm going to agree with Aaron. I don't think that just because money's gone into, let's call them smart beta factors, that it undermines the efficacy of the factors. I mean, yes, okay, there are examples perhaps of apparent inefficiencies in the market that have too much capital invested them and then they stop working. But I think there are plenty of reasons why things like value factors in the markets do have some long run efficacy behind them. And also just a practical point, if you look at where money has been invested in smart beta ETFs,

at least 90% of that is indexed to the US market. but the apparent lack of performance in value is something that has been evident in European markets. And to some extent, an Asian market has done for less well too in recent years. I think what's more interesting is this question of what that does for the goal of investing. And it's basically shifted the alpha-the-beta boundary somewhat. So on one hand, you can think of that as being a pain for an active manager to just raise the bar what they have to do is not just enough to beat the market. have to be the market and value and quality and low fall and momentum. But equally, I'll argue

that's what the ultimately good thing, because it makes it very clear what the true goal of actual investing is. It's a generation of idiosyncratic alpha. And if you can do that, it goes to the heart of why people should pay a premium for an active fund. One of the topics that we've been talking quite a lot about is value investing, of course, and whether or not if you did value investing in some different way, for instance, by including intangibles in book value, whether or not that particular factor would look a lot different and maybe be even brought back from the dead in one way or another. I'd be curious to get your views on value investing specifically. Is there a way to resuscitate that strategy and

what does a new regime shift if there is one actually look like? Well, this is Aaron. Adding intangible assets I think would not be a good idea. That's kind of sticking opinion into what should be a quantitative measure. There is active research in the value factor, and we shouldn't talk about it like it's dead everywhere. The large-cap U.S. equities, yes, European equities, yes. Other equities, not so much. Commodities no, interest rates no, real assets, no. So value is still working many places, but there is very active research. As I mentioned earlier, most of the focus on the research is not on the assets. but on the dollar, you know, is the dollar still a valid measure of value, a value,

a valid thing to measure value in? Yeah, on my side, I think that there are headwinds, the value factor. You know, I mentioned some early on, you know, this idea that some sectors have lost defensive motor around them. And so their value, not just because of a passing higher risk premium attached to them at some point the business cycle because of a structural problem. There's also the apparently monotonic move down in rates that's kind of messed up the process of mean reversion as well.

But as I said earlier, I think that one thing that's clearly been missing is a macro force in the form of inflation. And probably now plausibly for the first time in 10 years, I think there's a good reason to think why inflation kind of could materialize. And so the idea of finding, you know, cyclical undervalued companies, which fundamental or quant research implies they're not going bankrupt through the kind of COVID period, they should respond very well indeed to an uptick inflation, you know, that occurs on a one-year-forward horizon and a whole bunch of the policy tools and goals of policy that have changed to make that

a realistic possibility, I think, in a way that it wasn't before. So I think that there could be a partial macro resuscitation of the value factor. As I said, though, that implies a split, though, of value perhaps working in in core cyclicals, in commodity stocks, we're probably not in financials. And then so some of the structural headwinds are there in the background, but I think some them can be resolved as well. So we start this conversation or debate about quant investing, and then not surprisingly, it ends up turning into a debate or question about value investing and when it's if it's dead,

which often these discussions do. Why not just look for other stuff? Why this sort of like, all this research into value investing is value investing dead, et cetera? Why not just move on and find some new factors, find some new dimensions of quant and sort of leave this debate behind? Well, of course, people are doing that and there are, you know, arbitrages. Good. Momentum investing is doing very well. But value is fundamental to Quant. The day quant gives up looking for real economic value in things is the day that it just becomes another form of technical analysis. It is very difficult for me to imagine a robust quant investment management business that doesn't have at its core value. There's all this other stuff and it's great and it has great

returns and it has great properties, but if you remove value from it, you have no anchor. We agree with that, in that at least the vast majority of quant approaches, we have investment horizons that are, we have measured in, you know, quarters or longer, it's hard to imagine not having some kind of value anchor in that. Of course, there's been a huge investment of time and dollars in trying to discover new factors. I mean, I'm skeptical of the extent that that is a worthwhile activity, but I think that certainly at least applying, say, machine learning techniques to extracting data that we didn't have at our disposal 10 years ago, at least seems like a worthwhile thing to go and try. But equally, there's a danger there that one ends in a sort of IT arms race

trying to discover new factors before their arbitrage out in the market. So that can certainly work for certain business models, I'm not so sure that as yet, at least as evidence, that can work for long horizon and for a mass market approach. But one thing I would say is that if we, you know, think about what else Quant can do, you know, and yes, you can be more than the value factor, but it can be more than just thinking up new factors as well. You know, I think the one of the, you know, kind of key questions that interest me is where can progress really be made in finance and investing? I mean, I think it's hard to argue that progress is really made in how we make directional investment decisions in the sense that a given view on a security now is unlikely

to be more valuable than similar view arrived at several decades ago because markets are more efficient. Likewise, it's hard to innovate, I would argue, in a more kind of theoretical sense in finance. But where progress can be made, I think, is on investment process. And there there can actually be a series of incremental improvements over time that are not things that simply arbitraged out by the market. So things I had in mind might be the process of portfolio construction, how that's applied to different kinds of ways that Arthur's generated, or also the way the goals are set, frankly, I think it's a huge issue for the pension fund and a diamond industry at the moment, just to think about how they set long-run goals and how they then use those to issue mandates,

to fund managers. And those are things that actually can be improved on incrementally over time. And there's no reason why Kronk can't be brought to bear to help with issues like that. So, Aaron, you mentioned this idea that the dollar might not be as valid as it once was as a way of actually measuring value and that that might be part of what's going on here. I'd be curious on that last note that Enigo made about actually improving the investment process. Is there anything that investors could do when it comes to the dollar or how they're incorporating that into their portfolios? If you're a U.S. dollar, U.S. citizen, you know, run your affairs in U.S. dollars, it's pretty hard to ignore that. But I would argue the biggest investment risk, if you're looking, you know, will I have enough money to retire in 10 years or something like that, you really have to think about what's the dollar going to be worth? You know, what's a tax regime going to be? What's the inflation regime? What's purchasing power? Will, you know, Libra or Bitcoin be the mode of transaction at that time? Will the law allow you to spend your money the way you want to spend it? Will the Fed have bought so many assets that everything you want to buy?

You have to go to the Fed to buy a loaf of bread. You know, we just, we have huge uncertainties about that. Much more so, I would argue that, you know, what's the SMP 500 going to be in, you know, real economic terms, which companies will be profitable and so on. I don't think that's really been true, that level of uncertainty about the U.S. dollar. You have to really go back to maybe 1970 and the 1970s to think about when the risk of the currency was greater than the risk of the equity market. I want to go back to, inigo, something you said, or both of you may have made this point. But this idea that historically speaking, empirically, it suggests that periods of a greater inflation, which is possible that we have in the post-COVID period, but I think that's highly.

TBD have historically been better for value investing or the value factor. Is there an intuitive reason for that? We can talk about macro regime shift leading to quant regime shift, but what's the sort of logic behind it? Or why should we expect that to be the case? I mean, on my side, I see this one part of that reason as being, you know, essentially a signal of a way we're on the business cycle and the ability of certain kind of corporates to raise prices and equities being in the main real assets, but then the benefit that certain corporates can get from that. So normally those upswings, I mean, inflation, so signal something of the macro regime change or put the other way, you know, if there's, well, yeah, disinflation, as we've seen,

you know, over the last 10 years, and every episode of higher risk. of this inflation tends to be signaling a cyclical risk and a increase in risk aversion, which tends not to go to value companies. Not so much high inflation as inflation uncertainty. If you have a consistent 6% inflation every year and everybody knew it, I don't think it would matter very much. But the fact is, you know, if you just don't know what inflation is going to be, if it could be 0%, it could be 12%, that.

makes value hard to measure in dollars. On April 4th, 2023, around two in the morning, a man was found stabbed multiple times on a sidewalk in downtown San Francisco. What happened next turned the story into a political firestorm. Reports have identified the victim as Bob Lee, the founder of Cash App. From Bloomberg Podcasts, this is Foundering, the Killing of Bob Lee, beginning April 6th. Aaron, you said something I want to go back talking about value X equities, which is something that I haven't heard that much discussion of because in my mind I have this sort of like intuitive sense of what it means to find value within equities, whether it's some measure of assets or earnings power. But talk to us a little bit more about value approaches or quant approaches outside of the traditional equities realm and what really that means and what what's percent.

sued there? Sure. Well, one classic quant strategy, of course, is to borrow money in low interest rate currencies and invested in high interest rate currencies to earn the carry spread there. But you need a value overlay in that to protect yourself against hyperinflating currencies, currencies where the high interest rate is really illusory or countries where the low interest rate is is an illusion due to currency problems. In commodities, people do analysis of supply, demand, actual use value of commodities and use that as a quantitative way to decide which commodities are over and undervalued. Real assets, real estate, forestry, mines, things like that. people do the same strategy of buying cheap stuff and shorting very similar, highly correlated,

expensive stuff. It doesn't work all the time. Again, with all these quant strategies, important to emphasize, you know, they work 51% of the time if you're lucky, if you get it right. And you have to be very, you have to be rigorous about containing costs because you don't have a huge amount of alpha. You don't have the kind of alpha where you can just run out and buy the stuff you like and short the stuff heedlessly, you have to watch. Prices very carefully, keep your costs down,

and you can eke out, you know, 100 basis points, 200 basis points a year with very low volatility, and therefore you can combine a bunch of these strategies and level it up and make a nice, safe return most of the time. I think that cross-asset angle is actually super important. I mean, I end of my essay, you know, really thinking about, okay, so there's been this recent problem with traditional quant strategies, you know, if one's running the quant approach, you know, where can one look to see as some kind of potentially in growing market? And I think that probably the biggest problem in investment right now is the problem of saving for retirement and the idea of how on earth pension plans are going to be able to preserve purchasing income in the long run if we end up

in a world where the cross-asset return of traditional asset classes is low and inflation goes up. a horrible combination, which really, I think, upsets the whole retirement model that's been in place for the last for 30 years and even potentially challenges with the idea that you can hand on retirement risk to individuals. And so I think factors have to play an enormous role in that. And so I think there's an interesting angle for kind of quants to think about perhaps a slightly different kind of client base. I see some quants already there. But in a world where where asset class beaters are going to be lower, and also, frankly, not often enough diversification amongst themselves,

then I think there is potentially quite a big bid for thinking about a factor-type strategies within strategic asset allocation in a much bigger way. Stan has been attempted historically. Awesome, the trouble with that is we don't see a huge correlation among, you know, if value is not working very well in U.S. stocks, that doesn't tell you very much. much about whether value is going to be useful in commodities. We played a lot with trying to do

factor-based asset allocation. And really, it's hard to come up with anything better than risk parity. You know, the correlations are too uncertain. The factor correlations are no better than the, you know, gross, you know, raw correlations. So I don't, I don't disagree that this would be very useful if somebody could do it. But until somebody can beat risk parity consistently, I don't see there's much value here. Yeah, well, I mean, so you mentioned risk parity and it's not quite the same thing, but it seems like in many cases it's a more advanced version of, you know, the 6040 portfolio in many cases.

And there's so much talk about that being dead because the bonds component of a traditional diversified portfolio, in theory, treasuries don't have that much more to rally of interest rates in the U.S. don't go below zero. like is are these are you worried Aaron about like these sort of like basic bread and butter portfolio allocation strategies because it seems like indigo is and I'm curious both of your takes but are you concerned that the sort of like what's sort of simple and has worked for a long time could be coming to its end just for sort of mathematical reasons like that well let me you know 6040 never worked never had any theory behind it was never a good idea risk parity is is is is is is is is considerably more. Okay, yeah, people have been saying bonds are dead for really as long as I've been in finance, but so, you know, they've outperformed other asset classes. I do believe there is a significant possibility in the future of sustained periods of significant negative rates, meaning treasuries could do very well. But I also agree that it's, you know, you have to consider

the fact, you know, is zero really important? Is there a reason, you know, know, in the basically most risk parity allocations would have something like a quarter of the risk allocated to major market, major currency interest rates, you know, is there a reason to look for other investments within that bucket that might give a better return? I'm certainly not ready to say you should do that yet, but I know a lot of people are looking into that, and it is a little scary buying bonds at 0%. So having to have this conversation, I feel like there's actually a bit of a consensus forming, which is that quant investing might change in one way or another, but in another

way, the demand to systematically invest in assets, whether it's a single type of asset or cross assets like we were discussing earlier, is probably always going to be there. and it's just going to change in shape and form. And the thing this really reminds me of is, you know, a few decades ago, no one would have thought that low volatility would be a desirable thing. And yet nowadays we have all these low volatility ETFs and products and factors and things like that. Is that where we're heading? Could you maybe give a summary of what quant investing is going to look like in, say,

five or ten years? Is it still here, but it's just changed in its nature? Why don't we start with indigo? Okay, yeah, I think that we're heading towards a world where there's no one kind of canonical view of what quantum investing actually is is the first thing I'd say. I can imagine, you know, a number of routes being explored. So one would be an area where, in fact, but there ceases to be a distinction between a quantum fundamental investing.

So, for example, if in a future an analyst forming a, a view on a single stock happens to form that view via a model that's written in Python rather than in Excel. Is that a quantum model or a fundamental model? Well, I don't really know. I don't really care, frankly. But, you know, it ends up with a kind of blending of quantum fundamental approaches. So that's one possible route.

You know, I think there, you know, will be a further attempt to make kind of traditional quantum approaches going to work and, you know, turn in value. And it would help with that. I think there's the possibility of exploring quantum approaches. approaches which are less diversified and have longer holding periods, which is an uncomfortable area for Quants to be in for all kinds of good reasons. But equally, you know, I think that's something that kind of could be explored. There's the potential of, you know, applying new techniques to new data sets. I said, I think that is something that will continue to be of

huge interest. But I think probably as a commercial proposition, something that's only relevant probably for a small group of asset managers. And then also, as I mentioned, just using, you know, factors embedded as a way to try and solve a long-run pensions problem through strategic decisions and allocations to them. I would say that, you know, if we define quant broadly as any kind of systematic investing, then that's clearly only going to grow.

It will become more machine learning and artificial intelligence dominated. but I use quant a little more narrowly. I mean sort of the current academic and professional consensus around kind of mainstream quant ideas. If these ideas were somehow overthrown, if they stopped working, people would not go back to looking for the next Warren Buffett or David Einhorn

for looking for individual lone geniuses that can't really be scaled. They would look for new systematic quant methods. I think that the base, academic quant consensus is pretty safe for the next 10 or 20 years, there is always research. It's always evolving. It may look the same if you're from the outside, but having been in this industry for decades, it changes enormously. The research is going on. But some fundamentals, like value, like momentum, like quality, like low volatility, I think those are going to be there. They may be interpreted by a machine and no individual human can understand them.

They may be marketed and pitched in different ways. There will certainly be improvements in how they're measured and how they're exploited. And as Inigo has emphasized, how they're constructed into portfolios. One thing we haven't really mentioned is even the most sophisticated quant shops tend to have very crude ways of forming portfolios. You know, you do a value, you go along the 30% of stocks that are most. undervalued and go short the 30% that are most overvalued. I mean, it's a little more sophisticated than that, but it's not, there's nowhere near the amount of sophistication there is in measuring these factors, you know, risk parity, you just weight everything in inverse proportion to its

volatility. You know, that's, those are pretty crude techniques. So I suspect there will be a lot of improvement in those. But I, I have faith in the basic quant out. Look, I think the same people who successful quant investors today. If they don't retire, we'll be successful quant investors in 10 or 20 years. Well, that was really awesome. We really appreciated both of your perspectives. Inigo Fraser Jenkins at Bernstein and Aaron Brown, a longtime veteran of the industry, author and professor. Thank you very much, both of you for joining us. Thank you. Thank you, Joe and Tracy and Inigo. Thank you. It's so funny, Tracy had like so many of our conversations.

all end up being about the same thing these days. Even when we start with like, oh, this is a different topic than this, it sort of all comes back to the same thing. But actually. Yeah. Yeah. I was also thinking, that was such a polite debate. You know, I was hoping it would sort of descend into a drama and a shouting match. And at some point, like, Inigo would say something like, you killed my factor, prepare to die or something like that. But we didn't really get that. It felt like there was a sort of underlying consensus, which is that quant investing, as we know it, might die in one sense or another, but it's not really going to leave in the wider sense, and that instead it's probably going to morph and evolve along with the broader macro environment.

Yeah. And I guess, you know, like, as I was saying, like, so much ends up coming down to this question, and I guess it's empirically the case with the success of a lot of quant factors of whether we get a change in the macro situation. And the macro situation doesn't seem to be so much about growth or recessions or whatever, but whether we get a change of the macro regime, which is central banks being so inclined to fight any sort of volatility, you know, sort of limited fiscal response. Like so many of our discussions come down to that, including this question of whether the quant factors work. Yeah, I do think Inigo's point on that that want investors, rules-based investing strategies

might not be that good at capturing sometimes erratic policy or, you know, unexpected policies by regulators, central banks, and the government. Like, I think that is actually a fair point. And we know that sell-side analysts tend to be pretty bad political analysts. So it's going to be really interesting to see how the quant world grapples with that, because we do see this consensus emerging about governments taking on a broader role in the economy post-COVID. I guess the question is like, how long can you wait? Like, you can say, like, okay, a lot of these strategies haven't done well since the great financial crisis. So we're talking like 12 or 13 years or 10 or 11 years now.

You know, it's like that's a pretty big chunk of someone's career. Okay, maybe you're like waiting for like... Yeah, when mean reversion. Yeah, when I'm, when I'm, you know, 85, finally the mean reversion is going to happen and I'm going to make up for decades of underperformance. Like, kind of a lot of faith. Yeah. Like I think that, I think we'll one day be in like a new system, but man, like, you know,

that's kind of like, I kind of want to like find something that works in the meantime. Yeah. Actually, I kind of feel bad. We should have asked about momentum strategies in that podcast, which, We didn't, but we'll have to come back to it, I guess. Plenty more to talk about. Yeah, I have a feeling on whatever our next episode is, it's going to come back to the death of value investing or something similar.

For sure. All right. Shall we leave it there? Let's leave it there. Okay. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Allaway.

And I'm Joe Wisenthal. You can follow me on Twitter at The Stoll. follow our producer Laura Carlson. She's at Laura M. Carlson. Follow the Bloomberg head of podcast. Francesca Levy. She's at Francesca Today. And check out all of our podcasts at Bloomberg under the handle at podcast.

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