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Cliff Asness, CIO of AQR Capital Management, is on a winning streak after several years of losses. What’s working now.

Cliff Asness, chief investment officer of AQR Capital Management, one of the world’s largest quantitative fund managers, is feeling vindicated these days. The firm, with $103 billion in assets, uses analytical strategies to bet on different market factors, and lately these strategies have yielded solid returns.

Cliff Asness, chief investment officer of AQR Capital Management, one of the world’s largest quantitative fund managers, is feeling vindicated these days. The firm, with $103 billion in assets, uses analytical strategies to bet on different market factors, and lately these strategies have yielded solid returns.

AQR’s winning streak, however, comes on the heels of some of the biggest losses in its 25-year history, and a more-than 50% drop in assets under management, which peaked in 2018 at $226 billion. Like many quantitative funds, AQR was pummeled from 2018 to 2020 as the spreads, or return differentials between value and growth factors, reached the widest point ever.

“When you tell people [that the weakness in value factors] is ridiculous and that it will change, and then it does, you’re not entirely human if you don’t feel a little bit of vindication,” Asness says.

The AQR Apex Strategy, the firm’s marquee multistrategy hedge fund, gained 16% in 2023 and was up 6.2% year to date through February. The $720.3 million AQR Diversifying Strategies ), an actively managed multistrategy mutual fund combining six of the firm’s alternative asset strategies, has a three-year annualized return of 12.3% since its 2020 launch, according to Morningstar, placing it in the top 9% of its multistrategy category, versus a 4.2% three-year return among peers.

Notably, in 2022’s stock market selloff, the fund returned 14.5%.

Asness was a student of and teaching assistant for Eugene Fama, the Nobel Prize–winning University of Chicago economist and a father of factor investing, an investment approach that targets specific drivers of return. Barron’s recently spoke with Asness about value investing and the importance of diversification. An edited version of the conversation follows.

Cliff Asness: If value works, on average, stocks with low multiples are too low. It isn’t that low-multiple stocks are better companies, they’re not. They’re typically worse than growth companies. Their inferiority to growth stocks is more than reflected in the price, leading them to be priced too low. On the expensive-growth-stock side, these usually are better companies in terms of execution, markets, and growth, but on average the market seems to pay too much for them. Low multiples and high multiples tend not to be justified.

We also remove the industry bias because comparing, say, tech to textiles is a hard one on multiples. To remove the industry tilt, we compare stocks only to their industry peers, using multiple valuation measures. Based on that, we go long and short within an industry in roughly equal amounts, and then repeat this across every sector. The whole quantitative investing process is very different from the [Benjamin] Graham and [David] Dodd value process. It is betting on the average tendencies of things, not specific companies, but the spirit of what most modern factor quants are looking for is similar to what traditional value investors seek.

We launched our firm in mid-1998, in the last 18 months before the top of the dot-com bubble. If you asked me post–tech bubble whether there was a chance that valuations would get out of whack at a scale bigger than the dot-com bubble, which was bigger than we had ever seen in the data before the dot-com bubble, I would have said, highly unlikely. At the end of 2020, by the way we measure value, the price distortion was more extreme than in the dot-com bubble. The biggest lesson I learned was, the world is even crazier than I thought.

We had gotten near the dot-com bubble level pre-Covid. It took a pandemic to shoot past it, wherein the only things you needed to own were stocks like Peloton Interactive and Tesla. I’m not even sure I would have done something dramatically different from an investment perspective. Maybe I would have braced our clients more [for our underperformance].

What has helped your performance lately?

Our value measures did well last year. We don’t bet on industries, so we weren’t massively short the Magnificent Seven. We were long some of those stocks. I don’t remember which, because that’s not how I view the world.

We run an active portfolio with 1,000 longs and 1,000 shorts that isn’t capitalization-weighted. Last year, weightings really mattered, [as did] not taking industry bets and not betting against all the big guys. Value outside the U.S. did well for us. The fact that value is strong almost everywhere ex-U. S. is often missed. Everything else worked, too. It was a good year for quality and low risk and all the other things quants like us enjoy.

We’re starting to see a turn, although it has been slower than I would have guessed. People look at a rolling few years’ performance, so it takes time. A separate matter, which I have whined about publicly, is that privates [companies investing in privately held assets] have been sucking up a lot of the world’s alternative investment.

At the end of 2020, the spread between value and growth was the widest we had ever seen. It has been steadily narrowing. Value is cheaper now than it normally is on a three- to five-year horizon. I still like value more than average.

Momentum among individual stocks has been strong this year. Quality has been going strong for the past three or four years. Broadly speaking, you can think of quality as falling into one or two buckets. Is the company making more money than in the past, or are profit margins better? Also, low-volatility stocks have tended to keep up with their riskier counterparts.

AQR is a proponent of diversification, but the average investor is heavily weighted in U.S. stocks, particularly large-caps. That has worked in investors’ favor. Why should they change?

Since the early 1990s, about 80% of the U.S. dominance has come from relative price/earnings multiple expansion versus non-U. S. stocks. People were paying less for the U.S. at the beginning, and now they are paying considerably more. Maybe that is justified; maybe things like U.S. tech dominance are real. But justified doesn’t mean repeatable. Justified at best means something isn’t going to reverse in a big way.

Looking to the future, the case that the U.S. will have permanently higher equity returns is pretty untenable. Even if U.S. companies are worth it, they are priced as such.

Why should you try to do better as an investor? There are a few reasons. Bear markets still happen, both short-term and long-term ones. Sources of return uncorrelated with stocks and bonds will always make a portfolio better. They protect you when stocks and bonds have a tough year.

Markets on average are still expensive versus history, although not as expensive as they were. My partner, Antti Ilmanen, wrote a book, Investing Amid a Low Expected Return Environment, which looked at a rolling 10-year stock-bond performance starting from 1900 to 2020. The 60/40 [stock/bond] global portfolio has returned about 4.5% over inflation for about 100 years, which sounds low, but 40% is in bonds and the return is above inflation.

At the end of 2023, Antti’s forecast for the global 60/40 was a 2.9% real return over the next five-to-10 years. That is a low return versus history. If people assume that the 20 th century repeats [in investment returns], Antti would still say they are being optimistic.

Do you want to get more people mad at me? Let me step back to private equity for a second. Private-equity funds are concentrated, levered equities. The notion that they are less risky, except on a very short-term basis when they have to report the value of their holdings, strikes me as ridiculous. Private-equity managers say, we don’t know the value of it, but they had an estimate of the value when they bought it. If their market fell by half, it wouldn’t be hard for the best managers to tell you what their estimate is of the new value. You simply can’t look it up on Bloomberg.

Sometimes private-equity investors will say, being in a private-equity fund forces us to be better investors because the long lockups won’t let us sell and we can’t watch the value every day. I also admit my criticism reflects my professional jealousy because it’s frustrating to compete against people who don’t have to report the same way you do.

Private credit has all the same features and problems. It’s the same lockups and the inability to look at the holdings. There is no magic to the business: Private credit funds are buying high-yield bonds and holding on to them. There’s no magic to that. If a long-term bear market occurs, which we haven’t seen in quite a long time, you don’t want to find out that you have 50% more risk assets than you realize.

May I defend myself? If someone asks a reasonable question politely, I’ll go through 10 rounds of trying to explain some geeky thing to someone who is genuinely trying to learn. I do have a bit of a short fuse when I sense intellectual dishonesty or someone is being rude. I have a bad habit of being rude back.

Thanks, Cliff.