AQR

AgPa #81: Equity Risk Premiums and Interest Rates (1/2)

Honey, the Fed Shrunk the Equity Premium: Asset Allocation in a Higher-Rate World (2024)
Thomas Maloney
The Journal of Portfolio Management 50(6), URL/AQR

Risk-free interest rates, the most fundamental anchor of asset prices, increased dramatically in 2022 and are still considerably higher than over the last 10+ years. At the same time, equity markets around the world posted strong performance in 2023 and 2024 (so far). Many investors thus wonder how this fits together. Why should we pay the same multiple for stocks when the risk-free alternative is much better than a few years ago? Or more technically, why should we accept such a low equity risk premium? This week’s AGNOSTIC Paper is the first of two that sheds some light on this (very important, but also very difficult) issue.

  • Equity returns and risk-premiums were lower in higher-rates environments
  • EPS growth, valuations, and interest rate changes explain the effect
  • Treasuries and absolute-return strategies historically benefitted from higher rates

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AgPa #58: International Diversification – Doing the Right Thing is Hard Sometimes

International Diversification—Still Not Crazy after All These Years (2023)
Cliff Asness, Antti Ilmanen, Dan Villalon
The Journal of Portfolio Management 49(6), 9-18, URL/AQR

In the last post (AgPa #57), we have already seen that international diversification is a powerful protection against the higher-than-expected risk of losing real wealth with stocks over the long term. By coincide, three of the OGs from AQR Capital Management also just released an article about the Fors and Againsts of international diversification. Unsurprisingly, I picked that one for this week’s AGNOSTIC Paper…

  • For: Not everyone can invest in the best-performing market
  • Against: Everything crashes together
  • For: Historic returns don’t show changes in valuation
  • For: Valuation levels should eventually matter
  • For: International diversification provides opportunities for active investors

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AgPa #53: Investing in Interesting Times

Investing in Interesting Times (2023)
Annti Ilmanen
The Journal of Portfolio Management Multi-Asset Special Issue 2023, URL/AQR

Almost exactly one year ago, Antti Ilmanen (Partner at AQR Capital Management) released his outstanding book Investing Amid Low Expected Returns: Making the Most When Markets Offer the Least. The book is (in my opinion) a must-read and the timing couldn’t have been better. Many of the key themes began to materialize in 2022. Given how much markets have changed since then, Antti released a few updates for six of his major ideas in this week’s AGNOSTIC Paper.

  • The low expected return challenge
  • Investors’ response to low expected returns – private markets
  • What happened in 2022 and where we stand now
  • Long-only versus long-short strategies
  • Downside protection via trend-following

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AgPa #43: Buffett’s Alpha

Buffett’s Alpha (2018)
Andrea Frazzini, David Kabiller, Lasse Heje Pedersen
Financial Analysts Journal 74(4), URL

In this week’s AGNOSTIC Paper, the authors use the major factor premiums to examine one of the best long-term investment track records in the world – Warren Buffett and Berkshire Hathaway. The latest annual report just came out a few days ago and (as usual) summarizes Berkshire’s performance on the first page. From 1965 to 2022, Berkshire returned 19.8% per year versus 9.9% for the S&P 500. That’s a 24,708% cumulative return for the S&P 500, and an unbelievable 3,787,464% return for Berkshire. There are some investors who achieved even better results over shorter time periods. But to the best of my knowledge, there is no 58-year track record that is even remotely comparable to Buffett.

  • How good is Berkshire? Damn good…
  • The Buffett Style: cheap stocks with high-quality and low-risk
  • Don’t practice what you preach – Buffett’s Leverage…
  • Systematizing Buffett and Berkshire

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AgPa #40: Size Effect – Fact and Fiction

Fact, Fiction, and the Size Effect (2018)
Ron Alquist, Ronen Israel, Tobias Moskowitz
The Journal of Portfolio Management Fall 2018, 45 (1) 34-61, URL/AQR

After examining several Facts and Fictions around factor investing in general, momentum, value, and low-risk, this week’s AGNOSTIC Paper tackles the final anomaly. The size effect received a lot of attention in both academia and the investment industry, probably because it is one of the oldest documented anomalies. In this final paper of their Fact and Fictions series, the authors examine some myths around it.

  • Fiction: Size is the strongest documented factor
  • Fact: The size effect weakened since its discovery
  • Fiction: The size effect is robust across different measures
  • Fact: The size effect is strongly related to the January effect
  • Fiction: Size also works in international equity markets
  • Fact: Size does not work within other asset classes
  • Fact: Most of the size effect are micro cap stocks
  • Fact: Size is difficult to implement in real-world portfolios
  • Fiction: The size effect is more than just a liquidity effect
  • Fiction: There are economic theories for the size effect
  • Fiction: Size works because other factors are stronger among small cap stocks
  • Fact: There are reasons to overweight small caps even without the size effect
  • Fact and Fiction: The size effect is stronger when controlling for other factors
  • Fact: Size receives a lot of attention despite weak evidence

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AgPa #39: Low-Risk Investing – Fact and Fiction

Fact and Fiction about Low-Risk Investing (2020)
Ron Alquist, Andrea Frazzini, Antti Ilmanen, Lasse Heje Pedersen
The Journal of Portfolio Management Multi-Asset Special Issue 2020, 46 (6) 72-92, URL/AQR

After examining value and momentum, this week’s AGNOSTIC Paper examines some Fact and Fictions around defensive / low-risk investing. The defensive / low-risk factor captures various well-known effects like the low-volatility and Betting Against Beta effect, but also fundamental strategies like quality (a.k.a. the Quality Minus Junk factor).

  • Fact: Low-risk securities generate risk-adjusted outperformance
  • Fiction: The low-risk premium is weaker than other factors
  • Fact: Low-risk strategies worked out-of-sample
  • Fiction: Low-risk profits come from industry bets
  • Fact: Low-risk investing worked across geographies and asset classes
  • Fiction: Low-risk investing doesn’t work because the CAPM is dead
  • Fact: There is economic theory behind the low-risk premium
  • Fiction: Low-risk investing does not survive trading costs
  • Fact: Low-risk investing can lose money in bear markets
  • Fiction: Low-risk factors became too expensive

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AgPa #38: Value Investing – Fact and Fiction

Fact, Fiction, and Value Investing (2015)
Clifford Asness, Andrea Frazzini, Ronen Israel, Tobias Moskowitz
The Journal of Portfolio Management Fall 2015, 42(1) 34-52, URL/AQR

After busting some myths around momentum, this week’s AGNOSTIC Paper is the sequel for value investing. The authors, the same AQR crew as last week, present several Facts and Fictions around value investing which is actually one of the oldest investment styles out there.

  • Fiction: Value investing requires concentrated portfolios
  • Fiction: Value has low turnover and is thus passive
  • Fact: Fundamental indexing is similar to systematic value investing
  • Fact: Profitability signals improve value investing
  • Fiction: Value is redundant in modern factor models
  • Fact: Value also works in other asset classes
  • Fact: Value is best measured by a composite of signals
  • Fact: Value is quite weak among large caps
  • Fiction: The value premium should disappear because there are no plausible explanations

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AgPa #37: Momentum Investing – Fact and Fiction

Fact, Fiction, and Momentum Investing (2014)
Clifford Asness, Andrea Frazzini, Ronen Israel, Tobias Moskowitz
The Journal of Portfolio Management Special 40th Anniversary Issue 2014, 40(5) 75-92, URL/AQR

After examining the general Facts and Fictions about factor investing, this week’s AGNOSTIC Paper examines momentum in more detail. Specifically, the authors combat 10 misleading myths about momentum…

  • Myth 1: Momentum returns are economically not meaningful
  • Myth 2: Long-only investors cannot capture momentum
  • Myth 3: Momentum is much stronger among small-caps
  • Myth 4: Momentum does not survive trading costs
  • Myth 5: Momentum produces a huge tax bill
  • Myth 6: Momentum is better as a screen than as a factor
  • Myth 7: Momentum returns should disappear in the future
  • Myth 8: Momentum is too volatile to rely on
  • Myth 9: Different momentum measures lead to different results
  • Myth 10: There is no theory behind momentum

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AgPa #36: Factor Investing – Fact and Fiction

Fact, Fiction, and Factor Investing (2023)
Michele Aghassi, Cliff Asness, Charles Fattouche, Tobias J. Moskowitz
The Journal of Portfolio Management Quantitative Special Issue 2023, URL

Whenever AQR writes about systematic investing, it’s (in my opinion) time to listen. This one is a very good overview about factor investing. Given that this is the intellectual basis of many things I do here on the website, it perfectly fits to the series.

  • Fiction: Factor investing is just data-mining
  • Fact: Factors are risky
  • Fiction: Factor diversification doesn’t work
  • Fact: Factors work in different market regimes
  • Fiction: Factors don’t work anymore
  • Fact: Factors were and are not crowded
  • Fiction: Everyone should (and can) invest in factors
  • Fact: Factor discipline beats factor timing
  • Fact: Sticking with factors is often difficult

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#3: Big Data & Machine Learning in Asset Management

This week I gave a talk on “Big Data and Machine Learning in Asset Management” at Goethe-University in Frankfurt. Thanks again to my thesis-supervisor Sasan Mansouri for the invitation. In this post I will summarize a few points of the talk and share the slides. The key result is the following framework to evaluate investment strategies that claim to use big data and machine learning. I also apply this to several real world funds.

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