If you are a regular reader of The Economist including last week’s issue that had a feature on how Wall Street has been taken over by computers, you might hear of a quantitative hedge fund manager called Clifford Asness.
Clifford Asness is the Founder, Managing Principal and Chief Investment Officer of AQR Capital Management. He has degrees in engineering and economics, an MBA, and a PhD in Finance. Google estimates his net worth to be $2.8B which is not particularly high compared to other investing greats such as Ray Dalio ($18.4B) or Warren Buffett($81.8B).
Clifford Asness was once a student of Eugene Fama and built AQR Capital as a hedge fund that focuses on Factor Investing where a portfolio of stocks is assembled based on properties of stocks that may signify value, quality or even momentum.
AQR Capital, while not the most successful amongst quantitative hedge fund, is distinguished by their transparency and willingness to share with the investing public their best strategies.
A significant number of their investment ideas can be found in academic journals.
Although the Early Retirement Masterclass does not adopt the exact methods used by a professional hedge fund, Clifford Asness’ influence on me is pervasive.
Here is what I have learned from what he has shared in the public domain:
#1 – Stocks that give out a dividend can grow faster than stocks that don’t.
The first time I heard of Clifford Asness was as a CFA candidate, I was fortunate enough to read his paper, which was co-authored with Robert Arnott entitled ” Surprise! Higher Dividends = Higher Earnings Growth”.
This paper presented empirical evidence which contradicted orthodox finance.
It was revealed that companies that have a higher pay-out ratio actually grew faster than companies did not.
The impact of that paper on me was profound and it started me on the journey towards tilting my stocks towards higher dividend yields in my investment portfolio.
#2 – Momentum is not a fluke, it can be a factor in investing.
Clifford Asness was also one of the pioneers who busted myths about momentum investing, his paper, entitled ”Fact, Fiction and Momentum Investing”, published in the Journal of Portfolio Management sometime in 2014, reminded fundamental investors not to turn their noses up when they encounter a technical indicator such as the Relative Strength Indicator. In this paper, Clifford was able to argue very convincingly that a good momentum strategy can result in decent performance net of trading fees and even taxes.
Every run of the Early Retirement Masterclass considers momentum factors. While we do get occasional outperformance in our back-tests, as of now we are still seeing value factor dominate when investing in Singapore stocks.
I strongly believe that one day the tests would reveal a momentum strategy that will assume its rightful place as a winning move for local investors.
#3 – All good factor investing strategies can run out of steam one day
AQR capital is going through a really rough patch this year. The AQR Multi-Strategy Alternative fund fell 13.7% in 2018 and the company just completed a round of layoffs in 2019. This is a reminder that no matter how brilliant your investment models are, you are going to have your bad days.
The problem with quantitative investing is that it is much harder to explain why a quantitative strategy did not meet expectations. The first batch of ERM students was my first attempt to build a working portfolio for a class of retail investors.
A year ago, I back-tested a strategy that has a PE below 12 and dividend yield above 4% and noticed that a local portfolio built this way would have returned over 21% annually over the past decade. In practice, we went further than what the model did – we cherry-picked on those counters with a consensus buy rating on the SGX screener.
A year later, when I dismantled the portfolio, it returned 1.96% when the STI fell 5.5% (still -1.7% after dividends). Even though the portfolio still outperformed the rest of the market, no absolute gains were made after factoring for trading costs. As I always eat my own cooking with x2 leverage, I did come off slightly poorer by about $350.
The frankness of Clifford Asness on his underperformance resonated with me.
The losses of each individual stock can be easily explained if you are a value investing fund manager but how can you explain that the final outcome was more than 2 standard deviations lower as projected by your model?
My only consolation is that the overall performance of all my students remains decent at an unleveraged XIRR above 13%. (leveraged with an equity multiplier of 2, that means 23-26% returns depending on your broker costs)
If you’re interested in finding out how to build a defensive-oriented, high yield portfolio meant to enable early retirement, you can do so here.