The second day of the Morningstar conference held in June in Chicago kicked off with a conversation between AQR's Cliff Asness and Research Affiliates' Rob Arnott moderated by Morningstar's Ben Johnson.
The two investors were picking up in person a recent debate they've been having about the right way to invest in strategic beta or factor strategies. John Rekenthaler covered the basics of their disagreement in a recent article, but in short Arnott thinks investors need to keep valuation top-of-mind when investing in any strategy, while Asness thinks diversification is more important.
The first point of discussion was just how efficient markets really are. Asness described himself as being "courageously in the center" of the efficient/inefficient spectrum saying markets are highly efficient over the long term but that they are nowhere near perfect. Arnott is much more skeptical of efficient markets saying it is hard to believe prices reflect all available information in every market and every minute of every day.
But if there is inefficiency in the market, how can investors take advantage of this? Both speakers thought there were really only a handful of factors (like value and momentum) that will persist over the long term and they were split on other factors like low-volatility/low-beta and profitability. Asness said to beware of data mining to find new factors--although he does think that many of these new factors are really just different ways to implement existing ideas.
This brought up the key disagreement between the panelists. Arnott argued that just like you would check the valuation of a stock or asset class before investing in it, you also need to check the valuation of any factor you may invest in. If it is too pricey, make a note to yourself to come back and check valuations later to see if they have become more reasonable. Asness doesn't believe you can time the market in this way. He points to the benefit of a broadly diversified portfolio of factors as being a more important goal than just worrying about valuation. He is opening to "sinning a little" and doing some market timing when valuations are well outside of normal ranges, but that is a relatively rare occurrence.
The good news for investors is that the ability to exploit the behavioral mistakes that makes these factors profitability doesn't show any signs of going away. On one hand, these mistakes get made because they are human nature. Successful investing and buying unpopular asset classes can be painful and isn't something most investors can reliably do. That also means there won't be so much money chasing these factors to eliminate them. Asness made the point that there is lots of money flowing into strategic beta funds, but that much of the that money is likely coming from actively managed strategies that targeted similar factors, so on a net basis there aren’t that many new dollars chasing the factors. Until humanity becomes more rational, both see opportunities in factor investing.
