My guest in this episode needs no introduction: Antti Ilmanen, co-head of Portfolio Solutions at AQR, award winning researcher, and author of the books Expected Returns and the recently published Investing Amid Low Expected Returns.

A decade has passed since Antti wrote his first book, providing both a decade of out-of-sample data as well as a decade of new research.  I begin by asking Antti about where his conviction has hardened and the things he’s changed his mind about.  From there, however, the conversation topics become much more wide ranging.  We discuss structural changes in the market, the growth of passive investing, and his research on who is actually on the other side of style premia trades.  

We then discuss trend following versus put protection, trend following’s difficult decade, and why the outlook for trend may be rosier going forward.

Finally, we touch upon some more practical topics, addressing low-hanging opportunities Antti has seen in his role as co-head of Portfolio Solutions at AQR.

I hope you enjoy my conversation with Antti Ilmanen.


Corey Hoffstein  00:00

Okay, are you ready?

Antti Ilmanen  00:02

I’m ready.

Corey Hoffstein  00:03

All right. 321 Let’s go. Hello and welcome, everyone. I’m Corey Hoffstein. And this is flirting with models, the podcast that pulls back the curtain to discover the human factor behind the quantitative strategy.

Narrator  00:23

Corey Hoffstein Is the co founder and chief investment officer of new found research due to industry regulations, he will not discuss any of new found researches funds on this podcast all opinions expressed by podcast participants are solely their own opinion and do not reflect the opinion of newfound research. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of newfound research may maintain positions and securities discussed in this podcast for more information is it think

Corey Hoffstein  00:54

If you enjoy this podcast, we’d greatly appreciate it. If you could leave us a rating or review on your favorite podcast platform and check out our sponsor this season. It’s well it’s me. People ask me all the time, Cory, what do you actually do? Well, back in 2008, I co founded newfound research. We’re a quantitative investment and research firm dedicated to helping investors proactively navigate the risks of investing through more holistic diversification. Whether through the funds we manage the Exchange Traded products we power, or the total portfolio solutions we construct like the structural Alpha model portfolio series, we offer a variety of solutions to financial advisors and institutions. Check us out at www dot Tink And now on with the show. My guest in this episode needs no introduction. Auntie Elementen co head of portfolio solutions at AQR award winning researcher and author of the books expected returns and the recently published investing amid low expected returns. A decade has passed since Auntie wrote his first book, providing both a decade of out of sample data as well as a decade of new research. I begin by asking Auntie about where his conviction is hardened and the things he’s changed his mind about. From there. However, the conversation topics become much more wide ranging. We discuss structural changes in the market, the growth of passive investing, and his research on who is actually on the other side of style premia trades. We then discuss trend following versus protection trend following this difficult decade, and why the outlook for trend may be rosier going forward. Finally, we touch upon some more practical topics. Addressing low hanging opportunities. Auntie has seen his role as CO head of portfolio solutions at AQR. I hope you enjoy my conversation with Auntie Hillman on Thielmann, and this is a big moment for me. Because how many seasons? Have I asked you to come on this podcast now? I think it might be three or four years. It got to the point I think your communications department at AQR felt so bad that you offered me Cliff Asness as like a consolation prize. But this is it. I can stop podcasting after this episode. I am so excited to have you on flirting with models. Thank you for joining me.

Antti Ilmanen  03:21

Okay. Okay. So you were beautifully patient waiting until I was ready. So thank you for that piece. ICS, the multiple invites, but also I am thinking with this one that we are fellows of the same cloth. It’s not just our investment beliefs, and I hope we will be disagreeing or something here as well. But it’s a spirit of wanting to learn a lot about markets and share it with others, educate others. And I’ve seen that in you. And so looking forward to this.

Corey Hoffstein  03:49

That’s absolutely right. Yeah, I’m excited to dive in here. We’re going to be talking about your new book and broadly, things that you’ve learned and changed your views on hopefully over the last decade. And I suspect there might be some things that we disagree on, and probably a lot more that we do agree on. So let’s just dive in. And I do feel a little bad because this first question for you, after waiting so many years to get you on the podcast is not a friendly question. But I have to ask it anyway. Because a friend of mine once said that your first book that you wrote expected returns, which is like my Bible. I mean, he defined it as the absolute must read Bible for what used to work in quantitative investing. And it sort of struck me that I agreed, like anyone entering quantitative investing has to read that book. It is absolute table stakes. But I think that this person was also expressing a bit of frustration that a lot of the ideas maybe some of the style premier had really struggled over the last decade. And you’ve just published a new book titled investing amid low expected returns. And in many ways, it’s sort of a follow up, maybe a bit more practical to expected returns. After a tough decade and so, the first question is, if it had been a good decade for all these style premia, would you have published the book?

Antti Ilmanen  05:09

Okay, well before? That’s a tough question that I’ll need to set up in a couple of ways. I could start doing this biblical fashion, oh, ye of little faith and have little patience. I mean, the reaction is very understandable the strategies, we know they can have persistent disappointing periods, but it comes out of the gate where it became so popular in 2010. So then in late 2010, sort of disappointed, the reaction is understandable. But I would say that importance and difficulty of patience, you say, no pay no premium, I could add, no doubt, no premium. So those types of doubts are among the things that sustain these premia prevent the arbitraging away. Also, I would acknowledge that when our strategy becomes more widely known, it’s reasonable to expect somehow lower Sharpe ratios. I think this may be Ben went beyond that. But I think like I have some nice picture of it. So what could happen when alpha sort of morphs to better alternative beta, and that means that when you are in this business, even if you have got the solid core in your ideas, and you want to be faithful on them, because or cliche, you’re going to keep running to stay still need continuous r&d, somewhat better models, portfolio construction tools, execution skills, to maintain the edge, and you should do all of this while guarding against overfitting. So that’s easy. But I would also say that some styles did have good decayed like defensive style, had an excellent decade, I think momentum depends on which type was okay value and carry type of strategies disappointed, I realized, just recently, I have almost forgotten that the defensive bent against beta strategy is actually in my book. It was almost as a postscript, like I brought it in later chapter, I think chapter 19. With, I really wrote stuff the press, because I saw just before the book a few months before it, and I saw this unrehearsed analysis better guys better paper in SSRN. And it was so compelling that I’m glad I did, because I could argue that that was part of my story. Anyway, lots of the two hours before answering, I would have written it, I would have written it even after a stronger decade, maybe I would have had less time. So that’s another question. But it’s probably right, that this roller coaster experience influential tone in some places, emphasizing the importance of conviction and patience, and probably having even what you really didn’t dare to bring to the table?

Corey Hoffstein  07:37

Well, I will tell you that I sort of secretly blamed you for the struggles of 2010. Because you convince so many people of the style premia with your book that you created a crowding effect. And of course, you had to shake out the nonbelievers with the next decade. So I put it squarely on your shoulders. But I’m hoping with the publishing of this new book. I mean, the timing is right, because we’ve just seen value and trend, which were written off by many as just dead rise from the ashes like a phoenix. So what’s your take? Now we’re suddenly seeing these styles thriving in what is potentially a different macroeconomic environment, what’s changed, that’s all of a sudden brought these styles back to life.

Antti Ilmanen  08:20

Sure, let me take it more broadly. The book is about markets offering later and doing well with that, which gets to sort of a long shot. So first, I have totally confess my blessings, because the audience reaction to the book would have been much quicker to say the least a year ago, or even maybe half a year ago when assets markets were booming, and the styles were not yet flourishing. So when I think of the broader picture of this low expected return theme that I have, it highlights at the high asset valuations, low starting yields, means tough times for most long only asset classes, but lead to the long shot in a while. So this implies prospect of slow pain or fast paying for them clipping tiny coupons or getting these kinds of cheapening valuation paid. And the book arrived in April, when many long early assets were giving this past thing. And what’s behind this whole thing. It is all along all the assets have been expensive at the same time, because the common part of the discount rate has been record low. And now that those riskless IOUs are rising, it brings problems to all long only assets. It’s not only bonds, it’s also stocks, real estate, private equity, whose valuations were really underwritten by those low maybe negative real bond yields for sure. So the first thing in that sense is not surprise. So now long short strategies like alternative risk premia style premium, they are different from long only premium, in the sense that low cash yields are rising cash yields in this discount rate washes out between Long and short legs. So they are zero duration assets, you could say and then makes them more resistant to fed tightening and otherwise rising years. Some of these have performed even super well, such as value and trend. But I would say it can be a coincidence, but not having the headwinds that long holy assets face here. That certainly helps. So I think that’s an important part of the story. And I do want to say he had a love that the strategy or any strategy is really that positive long run rewards, and gotta be loved before we touch this, and perform well, when most needed. So this is a feature we have trend following looks quite good. In some detail. Hedging abilities, probably come back to that value is less reliable, but it has done it 20 years ago. And now when some other types of I think many people focus on just the stroke performance, or the first moment, but I really like to emphasize each element says timing this doing well, when stock and bond markets suck. Okay. So that’s sort of my best story, looking back. But also then looking ahead, it is nice to be in a situation where these things have done well. And I think we have got a decent case in saying that there’s runway for some more good performance. You’ve seen cliffs perspectives, pictures on how value spreads are still white that makes us smile every time. And so there are some intuitions, basically, fundamentals may be helping sustain those white value spreads. And we are shifting into new growth and value stocks and keeping the spread wider. But still, so that’s nice. And we trend, I think I want to come to that later on. But I think basically trend following is not hampered as much by Central Bank’s curtailing trends. In addition, we are now in a situation where inflation evolution is important. But I think anything typically inflation related developments are more gradual, and that is very convenient for trend type strategies.

Corey Hoffstein  11:50

It does seem like the setup for a lot of these style premia may be one of the better setups we’ve seen in the last decade plus, which is really exciting, right to your point about the value spreads within value, we’re now starting to see momentum shift into overlap with value, which is normally a sign that value stocks are going to rewrite into growth. But value spreads are so wide right now, you can see significant overlap in those factors for quite some time, which is interesting sort of reminiscent of era perhaps, and could be a good tailwind to value names.

Antti Ilmanen  12:22

Yeah, that was very much the 2000 2003. And in some ways of implementing these strategies, like when both of those key NS would say something, you should listen more than so take maybe more risky situations.

Corey Hoffstein  12:35

Right? The confluence of the signals, perhaps says something extra special about the environment, we’re starting to see this setup that could be really positive for the style premium after what was a decade of sort of mixed returns depending on which style premium people adopt you, of course, advocate for diversification. People don’t tend to do that in practice. But the book you just wrote largely serves to reaffirm a lot of the evidence and thesis you laid out and expected returns. And I’m curious, as you wrote the book, were there areas in which you gained further confidence? And were there areas in which perhaps you’ve changed your mind? Yeah,

Antti Ilmanen  13:14

it sounds says since I look at very low histories and other 10 years isn’t so much, but he certainly is willing. So when I changed my mind, I think like everybody, I certainly didn’t see negative one, two years, that can be just like a quid pro. But it’s serious because it had an impact on I think, again, no, no longer on the essence. But other than I think my core beliefs haven’t changed. But there are some of these fields. So I become even more humble about tactical timing, even more appreciative of the power of strategic diversification. And both of these are more due to our research, looking at long histories than the market experience of this decade. And I think from the market experience, there’s been a greater appreciation of the importance and difficulty of patience, it is a big theme, I really like trying to write it well into the book, not sounding self serving, because it applies, I think, for any kind of investments, the importance of patience. In some sense, I’m talking against my things in saying that investors shouldn’t follow my beliefs or anybody else’s beliefs, however compelling and in my case, evidence based they might be. Instead, they should figure out what the beliefs and portfolios are that they can stick with. And I guess some I’m preaching with more humility, I’d add here another change. And again, these big changes, I’ve had to think somewhat contrary and hard to the long run, and I still love diversification. So gotta do both, in some sense, value and one type of things. But I especially like strategies that combined positive long run rewards with some help in bad times. So trend and defensive have sort of become more of my favorites in this. Again, I realized just recently that in my book, The Cube had sort of this precise value momentum carry, it had volatility, and when the book gets was wholesaling. And very quickly soon after I joined AQR, which are classified that conceptually under carry, whereas if we take very big umbrella portraits, whereas defensive became a natural way of thinking about that fourth important bucket, by the way, I totally see that I’m giving too long answers cliffhouse. But this saying, has got to question and you’ll get three answers. And I think this is par for the course, though.

Corey Hoffstein  15:23

Well, that’s the way we like it. We prefer long thought out answers here. One of the areas that I have changed my mind on, or at least, I’ve thought more deeply about over the last decade, I think, in the early 2000 10s, I was more apt to believe research based upon a great depth of historical analysis towards 2020, especially after March 2020, I really started to question the application of some of that historical analysis, thinking about how perhaps financialization of certain markets changed the market structures themselves, or the emergence of new, large players, like Central banks can affect how returns and styles play out over time. How do you think about you’ve got this great breadth and depth of historical evidence for these styles? How do you think about updating your priors as new information comes out about participants in the markets? Or how people are able to access these styles? And when in reality, that new information you have might be noisier and certainly isn’t going to be sufficient to sort of knock out the historical data from a statistical perspective?

Antti Ilmanen  16:35

Well, I would add just slowly, like a good basis, and with strong buyers having researched this thing, so. So one question I raised in the book is, how do you balance between 100 years, so it’s paper evidence, which has got strategic persistently pervasively doing well, against a few years where your own life portfolio is sucking? So it’s understandable that statisticians give you one answer, and most real world investors give another answer. I’m trying to bridge a little I think, then by saying that if we learn more about this long run evidence and economic rationale, so that may give investors a bit of that longer wait. So that’s my pet answer. And I think that’s a key thing. But I think it is also it’s fair for skeptics to ask, the world has changed, if structural changes make history is irrelevant. And you had some examples, I think with the negative es que, again, I feel very comfortable saying this important story. For long only assets, not so we are so long, short strategy. So again, level effects tend to wash out with them. And then I get to the qualifier set, okay, so that could be financing spreads, widening, with higher yields, or the leveraging scenarios with titles and so on, that may matter. But again, to be really less important for long, short premium. I just heard a couple of times recently, like a version of this, okay, the market portfolio is now so different than it used to be in the olden days now, maybe tech companies with the intangible assets used to be energy companies or finance has dominated. So what does that doing? I don’t know. I think there’s still enough that remains the same in the latter case with equity premium, some key risks human behavior, whatever the details are on your commodity financialization example. I do. So there I would buy that role has turned somehow to negative but the other the original and financialization stories emphasized as much this idea that commodities may now be positively correlated with equities, because they were for a moment, that was pretty fleeting moment. So there’s, I think those stories can be overdone. And the most important thing, I think, with these types of doubting questions is they can be too easy challenge, like after a couple of barriers, those who don’t believe in systematic investing that it’s easy to say that the world has this. So I would want to raise the bar there. I would want to say that, yeah, let’s think about that. But that should be more specific. So you should have a particular mechanism, how the world has changed, and you had something with commodities. But like, one thing that I think was fair question 15 years ago was whether regulation fair and exposure, whether that would weaken momentum, because there was whispering from the management, that’s all less under reaction. So if you get that story and data that fits with that, then you get more. So I raised the bar. But ultimately, I do consider quants, especially contrarian suffer from structural changes. I’m glad we diversify, and we have momentum or trend that can often benefit from those types of changes. And then systematic may have some disadvantages versus discretionary type. So it may be best sometimes to step back, either and use your weight or even to power them some strategies. Before Brexit or now maybe in response to the Russia, Ukraine, where you can ask the question, is there something that we shouldn’t be doing in this environment with hindsight but forward looking sets There’s no easy answer. So I do want to throw it back to you. So you told that you have changed. Do you have some constructive answers? What do I couldn’t do?

Corey Hoffstein  20:09

Well, I never have constructive answers. I just have a lot of questions. I think when I look at market structure today, and I’m still young, so a lot of the evidence I looked back can only be historical, not my own experience,

Antti Ilmanen  20:23

not only young compared to me, by the way.

Corey Hoffstein  20:26

That’s right. I’m not as young as I once was. But I certainly look at, for example, the experience through COVID. And say, it felt like there were a lot of endogenous market factors that maybe wouldn’t have existed necessarily 20 years ago. And it’s hard, obviously, to prove a counterfactual, or to really necessarily determine is that is that information relevant, I’m sort of have the growing view that markets have always been a mix between a long term weighing machine and a short term voting machine. And that some of the financialization and commoditization of access to different styles, and changing market participants has made that voting machine perhaps a bit more violent than it used to be. But I don’t think it’s so overwhelming that the weighing machine never comes into effect. And so for someone with very long term outlook, pension and endowment, retiree saving for their retirement, to me, it’s just being aware that these market factors are at play to help with the psychological aspect that you should remain diversified and expose the positive risk premium assets. And that’s probably the best most people can do. So does it necessarily change my long term thinking? No, other than just acknowledging that a 4% move in the s&p today may not mean what it used to two decades ago, it’s just a different market environment with different market participants, you know,

Antti Ilmanen  21:50

unfair, unfair, but I think it is difficult and say, to draw lessons, what should I do differently because of these things, but again, maybe some sympathy and then again, highlighting some of these lessons that we are anyway, emphasizing throughout,

Corey Hoffstein  22:07

absolutely extracting meaning and action from all these things is very difficult in a very noisy market environment. So I published my liquidity cascades paper, which I think requires you to wear a tinfoil hat when you read it, because it’s full of just conspiracy theories. But whether any of them are true or not. I think they’re just interesting concepts to think about. And be aware that, again, the market has changed from where it was 20 years ago. But the fundamental principles of pay by positive expected risk premia assets and diversify as much as you can. I don’t think that ever goes out of style from an good investing behavior perspective.

Antti Ilmanen  22:41

Yeah, I think we later come back to trend and at that context, I may still come back to your liquidity case case when we will,

Corey Hoffstein  22:47

we will. So one of the other structural changes, and I sort of quipped about this earlier, but I do actually want to come back to it is on the behavioral side, because you really did educate an entire young generation of investors, both with your work and expected returns the papers you published, and really AQR as an organization, really helped teach the world about factors and style premia and helped convince the world that these were positive expected return styles that people should diversify into. And I think there is a genuine question of at what point do you become so convincing, and gather so many assets in these styles that you create a crowding effect that erodes the premium themselves?

Antti Ilmanen  23:38

Well, I think the last few years tell that there’s nothing we can do that three bad years can’t offset so. And I could repeat, you know, what I just said about weighing past century versus personal life experience. And again, it’s not only empirics there’s lots of other things here. But again, they tend to lose out to this few bad years. And I do like your signature, no pay no premium. And how these bad times can sustain these strategies in the long run and make risk cream. I mean, one feature is that like, there are some people who say that I cannot trust premia that don’t have risk based origins. And we’ve had lots of arguments and how you can have risk premia, even now those strategies that have behavioral origins, as I think trendy certainly like that, just bad performance itself. And maybe some effects like you are integrated, you get crowding effects, deleveraging effects, and they could become serious risks for those strategies, which is, again, in the spirit of what you were saying earlier, how you are changing market dynamics may be in a way if these things become too popular. I do think that there still seems to be pretty natural balance in the market between people who like these types of things, and we don’t and then we get fluctuations in that balance our time

Corey Hoffstein  24:54

will say for me, anecdotally, it felt like value became the day Prominent premia post era everyone learned their lesson. Okay, we need to have a strong value basis, every advisor portfolio, pretty much I’ve ever looked at. And I know you head up the portfolio Solutions team at AQR that does a lot of this work. I’d be curious if what you saw just about every advisor portfolio I’ve ever looked at, as an allocation to value, a lot of them small value, it was the dominant belief that that was the style tilt that should be taken. And so I sort of started to believe perhaps, that it was so overcrowded, that the premium had been squeezed out. And yet, the counterpoint to that is value spreads reached levels, which you would not expect. I’m just curious as to your thoughts on this, like, it’s not as obvious in other factors where value spreads, perhaps have less meaning and a high turnover factor like momentum. But when you sort of look around the different styles, how do you think about maybe measuring crowdedness, and that sort of risk.

Antti Ilmanen  25:58

So this is related to this other side topic. And I do think that crowdedness, in my mind is best explained or measured by evaluation. So let me just highlight some of these key ideas that everybody must hold market portfolio. And for anything else, you need another side, and we may come back to that market level. But this is also true for these long, short strategies. So if we all become more fundamental, believe more in value strategy, we should see it very expensive. And in general, I thought that okay, effect if there’s a crowding problem with this systematic style, premium 20 attempts, we should see a generic featuring of them, and we didn’t. So that was something that made me comfortable. And I stick with hindsight that I think I say it in the book that the pocket where there was possible crowding, that was a defensive one. So if the problem had shown up there, then the story would have more legs, but value strategy, you are sort of pointing out, it was already from 2000, it was longer and story where that popularity came, but really, really, after 2007, we didn’t see value ever become particularly expensive, then I think, you know, post GFC years. And so there are some versions, so that 2007 was expensive, but that’s even dependent to the specification that you have. So I think that’s hard to link that crowding story to the experience of 2010s. I’m still with hindsight, wondering how to best think about it. Let’s return to that. Still. I mean, I think they’re gonna think about this. crowding and other side, issue a little both with value and other strategies, and come there.

Corey Hoffstein  27:42

Let’s dive into that other side topic, because I had the distinct honor of getting to serve as your discussing a couple years back at our friend West Gray’s democratized quant conference. And I think it was a paper that was still a working paper for you at the time. And you actually now talk about the research you did in chapter eight. And the whole idea behind the research is, okay, who is actually on the other side of these trades? And so I was hoping maybe you could explain a little bit about how you went around that about doing that research? Because I think it’s pretty novel and interesting. And then I’d be curious, after all was said and done? What was the most surprising result for you?

Antti Ilmanen  28:22

Yeah, okay. I mean, this is a huge, it has sort of snowball, so that, I wonder whether we will ever end up writing the paper because it’s just broaden initially. So it started from this idea that if we tell the world that there is a longer premium for some strategy, it’s almost a fiduciary duty to consider, who is the other side who’s going to sort of lose out of it. And then you can think of that from theoretical perspective, think of the various economic rationales and I think I mentioned in the book that that part is predictably satisfied. So there are so many possible stories for value momentum carried defensive, that we could even say that there is theory mining out there as opposed to data mining, there are so many possibilities, but again, it is important that those exist. So after that, we went to this. Okay, so let’s study flows. Let’s think about flows and holdings data. What that says about whether there are some interesting other sites that we can identify with the data, and then we are somewhat constrained with what kind of data existed it typically is between different investor groups. And so first, I’ll just tell you, I think the most surprising result is, is this that one could see that for the defensive strategy, hedge funds were the main other side that we could identify, and that sort of we only because defensive, better guys better strategy. So So one key story for them is that investors are leveraged, constrained, and that course is it well, hedge funds shouldn’t be leverage constrained, they should be in great position to take advantage of this, but they haven’t they’ve if anything, they’ve made it worse with their behavior and in some way underneath, okay, maybe they do have some leverage constraints or they just love that. lottery tickets, the other explanation so much that they have chosen to know that. So I think that’s among the many interesting results. I think that’s the one stands out. But let me just step back a little to what we started with earlier, that whole research leads to some really interesting insights. So first one is almost trivial market portfolio is the only portfolio that can be held by everyone, everything else requires an active other side on this one. So I think that’s really cute. And Jonica. Crane has taken that further into suggesting that when we think of what kind of portfolios we should hold in the long run, one useful approach is to ask, How do I differ from the average investor who holds the market portfolio and that gives you sort of the relevant tools? I like the idea, but when I’ve thought about it over the years, I see we get quickly into troubles. So that average investor is not an equal weighted, we are talking of wealth weighted average investor, okay, so I think I know that this investor would be wealthier than older than average. So but I wouldn’t be able to put some numbers. And so then thinking, How do I deviate from that? It’s very difficult. And then same parent with my book writes quite a bit about that market portfolio. How do you deviate from the market? Well, there are lots of questions on investable market portfolio. My favorite one is okay, we know that stock can gold market capitalizations are in the ballpark of $100 ones might be 200 trillion and places, but with real estate is the correct number 3 trillion or 30 trillion or 300 trillion? It really depends on what you think of the world investable. So this is just showing how messy that is. And I’m sorry, that was totally detour. But this whole question leads you to some of these interesting paths are you already mentioned to you then how when you think of the styles, you’ve got to have the other side, but let’s just take this to the simplest level to the equity market direction. So the idea here is that if we held hold on average market portfolio, it also means that we cannot net have different tools from that, on average, we hold the market portfolio. And this then means that if we all become more risk averse, at some time, could be now you could think of 1987, you could think of 2008? Well, we can’t rush to the exit at the same time. It’s a prices that have to adjust. So there is this, I say this, if aggregate risk preferences change, then valuations must change, not some Netflix because Netflix must add up to zero for everybody else, SSL or recycle. So anyway, so that’s something which is so obvious. And yet, we just keep forgetting that one. And so again, I think there are implications to the value and other times. But this just made me think in recent days, this is where I’m trying to get, I thought, we really should just have my notes on the dynamics of markets in the kind of situation where we might be heading now. I think in chapter 20, of my expected returns, I talk about this idea of balance of different investor types, you need to have procyclic and stabilizing investors. And 2008 was a very interesting situation where that sort of imbalance. So Larry Summers wrote great papers, actually, at that time, as if the Column list of the procyclic vicious circles that were overturning the normally stabilizing genius of capitalism supply and demand. And the intuition is basically that normally stabilizing investors stepped away from the market soon after Lehman event, but then it wasn’t clear how deeply we would go down that abyss. Anyway, so I could go so many different directions on this, but we already got to the value strategy. One last thing I think I want to say is that I do think that valuations are the most useful crowding measure. That’s where we get to that one. But then there’s this other feature that people said okay, we could look at some relevant investor subsets and ask whether they are useful crowding indicators, and typically the ones that are highlighted or that are then leveraged investors could be hedge funds and short sellers. And there is this weird resultant, they are indeed, they make sense that they are useful crowding indicators, but in practice, following their positioning has been pretty good idea. Not so 16 months ago or so and retailers are creating a little revolution there. But in general, that has been the case. And that means that if you are trying to insure yourself against crowding problems, deleveraging scenarios through that lens, you are going to pay very expensive insurance premium, you’re going against the smart money hoping that that’s going to help you in a particular episode, and that just happens so rarely as all that I don’t think it’s a good idea. Anyway, again, lots of things from this they’d like to throw it back to you again, whether you have got something or the crowding issue, especially on strategies, which are faster moving, the logic that I was talking about looking at valuations on, that doesn’t seem to be so important for trend or momentum strategy. So there may be your liquidity caskets that ghost stories are much more important.

Corey Hoffstein  35:21

I would like to point out onto that this is my podcasts. And I’m supposed to be asking you the questions, not the other way around. I’m giving you many of the answers. There was a lot of research in the mid 2000 10s, where people tried to ask this crowding question and I think Research Affiliates wrote quite a bit about valuations and crowding, and then lift fired back pointing out that makes absolutely no sense for things like momentum where you can have a 75 or 100% turnover in a couple month period. What is the relevancy of valuation spreads, because valuation spreads tend to collapse over a multi month, multi year period. So not as relevant? A lot of the metrics I’ve tended to look at actually tried to be the actual holdings overlap, because the risk being that you have a large number of parties that are unintentionally crowded, right? If you have a momentum manager, that’s only looking at what they’re doing a value manager that’s only looking at what they’re doing in a defensive manager. And they’re not neutralizing exposure to other factors, they can all end up in the same factor thinking internally that they’re well diversified in their portfolio, but not realizing there’s a huge overlap in the holdings that they have across managers. And I think that sort of goes to potentially what happened in the August 2007 quant quake, to a large degree. Now, if you’re talking about multifactor, manager, well, then I think naturally, they would be gross, because they have so much overlap in the same concentration of positions. But when you have more isolated managers, seems to me like there’s a larger risk. And one of the things I didn’t write about this in my liquidity, cascades paper, but I’d be curious as to your thoughts. One of the things I’ve thought a lot about is that risk factors and style premia getting more popular baked into a lot of portfolio construction, the traditional Barra risk analysis, I almost wonder with so much of that factor analysis, ending up under the Barra definition, do fundamental managers who tend to rely on that more than say quant managers who might build their own signals, does that end up creating unintentional factor crowding among a large cohort of fundamental managers potentially, into the almost identical definitions and characteristics of a factor?

Antti Ilmanen  37:34

I would often say that this is surprisingly much divergence in among systematic managers, different types of ways of doing value can be quite different. Also, momentum actually like can be. So it is true that if there is something like maybe it’s especially that through that if there is something which is very common, and it’s probably fair to say that systematic managers, for example, so if the anchor has been booked to price or something like that, you could worry about that. Or now you say that, let’s worry about Barack, whether it’s through systematic or discretionary managers, that that would be driving this concentration. And as possible, whether you have seen more of Gnosis or the opposite problem that clients will look at different value managers, and they complain that they’ve got so divergent before lunch said, we thought that there would be some common thing. And so it really wasn’t so obvious that there is so much similarity. And I did want to just throw back to this earlier point you then made of looking at these overlaps, somehow, I think we just have to think about the bloody accounting identity. If we were capturing all investors, then let’s just put some measures of overlap just will always be the same. And so it’s really matters, then you are thinking of overlap in some particular types of investors that you think are more relevant, and then you have to specify that and then you can get to them. For example, you could get to that kind of story that I just said that maybe it’s especially relevant to look at those hedge funds, celebrities, players, and then you end up paying some insurance costs. So again, just for ourselves, and for anybody sort of raising the bar, when one thinks that there’s a cool story about flows, almost very rarely can be about total flows, it’s gonna be some subsets and then you better start thinking what subsets you are talking about the does this seem right? Otherwise, it’s going to show up in valuations. But then you had the point, something of this going to the exit, you mentioned, I do think somehow, with faster strategies. So with momentum, entering the risk of too much money doing similar things, it’s either that trading costs get higher when there’s too much synchronous trading. And then the other thing is that if we do really try to exit at the same time with those types of strategies, then the exit is going to be particularly painful when you get very steep falls. And again, I think that the idea has been there, and I don’t think we have seen as many examples of that, as we may be worried, but logically, it seems like

Corey Hoffstein  39:56

I think that identity that you pointed out that accounting identity is especially important, I think, in my mind, what sort of where it’s always come down to is it’s potentially levered players who are at the greatest knockout risk. So if you have the same hedge funds, who are levered borrowing effectively from unlevered players, those unlevered players don’t get knocked out. But when you get concentration in the levered players, that’s where you can potentially get the catastrophic, unwinds.

Antti Ilmanen  40:20

That’s exactly then my point, since there is a literature follow the smart money some sense, that’s that’s the money worth following in at least some studies, that saying that you are going to pay a very high insurance cost wanting to go against that, because you’re gonna hit against the leveraging scenarios.

Corey Hoffstein  40:38

Maybe my natural follow up question is, in this research, did you find that the other side was fairly consistent over time? Was it that hedge funds were always on the other side of the defensive style premium? Or is that something that tends to ebb and flow?

Antti Ilmanen  40:54

That’s certainly some ebbing and flowing. One way we briefly tried to identify things were people like eyeballing whether the positioning tended to be on one side, you can’t expect it to be very stable, but it was typically on one side. So that’s one kind of answer that while there’s variation, there’s enough, this one tilt seems like but the other result is, when we really drilled into individual accounts within 13, FDA that we did find that there is a tendency for whoever is on one side of a tilt tends to be on that side of the tilt six to 12 months later, or something like that. So basically, this kind of matrices that look at how stable things are, they were telling that there’s not total flip flopping around, and so on, but there is predicting a tendency, and that was helpful, because otherwise, we really, were often not getting very strong results. Because if you are looking at overall, let’s say mutual fund industry, you’re not gonna get very big overall Eutelsat because you have lots of value managers and growth managers inside that, and aggregate for the mutual fund industry is just going to show it. So going into the more granular data, it was pleasing to see that there is stability in the field set various investors when taking.

Corey Hoffstein  42:08

So one of the big trends, big structural trends of the last 2030 years has been the growth of passive investing. It ties to me nicely into this idea of who’s on the other side, my question to you would be do you think that the rise of passive indexing can lead to fewer people making cross sectional pricing errors being sort of the sucker on the other side, and therefore lead over time to smaller opportunities for that sort of cross sectional mispricing?

Antti Ilmanen  42:37

Yeah. So this is open to debate, I at least read it the like Michael Mauboussin had this idea of paradox of skill, he linked it to baseball players were those four, the four batting averages anymore. So when the rising skill level of market participants makes it harder to beat the market. Okay, so that’s the idea. He used, I think the poker analogy. So most fancies have left the poker table. And you may now be playing only with sharks, such as hedge funds or high frequency traders, so some of the experts. So I’m countered that by saying that we really don’t know from the rise of passive investing, what it means regarding whether Petzi has left the table and let me just clarify this. So we know that there’s been a shift from active to passive, but we don’t really know whether the money that went to index investing came from the amateur investors directly, or whether it came from money that they had delegated to active managers, typically fundamental active managers who had high fees and hadn’t performed so well. The idea that when we think of how markets work is those managers, they do lots of fundamental analysis, they are the ones who set the prices. And if it’s also delegated managers that actually were lost from the poker table, then I think we may have lost, arguably, the sharks, who sent the fair price and had done most of the work that said, market participants are more than free riders in this. So with that logic, it could be that market pricing may have become more or less efficient, really, depending on whether the index flows are replacing the amateur or this supposedly expert delegated manager. So I summarize it to say, it’s unclear whether the pants or the shark has left the table. I like

Corey Hoffstein  44:29

that. I think it goes back to that accounting identity. I sort of think of it as if every growth investor in the world wanted to capitulate and become an index investor. The only way that happens is either every value investor in the world capitulate at the same time and they all buy the market portfolio and cancel each other out and the market portfolio doesn’t change, or they all start capitulating and have to drive the market portfolio to a price that actually meets exactly what the average value investor would hold. And then they’re all on Same side, but it’s sort of this. Again, it goes back to the accounting identity and a question of who is stepping away? Is the Patsy stepping away? Are the sharks and the Patsy stepping away at the same time? Are the sharks getting priced out of the market? Yeah.

Antti Ilmanen  45:13

related question that is often asked is whether this rise in indexing has implications for the style fields. And it really depends on what the market index is. And it depends on where it’s sourced. So if it comes mainly from value, then there’s something and if it comes from growth, that probably it comes from whatever was doing less Well, recently, and I think that’s something then the other side is whether the market index itself has got some factor Thiel said sort of interesting other side, they’re like, the first answer is, if you have to go through a market index, let’s just focus on equities and not get to the complexity of multi asset classes. So with equities, if the market index were all cap index, and I think it really wouldn’t be neutral, but since SMP 500, is in practice, the most common indexing vehicle out there, and it has got some large cap growth by us, it sort of makes sense that indexing can boost that style box. And I think they probably make too much out of that. But there’s something and somewhat related, there’s some type of market portfolio is momentum oriented, compared to what it probably there’s something to that, let’s say certain stocks or sectors are getting overpriced, then market will weigh them more, or there’s something to that. But any effort that when we tried to look at that data, it certainly wasn’t the momentum we think of as last three to 12 months momentum. I think it’s a much more gradual, I think, like if you try to make sense of what kind of deals market has, I think it would be multi year momentum. And we wouldn’t be sort of that story. I think it’s more to the value territory, the market portfolio has become too anti value, because of such momentum biases.

Corey Hoffstein  46:47

I think a lot of that story, and and certainly one that’s getting a lot of popular play on Twitter, I know you’re not on Twitter, that’s probably a good thing. But there’s a lot of active debate around this whole indexing effect. And I think a lot of it goes to stock versus flow in many ways. By definition, the market portfolio, we’re again, just talking equities. If you’ve got the total market portfolio, it can’t have tilts tilter, what’s off portfolio, so by definition, the market portfolio shouldn’t have tilt. But I think people who talk about that momentum effect are talking about is the ongoing flow, when you look day to day that the next day’s flow is going to buy more of the relative recent performers and less of the relative losers. And the big question is, does flow, whether it’s informed or noise have permanent impact on prices? And I think that’s a lot of the interesting academic literature that’s coming out. Now there’s people who are very strongly in the camp of Yes. And there’s people who are in the camp of maybe in it, again, it’s that voting machine versus weighing machine in the long run, it all dissolves and there might be some event driven flow arbitrage, you might be able to work out of it. Then there’s obviously the camp that says now this is all just noise that washes out. So it’s a really interesting live ongoing debate that I suspect we’ll never get to the bottom of.

Antti Ilmanen  48:04

Yeah, but let me say something about that. So again, if the flows to equity index are coming from active equity managers, delegated managers who had higher fees and people that shouldn’t probably have too much impact on the overall so it is that intuition says, okay, matters much more than money is coming from outside equity market, when the classic academic idea was that individual stocks are perfectly substitutable, there really shouldn’t be almost no flow effects. But the new results that have come from some academics and ebikes Korean domestic market hypothesis says in the spirit that we were saying, if the money travels across asset classes, it comes into equities from something that’s that couldn’t be very much pricing impact that they are solving five times or eight to seven times impact. My best reading is this is a real challenge now to hold academic consensus on this. But it’s that study is still new, its econometric methods are so complex and not transparent for most readers. And there are debates about it. So let’s see as it moves on, these are super smart academics. So one has to give them the benefit of the doubt. But yeah, I’d be surprised if the headline results will survive as they are now. But I think the basic idea that there’s very different types of numbers if we’re talking about money flowing into equity markets, as opposed to within equity markets, and that’s taking our knowledge a bit further. Now.

Corey Hoffstein  49:31

Speaking of the new literature, again, the 2000 10s were a period of just prolific academic publication, a lot of studies around style premium portfolio construction. I’m curious, what was the favorite paper that you read published by others? And what was the favorite piece of research that you worked on?

Antti Ilmanen  49:51

I do a lot of work by my colleagues value and momentum everywhere or betting against beta. In services, they introduced a CQRS where you’re studying the is key factors in a very holistic way, looking at empirical evidence in many different asset classes covering economic rationales, etc. So I think that’s great. But now, those were actually already written first versions anyway, in late August 2000. So maybe they are disqualified journal publication process these 220 3040. So with something with more honestly, electricity tents, they were, I think, total concrete discount rates. So this was his presidential address when AFA in 2011. So he told in that paper that there’s been a shift in academic consensus for, for thinking about expected cash flows dominate asset prices to thinking that time varying expected returns required returns are the key reason. It’s just one thing that he coined the term factor zoo there, talked a lot about this systematic cross sectional strategies. And in general, he provided a great blueprint, I think, both for finance research and practitioners. And some of the things we’re suggesting, like advisors should also like focus a lot on more humble parts of ways of improving client portfolios, then, let’s say the technical timing goes on. So that’s I think, my thing that we don’t papers, in general, I am not going to give you one because I like to diversify. I like blue color finance. So far, my friends thought this type, let’s look at too fancy, let’s try to understand the extremely important issues with relatively simple analysis. So I think well, investing with style was important, somewhat related, even simpler, exploring macroeconomic sensitivities. Both really think talking about the style, especially from diversification, providing lots of evidence, but also about the benefits of diversification. And then seeing the literal the market timing paper, all of these are co authored with your colleagues, most of the papers I’m most proud of.

Corey Hoffstein  51:51

Alright, we’re going to take a hard left turn here, little into the world of gossip, but we’re making our way towards talking about trend. So I’m going to lay the foundation here that in post March 2020, Cliff Asness and Nassim Taleb gotten a pretty incendiary spat over Twitter, again, reminding you stay off Twitter. But it was an argument about the use of put options in a portfolio versus trend strategies as a means to manage portfolio risk. And what I don’t think many people were aware of even myself I was not aware of at the time that it was really just a rehash of a debate that you and Talib had back in, I think was like 2012 2013, where you both argued from empirical and economic rationale and you were arguing in support of trend. Now, if we take a step back, I always when I read cliffs arguments and seems arguments, it seemed to me like it was really two parties talking past each other one evaluating the strategies on a standalone basis, and one sort of talking about the impacts on a portfolios geometric return. Again, Twitter is not a great place to have a debate. So a lot of it could have just been lost in the nuance. And I suspect I am missing part of the picture here. So I sort of want to take a step back and say, you had the debate in the early 2000 10s. We’ve now come forward a full decade, has your opinion changed? Or is tail hedging really just an expensive fool’s errand?

Antti Ilmanen  53:17

Because we that Twitter exchange there, I did love this way, Cliff has got the instinct to defend someone in his team. Whether it was me or somebody else didn’t really matter, but it’s part of his character, this Don Quixote fighting windmills and populist if needed, and my case I wanted really to answer that stuff. Twitter is not my playground and I wanted to do a serious paper, which I did a couple of months later, we have to pay per tail risk hedging, comparing contrasting that trend strategies, I would say to your reading, I don’t think we were talking past each other. Like certainly in 2013, talent made things very easy for us because he was really focusing on standalone performance. So on your idea, we talked past one another. I don’t even think in 2020. The question was about the portfolio role, because we do agree that the good tail hedge strategy, even if you have a negative Sharpe ratio, you can improve portfolio performance with that. And in the various ways that math is clear, though, in reality, regular good buying strategies have had such a bad long run surprise, so that would probably have done a good job. And the other thing I often highlight is that investors tend to succumb to line item thinking and impatience, which makes it very difficult to expect this kind of rational behavior that’s required with a portfolio aspect. But, again, definitely that older exchange I had with him in FHA financial analysts journal. I think he made it easy by focusing on standalone performance on foot binding, and I do think that with was pretty careful to him. He was clearly hot blooded there but he That’s a safe ground to debate here. And so, on that topic, now we’re going to be loose because we could be talking about volume by input by being tailored to our eyes, like they all are distinct but related strategies, my argument had always been our argument is, those strategies can tend to have negative long run, return premium, they tend to lose money, maybe for a good reason. Whereas talent has tended to imply that they have cost less or better. So when you look at empirical evidence, those strategies have tended to lose money, but they have provided wonderful financial catastrophe insurance, they made money at very valuable times 2008 87, march 2020. So there’s also good theoretical arguments or the best theories say that you should basically pay for such a service. And that strategy, basically, market tends to dislike fast crashes, that’s pretty evident from the pricing, when we look at the option pricing. And that means that if you just keep doing that, and you don’t have some extra secret sauce, then that’s going to be very costly, sort of at least minus point five sharp price of strategy. I would say that’s, that’s what we have shown in many papers over the years. The latest one, I think, is the best reading. By the way, I saw an Amazon review on my book, and I confess that it’s irritated me a little that there was criticism, I haven’t done full justice to the tail risk, hedging Nazism. Okay. I’ve been lots of topics in this books. And I got, I think, four pages on this topic. And I am telling that there’s more detail in that article, that article has gotten pretty much all the arguments, and I’m really trying to be with my co authors even handed on these issues. And I think we still can say very comfortable with those strategies are costly, they do tend to lose money in the long run, unless you’ve got some secrets or success, identifying cheaper ways of doing this, doing the protection or monetizing, which are basically some bells and whistles, which are not sure to be successful, but they can there are good studies on it. So but the base case that we show is those strategies have lost money and telex critic, then to Editor team, I mean, it had many parts, there was you should include 87, which are included later, that ultimately he was saying that you really you need 2000 years of data when you have these types of fantail strategies that rely on rare events. And my only answer to that one, okay, we do not have those types of yes, we haven’t 35 years of data since index options were created. That data tells a very clear story, which has got a very natural theoretical rationale. According to this logic, I think things seemed pretty clear. And he’s pretty alone on the other side, and maybe as a minority, once I say that, like because he’s logic really had, I think, then implied premise that these reasons the case must have been too benign, overall, so that they don’t reveal the true value of put by him. Then I just said, Well, look at those 35 years, we had a two 50% drawdown and we had other fast crashes like 8720 20. So I don’t know what reality we should consider neutral. But that did not seem to be too benign. So anyway, this is long winded way of getting over failing that, I do think tail hedging is very costly, even the good ones who have a good track record. And that could be like poor skill, you can’t really tell and you might need 2000 years ago, to make judgments of that one. I much prefer tail hedging strategies, which are less costly. And that gets us to the trend type of strategies, which are not foolproof, and they don’t give us convex bigger jackpots smaller strategies to but I think they are much more sustainable than this option based approaches.

Corey Hoffstein  58:52

You have sort of always been of the view just from an economic rationale perspective, if you believe equities have a positive risk premia, I don’t know how put options could you’re buying insurance against an asset that has a positive risk premium that should have a negative expected return. Maybe I could agree with Nassim that tails are inherently under priced to a certain degree. But you will never know that, by definition, there’s very little data in the tails. And so this is just a pure theoretical exercise. I’ve always sort of viewed this as those sorts of hedges really make the most sense, potentially, if it allows you to take on more exposure to positive expected risk premium assets to hedge that one particular path dependency that would knock you out of those assets. And maybe it makes sense under those conditions, but otherwise, and again, I do believe it can add to the geometric growth of a portfolio that’s been demonstrated squarely to me, but it doesn’t have to be either or, like you can diversify your diversifiers and perhaps that might be the best way of all. I think that’s

Antti Ilmanen  59:55

fair, but I think it is important to again, recognize and people bring about the costs that anybody who does this gets this as a trend following when it has a disappointing decade tends to be flat. This one loses 80 90%. So that’s, that is something the other Okay, so now if I want to be picky, then I say there is this distinction again, between fast and slow crosses, I think it’s that’s in that market cares more prices more aggressively or the fast crashes because again, it’s negative Sharpe ratio strategy in put by us, you have historically clearly positive Sharpe ratio in trend following strategy, which is more fitting to the gradual bear markets and fast crashes can be an Achilles heel for trend following they not always, but sometimes they are. But so can slow crashes can be four foot by being. So the early 2000s, when you had three year bear market often happened that you didn’t reach the strikes and you paid for insurance, and you paid for a very higher auction prices in that, and then you didn’t get the protection. So that must have been very frustrating. And actually, I just have a few days ago, the new P put data for 2022. And that’s the situation that the standard data they’re tested this year. So far, the bear market, at least until recently was so gradual that you are losing money, but you are not getting it back from your protective puts up. Again, they too have them Achilles heels, which tells that you are right. Diversifying across them can be good, but I would diversify them, not equally, I would favor the cheaper one than the one which goes further what gradual bear markets.

Corey Hoffstein  1:01:33

One of the things that I find a little funny about this debate is that there is a connection between trend following and option strategies in many ways. And we’ll ignore sort of the multi asset nature of a portfolio. But if we just look at, say, trend following on one particular market, it looks very much like the Delta exposure you would have if you were trying to hedge a look back straddle that research has been done. So it’s interesting to me to think about with puts in particular, you’re paying a premium for the market’s perception of risk, and then you’re getting a payoff if that perception goes up, or if the house actually catches on fire. Whereas trend following tries to avoid paying for the perception, but perhaps ends up paying for in a different way with whipsaw.

Antti Ilmanen  1:02:20

So before you go to the next topic, I gotta say this, our age differentials 1987 is so relevant for this one, and I was a young portfolio manager there watching actually that crash in my first working year. And of course, the story. I didn’t ask your age 1987. But anyway, so that’s a famous story of portfolio insurance, which is basically a dynamic strategy, which tries to capture up some payoff. And then when, if market gaps down, it fails. And that’s the difference between trend type of strategies and option based strategies. And I think the lesson people maybe took too much to their heart from 1987 was really one protection against those crises. And that just has been with this history. It’s been a very expensive requirement.

Corey Hoffstein  1:03:02

Yeah, absolutely. That gap risk is what they’re trying to protect against. And to protect against the gap risk, you’re gonna pay a premium. But as you mentioned, trend following, then, because of that whipsaw when it underperforms can underperform for a decade, and it did in the 2000 10s. And there’s been sort of the unsatisfying answer to me is, well, there were just no trends. And the question that’s more interesting is why were there no a trends? I’ve heard some people argue that post 2008, there was so much money that came into the space, because trend following got promoted as this crisis risk alpha, or this sort of tail hedge strategy that not only did it become crowded, but it forced all these trend followers into longer term strategies where the trends weren’t necessarily as prevalent. You mentioned earlier in the conversation that it might actually have more to do with the macro economic environment, and that the setup today might be more interesting. Curious as to your thoughts. In your opinion, is there any clear reason why the prospects for trend going forward should be meaningfully better than they were over the last decade?

Antti Ilmanen  1:04:07

Yeah, my colleagues had this paper, you cannot always trend when you want that. And there, they looked at different explanations. And it really came up with this sounds like obvious, but it wasn’t so obvious. That explanation that it was the very short trends, abnormally short trends in 2010s. That was the reason and then it begs that why question and they didn’t address it too much. My best takeaway on that one certainly is that central banks were trying to curtail big macro trends that that hurt both macro managers and trend followers. I do want to say that when the paper came out a couple of years ago, I said that this pretense sort of difficult environment for trends still for a while because central banks still are able and willing to curtail those threats. But there will come a day when central banks no longer can easily do this with their own credibility is on the line and when they have to make hard choices between inflation versus recession or market draw jobs. And then they clearly has arrived this year. And trend strategy is shining like it has comparable to 2008. So that’s I think that’s a macro environment. Now, while we don’t normally think that that is good than bad environments for that story, I think it just really seems like to me another reason, I think, sort of macro reasons why trend couldn’t sign and it is related is we just didn’t get those persistent bear markets because that is, again, short bear markets tend to be the weak source them. And so it’s gradual ones where they are more reliable. As for somebody doesn’t, there’s no trend following strategy does especially well, when it can turn from risk on to risk of and it’s not just equity shorts, it can be duration, long sent anti carry and pro gold versus growth, the commodity, so risk of in many asset classes and ride that along the protracted bear market when most risky assets suffer. And this is super valuable feature. And by the way, this is especially useful for private equity, private assets, because they don’t suffer from the past their market smoothing helps them in those situations. For them. It is this protracted bear market, which is a problem. So we have basically labeled trend and private equity marriage made in heaven because of this complimentary. And we basically checked data on private equity history. And we see that what they have done had they’re rare, but Windows trend following indeed, is doing well. So I think that’s pretty cool.

Corey Hoffstein  1:06:29

I’m going to push you into what might be a deeply uncomfortable zone and talk to you about cryptocurrency for a second, because I noticed that crypto was a pretty large development in the sphere of financial markets, or at least tangential to financial markets. And it was largely missing from your book. And so let’s maybe start with an easy not so easy question, which is would you expect style premia to exist in crypto? And would you be surprised if they did or did not?

Antti Ilmanen  1:07:00

Yeah, absolutely expect to see patterns like value momentum and low risk effects there. Because when we have extended our research to various investments, we just almost always find them. If we don’t, there’s something I mean, there are some like, in China, there was more reversal, maybe related to retail. So there’s got to be some really good reason why this is happening. And I suspect on market develops, we do get these things. So yes, I expect them in Kryptos. And by the way that we have my colleagues who are doing the trend following strategy with some alternative assets, they have included some Kryptos, mostly Kryptos there. So I think that makes

Corey Hoffstein  1:07:36

sense. As much as I’d love to get your opinion about cryptocurrency, I’m not going to ask it, I’m going to give you a free pass on that one. But I am curious, as someone who takes a look at financial history, and someone who is a big picture thinker, we do see from time to time the emergence of new asset classes, and I’m curious how you think about when a new asset class comes out, maybe how you categorize it, or how you think about where it would fit within a portfolio when there’s a lack of data to analyze. Yeah,

Antti Ilmanen  1:08:12

since we have enough assets, where we have a long day that I am not rushing into those situations. But if I were I would try to learn from similar assets with longer histories, or better quality data. I’ve sorted this in private asset context, I may be like the drunk who is looking for the penny under the other side of the street, because that’s where the lamp is. So with private assets, I say that I bet the decent histories with real estate and private equity. I’m going to study those and draw lessons for things like private credit and infrastructure where we haven’t really sorted stories. So something similar, I think, in this case. And then another point is I would be conservative, keep risk sizes conservative, if not that zero, until there’s more that we can learn. I think someone discretionary can do this, but for systematic managers, unless they are very high frequency, there’s just not enough data. And yeah, now we didn’t even get to them suspicious areas,

Corey Hoffstein  1:09:11

maybe in a decade. In your next book, we’ll see Crypto Show up,

Antti Ilmanen  1:09:14

maybe we will, maybe we won’t, you never know. We never know and I am humble enough for that one. Absolutely. That much. I say that I have thought about the scenarios where I will feel very unhappy with myself with Bitcoin in particular, because I have seen the scenario of central banks losing credibility, and that would help bitcoins credibility as an alternative. And I was sort of waiting for this kind of situation as we have now this year. And I thought, okay, if I don’t put anything in them, and this is the way they get their long run success, I will feel particularly silly. So we’ll see but so far this year, you know, they haven’t acted along the lines of my worries. So they like prejudices.

Corey Hoffstein  1:09:52

There you go. Well, let’s get back to the book. And as we round towards the end of our conversation, some of the final book topics like did want to discuss with you, because again, this book re emphasizes a lot of the cases you laid out and expected returns around style premia. But it also really drives home the need for patience and discipline. I mean, you wrote an entire chapter just dedicated to good habits, which I expect probably came from frustrating client conversations. I won’t ask you, who knows, just a suspicion. But I guess my question to you would be, what would make you give up on style premium? Is there anything that would make you say the evidence is clear, either empirically, or theoretically, that I need to walk away from these

Antti Ilmanen  1:10:38

first, so it wouldn’t be easy this patience depends a lot on your beliefs, convictions. And my best evidence based judgment is that the long run story is so compelling that I’m not gonna lose my conviction with a few bad years. And that is both the evidence of how these things have worked in so many places in our long histories. And again, not every three year window. And so but the long run story is so compelling. And then separately, the diversification argument, how you can double your Sharpe ratios by combining the few styles if they are uncorrelated and double again, if you apply them in many asset classes, so those things, they are strong rooted convictions. So that means that my answer is probably different from what I’d suggest for almost anybody I know, but for most investors, because they will not have as much conviction. So patience, as I do, for me to give up on this course I pre made would require a combination of economic rationale, why the time is up, and some compelling empirical evidence which could be quite paid in sort of embarrassingly long time of disappointing performance, or perhaps too good performance of high valuations, that would be a nice way of getting there, or higher trading costs eroding the opportunity, or maybe correlations becoming less friendly, you know, that the diversification study, which has held up quite nicely, that that would weaken significantly. So I don’t hold my breath on

Corey Hoffstein  1:11:58

that. One of the topics that didn’t come up in the book, but it’s something I’ve been spending a lot more time thinking about lately is the topic of structure, because it’s one thing to talk about these ideas and concepts, but you have to be able to actually implement them. And the ability to implement some of these ideas might be limited by the investment structure that investors have access to. So for example, here in the US mutual funds and ETFs have significant leverage restrictions that may make certain strategies just potentially less attractive. Curious how much of the theory that you lay out is applicable when structure is more restrictive? Or how does the theory change?

Antti Ilmanen  1:12:39

So there’s no rule I’m not an expert, I pick my battles. And, again, some colleagues who are better at this, and I leave it to them. But there’s I think one interesting answer is as some structures clearly reinforce the opportunities, leverage constraints really other. They are at the heart of the bet against better explanation that this is why those boring stocks give better performance because you sort of have to choose them with leverage. Whereas the more speculative stocks with low leverage appraisers, they contain this embedded leverage. And then there’s a separate argument that shorting and leverage are tools that are helpful for arbitraging away any opportunities. And so if we have with real concentrated real world constraints and prevents an arbitrage activity that can sustain many premia. So I think that’s a nice answer. Also, I’m not an expert on that. But my understanding is that with mutual funds and ETFs, the leverage limits are not too binding anyway, if you’re trying to improve diversification and not get to some overall height, silly risk levels. So if it’s so some value at risk based payments, rather than notional limits, then I think it’s often isn’t binding for most investors.

Corey Hoffstein  1:13:47

And we are seeing those limits change here in the US, the SEC is adopting those value at risk limits, which could open up a large number more of leverage based strategy. So it’ll be really interesting to watch how that plays out. I also think to myself, Okay, how much of that is also potentially going to increase the risk of coincidental D grossing, that all these strategies that are now levered, end up hitting our limits at the same time, and having to sell? So it’s an interesting risk factor I’m keeping in the back of my mind. Yeah,

Antti Ilmanen  1:14:17

it was actually that he had some of that and it’s worth worrying, but also check the cost of your insurance.

Corey Hoffstein  1:14:24

Yeah. So these books you’ve written expected returns and your most recent book are both theoretical and somewhat prescriptive. I know that your role at AQR semi formally or formally is CO head of the portfolio Solutions Group. In your experience working with clients, I’m curious, maybe what’s the lowest hanging fruit to improving most client portfolios?

Antti Ilmanen  1:14:47

I’ll give the first one because the low hanging fruit really depends on how difficult it is to do this. The premier bad habit, as I call it is this multi year return chasing and unrelated capitalizations and that’s related to the impatience theme that We’ve talked about it, we demand more performance consistency than it’s fair to ask in competitive markets. But there are no easy answers to this one. And at best, this book can set it as a goal and propose some actually does even propose some tools, some tricks for self improvement, how to cultivate patience, if you agree that it’s a good goal. There are other ones under diversification and especially something we’ve talked about in diversity, equity risk concentration in almost all portfolios. That’s extremely common, and could be improved on but it is not so easy because it really is that the risk that is easiest to bear, conventionality, embedded leverage and so on besides good empirical evidence and theory, so I think there is more patients on the equity side for given that bad decade nothing else. So that is sort of flip side to my first story. If you’re gonna cultivate basis, maybe you should have equity oriented portfolios and forget diversification ambitions, then I must say you mentioned too much faith in illiquidity premium. So again, I think there is something in that. But something that resonates quite a lot with investors, even though they are loading up for those illiquidity premium is when I’m telling that inflows are tougher competition among these market participants that show up in narrower valuation gaps and prevents the pressure so the future will not be so great. And then there’s this thing that Clifford, I have been both preaching about it, any illiquidity premium may be offset by the other feature, investors love up there with the smoothing service like a mark to market. So those side I think.

Corey Hoffstein  1:16:32

So perhaps after all this discussion of theory, the most important question I can ask you, if you’re willing to answer it is a pretty simple one, which is, how do you actually invest?

Antti Ilmanen  1:16:42

Yeah, I’m pretty constrained by that. So I live in Europe, regulatory and tax raises mean that I only invest in UCITS funds, but it’s sort of okay, it’s with me, I invest simply and slowly, I don’t trade, I invest lucky enough that it’s been accumulation. So, so far, I was never sold, except when the job changes require this, when I’m buying, I’m still a bit contrarian, more likely to buy aftermarket parts. But the key theme really is I diversify about harvesting multiple premium as you have read. So besides any real estate that I have, the portfolio is pretty much a combination of barriers, long, short and long, lonely AQR funds, and some index funds. So I practice what I preach, I have skin in the game. But I admit that it’s very good diversification between my labor income and investments, maybe your audience knows this. But this sounds so static, it is important to understand if you do invest in this kind of style premium, I can make one decision, but actually, the underlyings will be quite dynamic there. They can evolve a lot because of the evolving style signals and risk management and so on. But really, the short answer is, I want to also figure out what I believe in and stick with it. And I am doing what suits me well, and that probably isn’t what suits most investors, well, if they don’t share my beliefs and convictions. So I’m just trying to encourage them to perhaps move to this direction, if it fits them, but recognize when they are going too far. And trying to stop there so that there’s too much knee jerk reaction, if one year’s performance doesn’t validate their beliefs,

Corey Hoffstein  1:18:19

about by the way, you said it very subtly, the acknowledgement of the human capital element of the investment balance sheet. And I think that often goes very overlooked in investment discussions of what you do for a career. And what that payoff profile looks like over the long run, and how correlated it is to the assets in your investment portfolio is very important. When we think about the holistic investment perspective. And I know for a lot of asset managers, it’s difficult, because your career is very much skin in the game. And you also want to invest in the funds that you manage. But in many ways, it’s doubling down in risk in a way that we would encourage clients not to. So it’s this weird, difficult situation.

Antti Ilmanen  1:18:58

It’s a bit like people say, if a trade goes bad, it becomes an investment. So in the same spirit, you can go to that skin in the game argument. And I think it’s been always there for me and many others, it does matter. And you got to, in some sense, accept some poor diversification, for credibility reasons.

Corey Hoffstein  1:19:18

Well, the last question I am asking every guest this season is to reflect upon the good fortune you’ve had in your career. And tell me what do you think the luckiest break you’ve had in your career is

Antti Ilmanen  1:19:32

1989. You did tell this just somewhere but it is the sliding doors moment where Ken French suggested that I should go further Chicago PhD program faster than I thought. So basically, he liked this young guy, and he encouraged me not to wait because there are some people who are much younger so I was getting 28. And thinking of this when we went and this there are much younger people. So when I and this is actually new that And when I go to the program bottom 89, that TA in pharma class is one obnoxious, but super smart, Mr. Asness that who is six years younger than me. And so that was very useful for my future career, apart from arguably more important existence, meeting my wife that year and getting the lovely, lovely education that I did. So there were lots of wonderful things that happened because of this. But yeah, meeting, Cliff, and John and other founder that was great. And it turned out very good for me that I was quite good at that class. And I think that somehow the impression that he’s a smart guy that sort of gave me I don’t know, some kind of ticket for the future when I moved to Europe. So when geography made it possible that we joined forces some time, we did activity.

Corey Hoffstein  1:20:50

I absolutely love it. Why don’t you I can’t thank you enough for joining me. Congratulations on your new book investing amid low expected returns. I would encourage everyone to pick it up. And I certainly hope that I don’t have to wait until your next book comes out to have you back on the podcast. But I’ll understand if I’ve got to wait a decade. I’ll wait.