Tell The Truth

The easy thing for an investment manager to do during a tough period is to over promise. The hard thing is to tell the truth. Cliff Asness does the latter in his recent piece, which is a must read for investors of all stripes.

Is this a huge tactical distress / opportunity?

Everyone wants me to say that it is. It would indeed be comforting to tell people “you have to stick with this or add more as it’s going to rocket upwards very soon!” FOMO can be a powerful inducement. But I just can’t do it. In stock selection, value is still not super cheap (i.e., super-cheap would be if the cheap stocks were way cheaper versus the expensive ones than normal. It would be fair to wonder why not, especially given the poor long-term value returns. Well, with any strategy, you can lose because either prices or fundamentals move against you. Unfortunately, more of this current drawdown has been about fundamentals. Value, at least using the behavioral explanations, is a bet that prices over-extrapolate current prospects. The better companies deserve to be priced higher versus fundamentals, but even so, they’re priced too high (and vice versa). However, sometimes prices are correctly reflecting this information, and sometimes they are actually underreacting to it (meaning what looks expensive is actually an ex ante good deal). Prices may over-extrapolate on average, that’s why value works long-term, but not all of the time. Value wins more than it loses, but when price differentials underdo it (meaning, unlike most of the time, cheap companies aren’t actually cheap enough versus the expensive ones) is a time that value fails. Importantly, we find no signal from this analysis for timing value going forward. Value is not predictably bad or good following periods where fundamentals move against it. Our forecast, and it’s not for want of trying for more, is value prospectively looks about normal versus history going forward. Thankfully normal is, on average, pretty good.

The most important thing investment managers can do when communicating with clients is to set realistic expectations, and if they can emphasize the limitations of a strategy, then that’s even better.

Unfortunately, I can’t promise you that things won’t get worse before they get better (though getting better is indeed our expected case). I can’t promise you abnormally high short-term expected returns because our process is poised like a coiled spring to erupt. But I can promise that to explain these tough times, we’ve looked under every rock we could imagine, found no smoking gun, and wholeheartedly believe that the gobs of long-term evidence, theory, and intuition, still strongly support the case for these type liquid alts going forward. I can promise you that despite that we’ll keep striving to make our process better and better.

Cliff knocks it out of the park with this one, hit the link below for the whole story.


Liquid Alt Ragnarok?