Cliff Asness

Cliff Asness (@Cimmerian999) joined Tyler Cowen (@TylerCowen) to talk about investing, comics, and asking the right question.

Before we start, I wasn’t going to write up this interview. The transcript and video are both online, and both great. The conversation is a little “wonky” at times, and not what I typically note.

But, this interview has stuck with me. It’s been on my phone and on my mind. I gave it another listen this weekend and I realized why.

Asness knows big things. As Cowen says in the interview:

“I think of you as doing a kind of metaphysics of human nature. On one side, there’s behavioral economics. They put people in the lab, one-off situations, untrained people. But here it’s repeated data, it’s over long periods of time, it’s out of sample. There’s real money on the line, and this still seems to work.”

Asness has theories, applies them and reports the results. You and I get to see what worked. 


Certain strategies work best at certain levels.

Asness is a momentum trader (in general terms). This means he buys things that did well in the last 6-12 months and sells things that didn’t. It might earn 1-3% over an indexed benchmark Asness says. What matters isn’t the strategy though, what matters is that it’s aligned with your actions.

When strategy isn’t aligned with actions we get problems. Asness sees when “momentum investors are on a value time horizon.” That is, the strategy of value is mixed with the action of momentum. It’s like trying to play basketball with the mindset of football.

Why exactly does the momentum strategy work?

Asness isn’t sure, it’s probably multiple things. As Sanjay Bakshi noted, “part of the reason thinking” is a way to frame the question so you get more than one answer. This is good because it sidesteps our existing biases to see what really stands up.

Asness identifies three reasons why momentum – or any empirical strategy – works.

1 – Complete accident. This needs to be an option. Asness says:

“You never reduce that probability to zero. You just make it lower. As it works again, you go ‘chance you’re just lucky, smaller.’”

Asness says this happened with his dissertation. He datamined (bought enough lottery tickets) to find something that correlated and, presto, he had a conclusion. It’s an example of weak correlations, and they’re everywhere.

In How Music Got Free, Stephen Witt writes:

“the Napster boom coincided with the two best years the recording industry ever saw, and even (Doug) Morris (CEO of MCA music) would later concede that, for a while, Napster’s pirate trade in mp3s fueled the CD boom.”

Correlation does not mean causation goes the warning in introductory statistics class and Asness adds a layer to it. Be careful that you don’t find something just because you looked everywhere. Even a blind pig finds a nut.

Of course, there’s an xkcd comic:


2 – Behavioral reasons. Asness says that momentum trading tends to work because of one of two behavioral explanations, both of which may be part of the reason. Underreaction and overreaction. Note, Asness echoes Ken Fisher’s advice to include what other people will do in our strategy.


Here’s how we underreact.

New information is outside information, and we tend to let it slip past.

Daniel Kahneman writes that we let it go because we are biased to prefer what we already know. We underreact to new information because it doesn’t fit in our world view. “That may be true for others, but not for us,” goes the hearty attitude.

But it gets us all the time. It gets us even when we see it coming.

Jason Zweig tells the story of working with Kahneman and the two falling for the planning fallacy. That is, the man who most clearly enunciated “it may take others a long time to do this but not us!” succumbed to that very idea.

I would too. So would you. It’s hard to get the right level of reaction. Michael Mauboussin talks about the difficulties of updating our beliefs. Tren Griffin quotes Charlie Munger on it. Maria Popova notes that changing our mind (updating our beliefs, reacting correctly) is an “uncomfortable luxury.”

That it’s hard to do explains why Asness succeeds with a momentum strategy. He’s just a bit better in a world where no one is that great.

The other behavioral reason is that we overreact to new information. Cowen thinks this matters a bit more:

“You receive a signal about the world. It’s to some extent a private signal and you over-interpret that signal and you think it’s a signal about the whole world so you overreact.”

This happened to me at Pizza Hut. It was a bad experience and – while waiting for a pizza that might never come – I resolved to never eat at Pizza Hut again. Yeah right.

It was an overreaction in that I took a signal (service at the local Pizza Hut on a certain night) and over-interpreted that signal (all Pizza Huts on every night). I told you, catching our biases is a tough task.

Barry Ritholtz agrees with Cowen and it’s why he says, “don’t just do something, sit there.” We tend to associate action with solution when that’s not always the case.

Sometimes these overreactions are for all the wrong reasons. Richard Feynman writes about this idea, calling it “cargo cult science.”

Feynman says:

“In the South Seas there is a cargo cult of people. During the war they saw airplanes land with lots of good materials, and they want the same thing to happen now. So they’ve arranged to make things like runways, to put fires along the sides of the runways…They’re doing everything right. The form is perfect. It looks exactly the way it looked before. But it doesn’t work. No airplanes land. So I call these things cargo cult science, because they follow all the apparent precepts and forms of scientific investigation, but they’re missing something essential, because the planes don’t land.”

We can act like the islanders. We see A lead to B and believe that A always leads to B. We’ve overreacted to a correlation. A few sentences later Feynman makes the same point as Asness:

“For example, if you’re doing an experiment, you should report everything that you think might make it invalid-not only what you think is right about it: other causes that could possibly explain your results; and things you thought of that you’ve eliminated by some other experiment, and how they worked – to make sure the other fellow can tell they’ve been eliminated. Details that could throw doubt on your interpretations must be given, if you know them.”

Remember Asness’ datamined thesis? He says:

“I sat there in my dissertation in 1990. I found this empirical relationship with a big t‑stat but I really checked 63 things so the t‑stat is a bit of a lie, and it never works again.”

3 – Risk and fundamental reasons. As it relates to investing, there a risk premium where it’s believed that riskier securities pay more than less risky ones. Asness notes this may be more true for value strategies than momentum ones.

“Now, in the value world they have the same fight. Does cheap beat expensive because it’s riskier? I don’t think they’ve done a very good job of identifying the risk but I find it inherently more plausible that something priced to a long-term lower level might have a risk element to it than a much more short-term phenomenon like momentum.”

If you’re as smart as Asness, why aren’t you as rich as Asness?

Okay, so Asness sounds like a smart guy. He’s also a rich guy. He’s giving away his trading theory. Can anyone now do this?

Not really. If everyone were to do these things, Asness says, they would go away yesterday. But people don’t because the work is too much. Asness says his system is:

“Good enough to be really important if you can follow discipline, not so good enough that the world looks at it and goes, ‘this is easy.’”

He calls it a “sweet spot.” There’s enough of a barrier that it keeps a lot of people out. (And we’ll see how little those barriers need to be).

Penn Jillette said something similar. The only trick he really does is to work harder than the audience thinks he would.

Asness on bubbles.

When asked what he thinks might be a bubble, Asness says nothing really. Bubble, like “Donald Trump” or “10 Best Ways To…” are headlines we can add to Clickbait Dictionary. All sizzle, no steak.

“A bubble,” says Asness, “is where you say ‘this cannot last.’” Things could be bad, but that doesn’t mean they are a bubble.

Take stocks and bonds, Asness says. The P/E ratio is higher than it’s been in a long time, but that doesn’t mean it’s a bubble. It just means that things are expensive. What we don’t know is whether it’s a bubble or a new normal or record high.

Asness also gives us a sharp framework for popping the next bubble you hear about. Ask, is there “a reasonable scenario that could happen in the next 20 years.”

If you can imagine  how things could work out and find an example of when they’ve done so, you’ve popped the bubble.

The best investment advice.

It’s not often that we get to pick the brain of someone smart – and Asness does not disappoint. So what does someone with Ph.D. from Chicago who worked at Goldman Sachs and runs his own investment management firm say to do with your money?!?!

Don’t overtrade.

That’s it?

Even worse than simple advice, it’s simple advice to not act (“don’t just do something, sit there”). No hot tip? No system? No trading chart with lots of green and red?


Asness probably has all those things, just not for you and me. Regular people succeed when they don’t shoot themselves in the foot.

Asness, like Jason Zweig and Tadas Viskanta and Ken Fisher, says that overtrading is a sure way to diminish returns.

The good news to this is that there’s an easy solution. In the terms used in this post, we can easily align our actions with our strategy. Taking a cue from Brian Wansink’s book,  Mindless Eating – it’s like giving candy to a baby.

If you don’t want to eat a piece of candy, give it to a kid. That doesn’t keep you from eating it. You could physically take it from them – or do as I do and sneak it away when they’re asleep. But Wansink has found that any small obstacle – in this case your morals – can keep us from taking actions. For food it’s all about perception.

At a movie with unlimited popcorn, people with big buckets ate 50% more. People at a buffet where the tables were cleared away after each course ate 28% more than people whose table wasn’t cleared. People who drank pre-lunch smoothies from a full glass ate 12% less than those who drank from half-filled ones. Even though both smoothies had the same ingredients and calories, one just has less air.

Each step created a perception that influenced how much a person ate. None of these examples were a diet, but the results add up. Investors give us the same advice.

Why Asness (and maybe his kid) is so smart.

This interview was good for me because a lot of what Asness said caused cognitive dissonance. I had to settle competing ideas.

At one point Cowen asks Asness about hedge fund strategies, and Asness explains arbitrage:

“There are so-called arbitrage strategies … a trade that has reliably worked over time where they go long and short, fairly similar things, they are clearly not riskless. But, something like a merger, A is buying B, if the deal closes, it’s going to go to here. A is going to fall, B is going to rise.”

Long Term Capital Management used (pioneered?) this strategy in the 1990’s. They found companies like Royal Dutch Shell which was listed on both the London Stock Exchange and the Amsterdam Stock Exchange. Effectively one company with one set of revenues listed in two places. From When Genius Failed

“The English firm had historically traded at an 8 percent or so discount to its Dutch cousin. The stocks were owned by distinct pools of investors, and the Dutch stock was typically more liquid. But there was no good reason for the price differential. With Europe becoming a single economic unit, Haghani reckoned that national differences would matter less and less, and the spread between Royal Dutch and Shell would contract.”

Okay, this make sense. Normally it works. Normally it’s no big deal. Normally – well, you know what’s coming. It’s a fine position as long as you aren’t forced to act. That is, you can service the arbitrage and only sell when the time is right. This was not what happened to LTCM. Their position was big, really big.

“‘It was ridiculously big,’ said an executive at a Wall Street bank. Goldman Sachs had the same trade on. They believed it was a good trade. But Long-Term’s trade was ten times the size of Goldman’s.”

Note: Asness wasn’t on the trade:

One more from When Genius Failed:


So arbitrage is a devastating strategy. Both investments have to go to some middle ground or else you lose and you lose big.

Why is Asness interested in all this? He explains:

“I am dying to do this, I have not done it yet, I have talked about it for two years, I am about ready to try it. I want to ask one of my two older kids, they are a set of twins, they are 12 years old, “Does this sound like a good idea to you?” I’d have to hold their attention throughout this whole thing.

“There’s about a 98 percent chance they say, “No. That sounds like a terrible idea to me, you can lose a lot, you can make a little. Who wants to do that?” I’d be the proudest pop on Earth if either one of them kind of paused and said, “how often do both of those two things happen, Dad?” Because, that’s the proper question.”

The proper question!  This is a big idea! This is something I’ve learned and written about and still I missed it until Asness pointed it out (and that his 12-year-old might know the answer).

Don’t substitute an easier question for the one at hand.

I nearly did this twice asking Is Bill Simmons a Superforecaster?.  

Kevin O’Leary uses a version of this in the Shark Tank to his advantage. O’Leary will make an early offer that effectively anchors the negotiations. It switches the entrepreneurs from talking about their valuation to talking about his.

What traders and comedians have in common.

A question that never gets answered in the interview is “whose money is Asness (or any trader) taking?” It doesn’t get answered because it’s hard to figure out.
The best you can do, says Asness, is think through know both sides. You know why you do something, but why does someone else take the opposite. And if you don’t know, know this. If you look around the poker table and can’t find the fool, it’s you.

Comedians use this system all the time. Judd Apatow,  Phil Rosenthal, Judah Friedlander and B.J. Novak all say that the key to good jokes is deep understanding. When you understand why you told a joke and why the audience gets the joke, then you really understand.

Thanks for reading, I’m @mikedariano on Twitter.

If you want to catch up on the last 20 posts, a Kindle copy is here.


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