The transcript from this week’s MIB: Blackrock’s Andrew Ang, is below.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest and it is filled – our conversation is filled with geeky goodness, Andrew Ang, head of factor investing at Blackrock, they run on a six point something trillion dollars.
And is really a born and bred factor investor, not only does he have a background in stats and finance from Stanford but he taught finance at Columbia and the opportunity to put his theories into the actual practice at Blackrock just proved to be too tempting, he had to leave the theoretical practice of teaching and working at Columbia that he really enjoyed to give it a shot at Blackrock, and it’s worked out extremely well.
If you are at all interested in quantitative investing, modeling, factor investing, anything remotely involved in the wonky goodness of mathematical theory and investing, you are going to love this conversation.
So with no further ado, my conversation with Blackrock’s Andrew Ang.
My extra special guest this week is Andrew Ang, he is the head of factor investing at Blackrock, the firm manages over $6 trillion. He comes to us with a PhD in finance and a Masters Degree in statistics from Stanford and he is the author of a book called “Asset Management, a Systemic Approach to Factor Investing.” Andrew Ang, welcome to Bloomberg.
ANDREW ANG; HEAD OF FACTOR INVESTING, BLACKROCK: Thank you, Barry. It’s a real pleasure to be here.
RITHOLTZ: Thanks for coming in. You have a really fascinating background, you spend the first half of your career in academia, what made you decide to transition from theory to practice?
ANG: Indeed, I was a professor for 15 years at Columbia University and ended as chair of the finance and economics division and was the Ann F Kaplan Professor of Business. What’s interesting is that my wife, she was born in China, her parents have this long very scholarly Confucian style tradition and the highest life form for them is a tenured professor at an Ivy League institution, and I thought I was absolutely crazy leaving that and coming to industry.
My parents on the other hand, they didn’t go to university they actually really don’t know still today what a professor does, what you mean you’re not teaching? You mean you’re on vacation?
ANG: And they were really proud of me for getting a real job, so the disparity in the …
RITHOLTZ: That’s interesting.
ANG: In the attitudes. Well one thing that was very interesting as my wife said to me, “Andrew, you’re a hypocrite.” Because I used to feel that a lot of academics and I was myself one, they are very theoretical but they believe that the world should operate in a particular way, of course the way that they study the world, but she called me a hypocrite because actually I believe so much that I accepted a job offer to come to Blackrock because I wanted to change the way that finance was practiced in accordance to the research and factors that I was doing.
RITHOLTZ: So let’s talk about that research a little bit, you’ve a background in statistics, you got a PhD in finance, that really lends itself to factor investing, that sort of quantitative approach is practically made for this, but I have to ask from your research how did you find your way to factor investing.
ANG: I was a professor and I did a lot of consulting while I was a professor, and I had the privilege of working for some very large institutions including the Norwegian Sovereign Wealth Fund and this is a very special fund, it’s $1 trillion today, it’s multiple multiples times the country’s GDP and they went through some tough times in 2008 like many institutions and I was tasked by the Ministry of Finance representing Parliament together with two other academics to take a deep look at the fund, just analyze it to see where the losses were coming from and to make recommendations.
And what we found was that despite this fund owning tens of thousands of securities, dozens of active managers what mattered at the end of the day where these factors broad and persistent sources of returns, macro factors like economic growth, real rates and inflation which comes through market cap indices and then relative to those market cap benchmarks, style factors like value and momentum, quality, minimum volatility, explain two thirds of the variation of these active returns.
And so factors really mattered, and it was entirely appropriate for Norway to have these exposures to these factors, it resulted in long-term superior returns.
RITHOLTZ: So let me jump in right here and ask this, you are reviewing a $1 trillion portfolio, you are really separating the wheat from the chaff, you’re identifying what the source of returns within that trillion dollar portfolio, do the managers of the Norwegian Sovereign Wealth Fund then turn around and say we’re going to move away from the parts of our portfolio that aren’t performing and towards where our outperformance is coming from or did they consider that diversification and they leave it as it was?
ANG: Norway has always used different sources of returns including fundamental analysis and they continue to do that, but what we recommended and they did adopt was to take a very top-down deliberate decision on these factors, and as a result, Norway started directly allocating to these factors to better understand the risks to enhance the returns and as you say, Barry, to improve the diversification.
RITHOLTZ: So they seem to be pretty well versed in understanding the academic literature, but out in the real world which is a fair statement to say, out in the rest of the real world, how does the way most people invest differ from what’s in the textbook? What are the big disparities between people who want the Norway Sovereign Wealth Funds and the average investor, what’s the difference in their process and in the results?
ANG: Great question, Barry, because I actually think there are more similarities than differences.
ANG: But if you have to think about and I used to be a professor and now you’re a practitioner, what are these differences?
ANG: A lot of people talk about implementation shortfall and a lot of other jargon, the difference with transaction costs and stale prices, stale data, but actually the real difference between academic and practice is you go to work with a lot of people to get these things to fruition. And as a professor, you are sitting there in your office, you are sitting there by yourself, often and you just do your own thing.
ANG: But to make a difference, you have dozens of people and teams that you’ve got to partner with in order to make a product come into an advisor shelf.
RITHOLTZ: Let’s talk a little bit about the best way to use factors, are they designed to manage risk or are they designed to deliver market outperformance?
ANG: Well yes, actually, I think factors should be used in all facets of the investment process. We definitely need factors to look at really what drives our return so there is an angle for risk management and I think your firm has exemplified that, Barry, but we also would like to use factors to enhance our returns as well, and we can do that with value, quality, momentum, size, and combinations of these return enhancing factors, we can also use practice to target specific outcomes like minimizing our downside risk exposure through minimum volatility strategies.
Factors can be used for all of these and what’s really exciting is that we can ask what’s the outcome you want to achieve perhaps is greater diversification or portfolio resilience and we will have some combination of factors that’s right for you.
RITHOLTZ: So here’s the question that always comes up when I discussed factors with other people. It seems once everybody discovers a new idea, its power has a tendency to sort of fade away. Now that we know so much about factors, we know about value, we know about small-cap, we know our quality, why hasn’t that been arbitraged away? How is it that long-term factors still deliver some degree of outperformance?
ANG: Ultimately that’s a question of who’s on the other side because not everyone can buy cheap for every value stock that’s cheap, there’s got to be a stock that’s relatively expensive.
ANG: The economic rationales behind all these factors are the same reasons why we think that these sources of returns are going to persevere for a long time and there are three. There’s a reward for bearing risk, a structural impediment, and investors’ behavioral biases.
RITHOLTZ: So wait, before we get to the first and the third one which I have a feeling I know what you are going to say, tell me about the second one, what is the structural impediment to buying cheap or buying quality?
ANG: Well, for value there is no structural impediment because you can buy cheap, but for minimum volatility though…
ANG: This is where structural impediments come in. And if we look at the United States, there are a large number of very large funds, a lot of public pension plans but also other large institutions that have high total return targets but a lot of restrictions on what they can do with their investment policies.
Some of those institutions will gravitate to higher risk stocks in an attempt to meet those high total return targets and then underweight the low volatility or low risk stocks and that gives rise to minimum volatility strategies.
Now if that structural impediment disappeared and suddenly all those institutions had much more flexible investment policies, then perhaps we might see minimum volatility go away. But let’s go to the first and third of them, right? Well, what about reward for bearing risk? And here I’ll give value as an example since you raised this before.
RITHOLTZ: Or small-cap because I keep having discussions with people who insist that the small-cap premium is all risk and I’m not sure through that.
ANG: And it is largely risk, then resume, but that’s a risk that you should be comfortable bearing and will result in the long term with compensated high returns. Now value, a lot of value companies are a little bit old-fashioned, they often manufacture things or produce services, they are very good at that often with a lot of fixed of physical capital and when you get into a late economic cycle or an economic recession, it’s very hard to change what your factory is currently manufacturing.
ANG: And so not surprising, those value firms tend to underperform. Those fixed costs all of that physical capital give those value companies economies of scale, they tend to perform the best coming out from the recessions in the recovery. Now, you can’t stomach these cyclical losses in value absolutely no doubt has had a pretty rough ride of it over the past couple of quarters consistent with where we are on the late economic cycle, if you can’t stomach that underperformance, then well, value is not for you, but for those who can bear those risks of short-term underperformance, you will be compensated with a long-term value premium. That’s the reward for bearing risk.
RITHOLTZ: So how long is long-term because since the ’09 crisis ended, value is under underperform growth, that’s a solid decade, we’ve been having an argument in my office, is it one decade, two decades, it goes quite a while since value has consistently outperformed growth, what is the long term for a factor manifesting itself as alpha?
ANG: You know, these cycles can be 3 to 5 years, but over the last 10 years, value has outperformed, if we give a little bit of a story coming into 2016, that was a really great year for value, in fact, particularly in the last part of the year, started before Trump’s election in November.
ANG: 2017 Valley was pretty much flat and then 2018, there was tremendous underperformance, it was so bad…
RITHOLTZ: Until the fourth quarter, the fourth quarter, value had a…
ANG: 2017 quarter four, and then through 2018 we saw those losses accelerate, we find that 2018 to now where in May 2019 is the fourth worst value drawdown.
ANG: Fourth worst value drawdown in almost 100 years of data using the data set that starts in 1925 constructed by Nobel prize-winning Gene Fama and his longtime co-author, Kenneth French. Isn’t that amazing?
RITHOLTZ: Fourth worst…
ANG: Fourth worst in a century.
RITHOLTZ: That’s quite fascinating, well again fourth quarter of 2018 when the market S&P fell about 20 percent, we saw the value indexes do much better, they fell a little bit but not nearly as much as the growth indices, the FANG stocks got shellacked in the fourth quarter but here we are pretty close to near all-time highs and it looks like growth has kind of caught up again.
So is the expectation we’re going to see some serious mean reversion and at some point in the not-too-distant future?
ANG: Well, I believe in value, I’m a value investor, we do need to stay the course.
Let’s put that fourth worst drawdown in context, so it’s not unprecedented, there are some worst times and if we look at the top 6 to 8 episodes of really bad value performance, they are characterized by an environment like what we’ve had, late economic cycle except our cycle today has perhaps been very prolonged to be in this late stage I mean I think that’s a separate macro …
RITHOLTZ: Post financial credit crisis.
RITHOLTZ: Fed intervention, et cetera …
ANG: …monetary policy.
RITHOLTZ: Right, that makes sense.
ANG: And all the rest of that.
We also see some very severe recessions, there are two episodes in the 1930s as well that on but the worst one is the late 1990s, in fact 1999 and we’re about half as bad as 1999.
RITHOLTZ: So let’s talk a little bit about fixed income investors, are they actually beginning to use factors now?
ANG: They are, and we’ve just introduced a few fixed income factor ETFs.
That is part of the next evolution is pushing these time-tested concepts of like buying cheap and finding high quality names, finding trends, but pushing that from where it’s been, mostly equities to fixed income and then to other multi-asset applications like currencies and commodities and then also to go invest in a long short manner as well. Fixed income, it’s right there in the frontier.
RITHOLTZ: So when I think of factor investing, I think of cap size and I think of quality and I think of price namely value, are you creating parallel versions of this for bonds? I mean are bonds cheap or expensive as they function relative to the combination of their credit quality in their forward expected cash flow based on — will this default or not, how do you determine value or is it yield relative to what the 10 year treasury is doing?
ANG: All these factors are broad and persistent so they are seen in many different areas. But you do need some research to apply it in these different asset classes. So value, it is all about buying cheap relative to intrinsic, but what’s intrinsic or fundamental value for a bond?
And so we can measure apply value by looking at the yield of a bond, all that’s equivalent to price.
ANG: But we might now have intrinsic value versus a forward rate curve, or versus an option adjusted spread for example. But we can apply the same concepts, price or yield relative to a measure of intrinsic value.
RITHOLTZ: How does that is the risk-free treasury fit into figuring out what value is for a bond?
ANG: The risk-free rate operates across these different asset classes and it’s a base rate, it’s sort of like the opportunity cost, instead of parking your money in the bank, well, we are now going to take risk and we are going to be rewarded for it. So it’s common across asset classes. Now, the risk-free rate though in fixed income gives you a term structure, and the term structure will translate into different factor strategies.
So some people will talk about curve or rolldown, that’s certainly a part of our income investing or carry, we can also talk about risk rates affecting different countries and so now we think of an international version of our fixed income factor investing as well.
RITHOLTZ: Since we’re talking about fixed income investing, there’s now about $12 trillion of bonds that carry a negative yield, here I’m going to lend you money and on the pay you to hold my cash for me, how does that figure into factor investing for bonds and what does this say about the world of the cost of capital?
ANG: I am almost guilty really because a lot of academics spend an enormous amount of time writing down very complicated models to ensure that interest rates remain positive, but right now, they are not positive, it’s almost like all that literature could’ve been thrown up.
But most seriously, most seriously, what’s really relevant here is the real rate rather than the nominal.
RITHOLTZ: Relative to inflation.
ANG: Relative to inflation and there we have seen many episodes of negative real rates and some of them I’ve worked with some co-authors in papers about. The second is that if we think about the negative yielders that you invest in bonds and you’re going to lose money, but we’ve had debt consolidations, we’ve had demonetizations confiscations in the past, in the United States, we’ve actually seen some wealth disruption in the 1930s, we had a ban on individuals holding gold, and that is a near money substitute or at least it was at the time because we were on the gold standard.
So these negative yielding in a much broader context, it’s actually we’ve had these episodes before. Factors will continue to have a place in this period, I think you still want to buy cheap, you still want to find these trends, you want high quality names, probably that’s more important than ever, and you want to have portfolio resilience and we can hold a combination of factors to help these investors.
RITHOLTZ: So you mentioned the evolution of factors and the evolution of new products, what do you see coming down the pipe, what sort of stuff — we’ve been hearing for a long time about these 130 30 portfolios, these long short ETFs, what are the next things that factor investing is going to drive from the product side?
ANG: We talked about some of these already, pushing out these concepts from equities to fixed income and other multi-asset classes, but I think the real gains will come from applying data and technology to the mom and dad sitting across the table from a financial advisor. And my vision is that if you’re having that conversation with an individual and that individual says I’m really worried about losing my job, they are making a statement about economic growth and we can have some factors to help hedge that bad outcome.
RITHOLTZ: What’s a day in the life of Andrew Ang like?
ANG: What does that mean? Leading factor investing at Blackrock means I talk with a lot of people, I have the privilege of working with some really talented people and I feel like a little kid in a candy store.
ANG: Because there is all this great data and technology at Blackrock and we can put things to work and introduce new products and make it happen and have some factor analytics data and technology all based on factors as well.
RITHOLTZ: So let’s talk a little about your book, this is a serious quantitative work, tell us how the book came about and who’s it for?
ANG: I wrote the book after working for several large sovereign institution, sovereign wealth funds, sovereign pension plans, and I talked all about factors and I wanted to bring all of that knowledge that just even a decade two decades ago were only available to really large sophisticated institutions, and I wanted to democratize access, in fact, that is our mission statement, is to democratize the broad and persistent — democratized access to factors.
And this book really put into context which case studies based on some of those — some of those institutions, how to use factors in portfolios.
RITHOLTZ: So you said factors plural, and you mentioned Gene Fama before so the original Fama French model was three factors, right.
RITHOLTZ: Then we got the five factor model than the seven factor model and some people have made the claim that and I’m a little skeptical that most of these are of really significant value that there are 400 or 500 factors, some people said a thousand factors, how many factors are there and how many really can be implemented?
ANG: There are half a dozen macro factors and half a dozen style factors. Macro factors drive returns across asset classes, the big three economic growth, real rates and inflation and they explain about 85 percent of the variation of returns across these different asset classes, even private markets.
RITHOLTZ: Give us those three again.
ANG: Economic growth, real rates, and inflation, those are the big three.
And within each different asset class, within equities, we can find pockets of securities that over the long run have resulted in higher risk-adjusted returns, those securities that are cheap or high quality that we talked about earlier and we can find those same patterns in bonds and in commodities, we can even find them in private markets like private equity and real estate.
Those are style factors and they operate within an asset class. And in equities, we think of value, quality, momentum, size and minimum volatility. Now, the criteria for these and why there’s only like half a dozen macro, half a dozen style, there are four criteria that whittles down the potential hundreds or thousands to just these narrow — just this narrow set, the first is that economic rationale that we talked about earlier, reward for bearing risk, structural impediment, or behavioral bias.
We want very long histories and that removes basically most of this.
RITHOLTZ: Really? A lot of these don’t have…
ANG: Don’t have decades’ worth of history we would like that so that it informs how we can build those strategies and offer them, we want differentiated returns particularly with respect to market cap benchmarks, what is it giving us that’s– that is different and then finally we want and this is a choice for Blackrock, we want to be able to offer these in scale so that means we can possible low cost to our clients.
After imposing all those four criteria, we’re only left with that half a dozen macro and half a dozen style.
RITHOLTZ: Quite interesting. So what is next in factor land? Are there any yet undiscovered factors out there that might fall into either of these two half-dozen groups or have we pretty much squeezed all the juice out of the orange at this point?
ANG: There’s always continued development, but I think it’s a little bit like Shakespeare, you know, wrote some great plays and sonnets back in Elizabethan times, did that with quill and ink.
ANG: We still have – he will be writing screenplays today, perhaps we have some streaming TV and other things like that, but there is still character and plot…
ANG: But it is done in different forms and we want to involve buying cheap, finding trends, so the implementations of course will change, we can do this better with more efficient data and technology to lower transaction costs. We would also like to see how we can use them in portfolios, factor analytics, factor allocation that I talked about earlier. All right? That’s really what’s new.
We’re always going to have these half dozen macro and half dozen style.
RITHOLTZ: So you wrote a white paper that I want to wonk out about a bit, the title was what does the yield curve tell us about GDP growth? And there’s a professor at University — at Duke University who has a recession forecasting model which has a perfect track record or at least in the limited time it’s existed, it’s been perfect, the fourth factor and his model is the inverted yield curve, he uses the five-year and the three-month and only when it’s inverted for a substantial period of time which in his measurement is 90 days, a full quarter, last week we passed that, we’ve already been inverted for that period of time.
So I’m curious about what you found what the yield curve means for future GDP growth, he suggests it’s an indicator of recession 12 to 18 months later. What did you find?
ANG: The yield curve has a lot of information about future economic activity and there’s always been a slow down after a negative, there’s always been a slowdown following a negative yield curve.
RITHOLTZ: Meaning – to an inversion.
ANG: Around two to six quarters afterwards, meaning an inversion, there’s been actually one false positive and it’s in the late 1960s but there was still a slowdown in that period, and that’s old paper, Barry, that you brought up, and we actually show that in addition to the term spread, when the negative term spread forecasting, poor economic activity, the level of the interest rate was also pretty important too, and interest rates are fairly low now and they have actually decreased over the last couple of months around the world.
The level of that yield curve also forecasts slowdowns.
RITHOLTZ: So it’s not just the inversion but inversion from a relatively low level also has a negative connotation …
ANG: Well, both the level, low levels predict slowdowns and spreads, negative spreads also predict slowdowns.
RITHOLTZ: So why would low levels predict a slowdown, is it a function of demand for capital that’s used by an expanding economy or something else?
ANG: There are several explanations here, I will just give one by John Taylor the Taylor, right? The Taylor Rule when …
RITHOLTZ: Is that still in effect, I thought we sort of — didn’t we repeal the Taylor rule?
ANG: We have used it as the basis for many different policy and macro models just perhaps not in its purest form …
ANG: John Taylor 1993, but it’s gone through various iterations and I think the intuition is still sound. Policymakers generally will raise interest rates when we’re in very good times, inflation tends to pick up there and we want to take the punch bowl away.
During bad times, policymakers tend to lower interest rates to stimulate economic activity and all these types of policy interactions will give rise to when bad times come, interest rates tend to be lower.
RITHOLTZ: So that sounds a little bit like policymakers are engaging a little bit of market timing themselves. Let’s talk about another paper of yours where you look at factor timing and timeseries, can an investor use factors as part of a market timing approach, are there better a worse times for some factors or should it just be full factor diversification across the board?
ANG: That’s a paper we just published in the “Journal of Portfolio Management” not so long ago, investors should start with a long-term strategic combination to lots of factors, don’t hold just one, if you hold just value, well, I felt it, you felt it.
ANG: Over the last couple quarters, it’s been painful, we want lots of practice for diversification but around that long-term strategic multifactor combination we might think about tilting and I like the word tilting rather than the word timing because sometimes timing has these connotations a really short-term global macro …
RITHOLTZ: All in, all out.
ANG: Yes, that’s not what we’re about. But around the strategic benchmarks, you might tilt, and the paper gives a framework to think about how to do that. So first factors become rich or cheap just like every asset.
RITHOLTZ: So wait, so within let’s say the value factor which is looking at stocks that might be expensive or cheap, there are times when that factor itself is expensive or cheap.
ANG: That’s correct.
RITHOLTZ: So it’s a second derivative, removed once from the underlying cheapness of the equity.
ANG: Well, now I’m going to blow your mind because that’s true for momentum, momentum also holds momentum, too.
RITHOLTZ: So momentum has momentum.
ANG: Their value momentum, value momentum in fact value momentum of each factor, but that’s why…
RITHOLTZ: By the way, that’s the most interesting thing I’ve heard today, I just have to share that with you now that that each of these have a derivative that is reflective, it’s almost like a Mandelbrot reflectivity …
ANG: Or high-level meta-factor if you might.
RITHOLTZ: Meta-factor, okay.
ANG: Yes, so there are value and momentum effects will pull that second one relative strength …
ANG: Because we want to measure these trends of these factors to each other.
RITHOLTZ: I know that stocks can be cheaper or more expensive at different times but I always assumed, hey the bottom least expensive let’s call it a third of stocks is always going to be cheaper than everything else, I never stop to think that sure they are relatively inexpensive but on an absolute basis, cheap stocks can be expensive, that’s that meta-value is really quite fascinating, how do you incorporate that into what you do?
ANG: Barry, that is such a really deep common that you’ve just made because value is always cheap, so what you mean about using value for value? So what we really mean here is if we take the value factor how cheap is value currently relative to how cheap it’s been in the past?
RITHOLTZ: It’s own history.
ANG: It’s own history, right?
And then we can also compare how cheap value is to other factors and if you are a quant, you would call this a time series and cross-sectional score.
ANG: And that also applies to relative strength of momentum because momentum by definition, the momentum factor always has the most momentum.
ANG: So what you really mean here is what’s the current trend of momentum relative to the past trends that momentum has had and then once the relative strength of my given factor relative to the trends of other factors, again it’s this time series and cross-sectional …
RITHOLTZ: So in other words, it’s which factor is doing the best relative to other factors?
ANG: That’s right and so we actually put all these and one of the talked about the bit before about the frontiers of factor investing is factor investing is really about taking active insights, things like value and momentum but we can also apply them in other active ways, factor tilting is one of those ways.
RITHOLTZ: So let’s talk about that because years ago there were number of models that came out and then into factor tilting they try to do sector tilting, they would rotate within the S&P 500 within the different groups, they will go from technology to healthcare to finance and they always sounded great on paper and in the real world, they didn’t do so well.
So on a — on this sort of factor tilting model, how can you capture in real time those benefits, aren’t you always going to be lagging, what do use as a signal to say right, all right now is a time to overemphasize cap as opposed to quality or it is there too much of a lag to capture that, or do you get enough of a heads up, hey here’s the direction this is shifting you can move some of the portfolio quickly enough to take advantage of it.
ANG: Well, I believe all types of tilting, they are hard, and factor tilting it’s hard, too, but done in a disciplined way, there’s a couple of differences to country or sector rotation, so they are nice complements. So often we like to apply factors within a particular sector or within a particular region, so that gives room for factor rotation to sit side-by-side with these others.
Second is that exposure to sectors over the long run in fact actually the cap end works fine, there some academic papers on that, too. If we take a strategic portfolio that buys cheap, finds trends, finds high-quality names, all right, all those factors, those are long-term determinants of performance, whereas static sector exposure while actually the market has sectors might as well do that. But these factors, the strategic tilt gives you an uplift over the long run in it of itself and then around that, you might incrementally add returns, with the factor rotation.
And a third difference I think is that with these factors we can employ them in different ways, so we want to do this transparently, we have this paper, we have introduced some products, we want to be active with factors, let’s not just use one signal, let’s look at definitely at how cheap something is, we talked about relative to strength as well, we will use the economic regime, measures of the opportunity set or dispersion but we want to use all of those insights together.
RITHOLTZ: So let’s talk about something not market timing but factor tilts, if I had — could have my way I would at the end of recession, lean as heavily towards growth is I could, not always easy to do, everybody’s miserable, no one wants to hear you in March ’09 say “Okay, now the time to buy the growth stocks” that have done nothing but get killed for the past two years.
And towards the end of the cycle, and that assumes you know when the end of the cycle is in advance, typically we don’t know until after the fact, gradually move that tilt away from growth towards value, because if your charges you must be fully invested at all times on the equity side, the assumption is that in any sort of recession, be it a mild recession or something like ’08 ’09 or 2000 to ’02, you are going to see growth get shellacked and value is going to hold up much better and I can’t help but recall hearing ’97 ’98 ’99, this Warren Buffett guy is washed up, that sort of value crap is never going to work again.
And as people said that was really when he began another period of huge outperformance.
So first, is that something that you can accomplish with tilts and second, how do you get the timing right?
At the end of a market crash, it’s pretty clear when you close let’s say closer to the end than the beginning, so whether it was January ’09 or June ’09, anywhere in that range, you are pretty close to — you are much closer to the end of that in the beginning, how does one make that determination that we want to tilt towards growth here and here’s how to do it and then at the other end the cycle, hey we want to tilt more towards value here and here are the signals that send us that.
How would one do that?
ANG: Let’s remember first, diversification, diversification, diversification, that’s the key.
RITHOLTZ: Okay, so you have …
ANG: It’s really hard to, I think to call anything with precision or make decisions about individual factors or any type of investment, diversification is the key and that provides that long-term strategic benchmark. But around that if you have the risk tolerance and the capability and be active with factors, then would like to use information about how cheap a given factor is, would see if the factor’s trending up, right? Versus trending down, in fact value has been trending down over the past couple of quarters, but value is cheap today.
I would also like to see where we are in economic cycle, the fact that were in that late stage where we said that value firms tend to underperform, that’s not very favorable to value.
We also look at dispersion, dispersion for value, it’s okay but it doesn’t scream like it’s a big buy. We use all of those together and then we’ll have an aggregate view on these different factors.
RITHOLTZ: Quite interesting there were a few other questions I want to get to before we get to our standard question, we mentioned value stocks underperforming, I saw something recently that said they’ve underperformed for 25, 30, 35 years, is that remotely correct?
ANG: No, no…
RITHOLTZ: That seems wrong, doesn’t it.
ANG: In fact, they have outperformed in the last 10 years, but they have been difficult periods …
RITHOLTZ: Under the past decade, growth has outperformed …
ANG: In the past decade, actually, value has done quite well.
RITHOLTZ: Value since ’09?
ANG: Value yes, value over the past two years has suffered.
RITHOLTZ: Okay, that’s interesting though. I have looked it value as let me rephrase that, I’ve looked at growth as doing exceedingly well since the end of the financial crisis, think about Amazon at $8 and Apple at $12 or whatever their prices were and they’ve all exploded and I guess there categorized as growth although at those prices you can really call those value stocks.
ANG: You know, that is a great point at it echoes one of the topics that I wrote about recently in my blog at Andrew’s Angle and its “growth is not the opposite of value” and we kind of use the word well certainly value for cheap…
ANG: We’ve used the word growth to denote expensive, but actually there’s two other connotations of growth which are quite distinct from the opposite of value. And the first one is that a lot of growth managers will search for trends and you’d actually like a trend to be sustainable and that’s an aspect of momentum investing.
ANG: And that’s rewarded over the long run.
RITHOLTZ: Another aspect of growth is something that you alluded to his what’s the quality actually behind that and indeed if you look at many growth funds, certainly they will load many of them on momentum and quality factors. Growth itself is not the opposite of value but I think you don’t want to buy expensive.
If the stock does tend to be more expensive, that is not value, it might be justifiable because it might have aspects of quality or momentum in there.
RITHOLTZ: So when you are defining something as a growth stock or a value stock, you my frame of reference is there’s the S&P 500 growth group, the S&P 500 value group, and never the twain shall meet but I suspect you might take issue with some of the stuff they call growth and some of the stocks…
ANG: And I think it’s a little bit more nuanced, I would call the first generation exactly just splitting the thing into two.
ANG: And today we would think a little bit harder and many stocks will have aspects of multiple factors within that same stock.
RITHOLTZ: So let’s talk a little about back testing, we’re really going to go deep into the weeds here, it seems that a lot of back tests show these great returns for different combinations of factors and then implementing them in the real world becomes challenging, you mentioned the problems with organizations and getting everybody pulling in the same direction, but there have been instances of small hedge funds, quantitative hedge funds that try to implement these and momentum is a perfect example, momentum has some real application in real portfolios but it seems the back testers are always much better than the actual implementation.
What is it about momentum and some of these other factors that makes it so challenging to capture what theory says in practice?
ANG: Momentum has pretty high turnover, all momentum funds run a turnover above 100 percent, significantly above.
ANG: And because of that, transaction costs are crucial so you see some research in the literature that says actually we can’t really do momentum in practice and some others that will say well if you’re very good at transaction costs optimization.
ANG: And you have access to transaction cost minimization in your execution then momentum will be a favorable and profitable factor.
So it’s really key that you have to really look at the details once you implement a factor.
RITHOLTZ: The devil is always in the details. Let’s look at another one. Theoretically high beta stock should do really well but your research in as implemented at Blackrock has found low volatility stocks have done well. Why is it that the high beta stocks aren’t capturing those gains once you have a portfolio implementation, it’s the low vol stocks that seem to be doing better?
ANG: And this is a paper that I wrote in the 2000s and this paper I’m lucky and very fortunate that has played a really important role in building out the minimum volatility and factor industry more broadly, and you have hit on the key note here that the in theory, we should have higher risk, stocks should have higher returns, but actually we found the opposite.
And in the paper, my co-authors and I said the high risk stocks have quote “abysmally low returns” unquote.
ANG: Abysmally low.
ANG: And if we rank stocks based on risk and we did this by volatility idiosyncratic and total volatility than paper, subsequent papers did this by beta or downside risk measures, the general patent is that stocks have the same expected return and then as the volatility increases, there’s a very steep drop-off in returns for the very highest risk stocks. And that’s actually this low volatility effect.
If you construct a portfolio of minimum volatility and you can do that by holding low beta stocks.
ANG: Or stocks with low idiosyncratic risk or both, you form a portfolio of low volatility that gives you the same return over the long run as the market, but it does so with reduced risk.
The capture ratio (ph) is high not because of the numerator or the high expected return.
ANG: But it’s because of the decrease in the denominator the reduced risk.
RITHOLTZ: So if someone were to come to me and say listen I could give you market returns but much lower drawdowns, much lower volatility, of course I’m going to say I want some of that, if you’re not to get outperformance for the same volatility, well the same performance for less volatility, that seems like it’s much more livable for the average investor.
ANG: I think that’s one of the great benefits for minimum volatility strategies, it just helps an investor stay the course, so you are not subject to those tremendous swings practically on the downside and we can mitigate some of that downside risk with these minimum volatility strategies.
Upside downside capture ratios for minimum volatility and it’s all about trying to participate in as few as possible of these drawdowns, around 50 percent downside an 80 percent upside for these downside upside risk capture ratios.
RITHOLTZ: That is really quite interesting.
So one of the questions I mentioned to somebody I was speaking to you and they asked a really interesting question, do you consider factor indexes to be closer to the active spectrum or closer to the passive end of the spectrum? Where do you put factor investing on that continuum from active to passive?
ANG: This is another one of these yes questions.
RITHOLTZ: That’s right.
ANG: You know, this is a bugbear of mine, I have to say Barry is that everything is active and it’s just a question of greater or lesser degrees.
RITHOLTZ: I totally agree, I written and discussed that even the basic S&P 500 somebody made the decision.
ANG: That’s right, that’s a bunch of active decisions about what’s …
RITHOLTZ: It’s market cap rated and where do you draw the …
ANG: And what’s the free flow and what gets in there.
RITHOLTZ: That’s right.
ANG: And then, well, do you use the S&P 500 versus some other index, right? And then you know, when we go to other asset classes, it’s almost all active implementation. Right. So I think I’ll like to rephrase that question if I may?
ANG: On the difference between index or average, right? And then taking deviations from there.
ANG: And in this context, factors are absolutely active, we are tilting towards broad and persistent sources of returns, we don’t want to hold a market cap portfolio, we would favor overweighting stocks that have low prices relative to intrinsic value, those stocks that are trending up, right? Those stocks of high-quality earnings, and those are active decisions.
But we are doing it in a transparent way, it’s low-cost, we can put it into an easy to access fund, right? And we can put these insights into multiple asset classes, too. So you keep referencing this is being done in a transparent way, why is that important because I look at places like DE Shaw or Renaissance Technologies that have generated outperformance for decades, they’re not transparent, those are their secret sauce that goes into their alpha generation.
Why does Blackrock feel we’re creating something and we want to be completely transparent in this product?
ANG: I believe in active, I believe in alpha, and I define these factors as broad, you see them in many places and persistently rewarded, we’ve got decades of academic research behind that.
RITHOLTZ: So is this a peer-reviewed approach to investing?
ANG: Now alpha is actually not broad and persistent, right? Require specialized skills like the firms that you talked about, our firm too will use sophisticated techniques with big data and machine learning, you could have a fundamental approach that knows a lot about just a few stocks, right? The complete opposite of broad, and those when you find those schools, you should reward them, sometimes you might be able to generate alpha insights by taking advantage of very short-term high-frequency market dislocations.
When we find that school, we should pay up front but those things that I’ve been in the literature for decades that have been well studied that the game is all about implementation and efficiency, well, I don’t think we should be paying very expensive fees for that, we should be giving control to the client, we should be paying less and getting more and that’s where factors come in.
RITHOLTZ: So where does the transparency on some of these new models come in? Why share your findings as opposed to keeping it secret.
ANG: We believe in sharing and we know that these factors are going to endure because of that economic rationale, right? There is always going to be that reward for bearing risk unless the structural impediments get removed, they are going to be there and investors, well, they are going to be investors, there’s going to be these behavioral biases.
ANG: As long as these economic rationales endure, these factors are going to be with us, they are going to be cyclical, absolutely, so sometimes there might be room for factor tilting but these factors are going to be with us for decades to come.
And let’s share this and democratize access to all of this, that’s all-purpose, and we can do that so that you understand what’s inside, how we exactly buy cheap, and we want to make sure that you see it so sometimes you might want to have position level information available, it helps you fit that with the rest of your portfolio or integrate it with data and technology and you might have better risk management.
RITHOLTZ: I think that approach is unusual, not a lot of firms the size of Blackrock are comfortable sharing their research, although I guess Blackrock could say hey we’re so big, we’re so efficient, here, here’s the secret sauce, you can never do this as cheaply as we could anyway. I’m — that’s my words, I don’t mean to put words in your mouth.
ANG: We always put the client first.
RITHOLTZ: So – but you, but I mean not to the clients, to competitors, to other people who might say oh here’s new paper from Blackrock, let’s see if we can find something to implement from this, I find it to be a typical although I guess that’s not lots of firms publish white papers, lots of firms do that so maybe I’m over emphasizing the transparency aspect of it, I just find that intriguing that the secret sauce from a particular group of funds, you guys are that open with and I guess I think …
ANG: I think maybe you would agree with my wife when you come a hypocrite because I am the ultimate true believer.
RITHOLTZ: There you go, so that makes a lot of sense to me.
So let me jump to my favorite questions this is our speed round and we ask this of all our guests, let’s start with a simple question what was the first car you ever owned, year, make, and model?
ANG: Toyota Corolla 1983 1.6 liter, kind of maroon color which is really fortunate because the amount of rust in there, you kind of…
RITHOLTZ: You couldn’t see it.
They always make good cars but in the early days, that was a very thin metal and it …
ANG: It was a rust bucket.
RITHOLTZ: Right, it happens a lot, I remember those.
ANG: I drove the car across Australia.
RITHOLTZ: Really? Where are you originally from?
ANG: I was born in Malaysia and during the late 1960s and early 1970s, Malaysia went through a series of race rights and my parents wanted somewhere safe to raise their family and then White Australia policy ended and that was actually the official name of the policy.
RITHOLTZ: White Australia Policy.
ANG: It was ended by Gough Whitlam, Australian Prime Minister in 1973 and we were one of the first Asian families after the White Australia Policy to move to Perth, and I remember growing up, I was the only nonwhite kid in class …
ANG: And I was really different kind of marked my whole world view, factor is really all about …
ANG: Looking through and being different, too.
ANG: I did well in school, I was so thankful for the opportunities that that were given to me and then and I ended up in the US for graduate school, got to work on the Scandinavian portfolio as a professor and you know now I’m like every other person who lives in New York City.
RITHOLTZ: That’s so interesting.
So I was going to ask you a question, what’s the most important thing we don’t know about you but I suspect you may have just …
ANG: I don’t know, I’m a musician.
RITHOLTZ: Really? So what do you play?
ANG: I play the piano, I am a classical pianist, I used to play the violin but I’ve always loved the piano more, I’ve played in a few Blackrock corporate band so I’m trying to expand my musical genres.
RITHOLTZ: Away from classical towards ….
RITHOLTZ: So have you ever done like full classical concertos? Have you played for audiences? How far did your music career tell you?
ANG: Yes, I can play those.
ANG: That doesn’t mean I’m very good at it but I love playing.
RITHOLTZ: So tell us about some of your mentors, who helped develop the way you think about markets?
ANG: I would like to answer that in two ways, the first one is like who do I model myself on in Blackrock running a business man trying to change the world with factors and that person is Walt Disney.
ANG: It’s not investor, but if we look at Walt Disney he didn’t invent animated films, he didn’t invent amusement parks right or people dressed up in different characters, but what he did he brought all of those together and he just by integrating all that, created something new, and that’s actually what factors are doing, too, we didn’t invent buying cheap.
ANG: Right? We didn’t invent momentum but bringing all those together with data and technology, yes we can remake the world and give people a better experience.
RITHOLTZ: Interesting, just a footnote, I was at Disneyland two weeks ago, it is the first time I’ve ever gone to any Disney property and it’s quite the experience to — in your 50s experience a Disney park for the first time.
ANG: For all ages, it is the happiest place on Earth.
RITHOLTZ: And I basically any ride I don’t care fast upside down, doesn’t matter, I’m right there and we had a blast, it was absolutely — you can see why, now, I kind of get Disney, this makes a lot of sense.
ANG: But for the other mentors, I was pretty nerdy as you can tell.
RITHOLTZ: Wait, nerdy? I have not noticed. In his book on quantitative factor investing.
ANG: The 850 page…
RITHOLTZ: Right, I did not notice anything nerdy here at all.
ANG: And when I was in school, high school I got to go to national mathematics summer school, that was just an eye-opener for me that there were people kind of like me that like math and it really changed my life.
RITHOLTZ: So let’s talk a little bit about investors, who influenced your approach to investing, who were the folks that really shaped your investing worldview?
ANG: If any reader or listener out there hasn’t read Graham and Dodd, “Security Analysis” those were two professors at the institution I taught at for many years, Columbia University, you got to read that book, it’s the basis for value, quality is in there because they teach us that in order to estimate intrinsic value, you got to use the more prominent components of earning, things that we use in quality today. I have to mention Bogle, when I met him for the first time, he actually was citing some things out of my book, particularly that chapter on the governance or agency theory.
And one other person is Joel Greenblatt, just to look at …
RITHOLTZ: Oh sure.
ANG: How to look at a systematic approach to some …
RITHOLTZ: Gotham Capital, yes, he is a very interesting guy.
So let’s talk about books, what are some of your favorite books be they market related, not, fiction, nonfiction, what have you enjoyed reading?
ANG: I like reading popular science books.
ANG: My most recent one is by Sy Montgomery called “The Soul of an Octopus”
RITHOLTZ: I love that book.
ANG: Amazing creatures, right, and they just look so alien but they are emotional, very intelligent, like they are more like us than we think.
RITHOLTZ: I’m going to tell you something, I read that book and I stopped eating octopus afterwards, it basically and I eat pretty much everything except cauliflower and Brussels sprouts, that book is the first thing I’ve ever read that said…
ANG: I try not to eat Brussels sprouts either.
RITHOLTZ: I can’t eat octopus anymore, they’re just too intelligent and too soulful.
ANG: One of the things about popular science books that I like is even for the areas that I’m familiar with and in some cases you would say be in the weeds within the research, you always learn something from them because the best ones just present information in a new way, or they just open up your frontier completely.
RITHOLTZ: A hundred percent.
ANG: Like the Sy Montgomery book.
RITHOLTZ: A hundred percent. Give us another.
ANG: I think, I like a some popular books on number theory.
ANG: And just physics and sciences in general.
RITHOLTZ: Let’s hear some titles.
ANG: Well, one of them is “Moonshot” it’s about the American …
RITHOLTZ: The Apollo mission.
ANG: Space race, yes, it’s amazing book as well.
RITHOLTZ: “Moonshot” that’s – who wrote that?
ANG: I can’t remember the full title right now.
RITHOLTZ: Let’s have Google rescue us while …
ANG: And then you can mention it.
RITHOLTZ: “Moonshot” and then we will edit this out.
ANG: It’s a pretty long title.
In fact that “Soul of an Octopus” is a pretty long title too.
RITHOLTZ: So by the way, while I’m looking for this, I recommend that book to my friend David Nadig who send — sent me that book and said thanks for the recommendation, that book made me cry.
ANG: There is another one …
RITHOLTZ: “Moonshot What Landing a Man on the Moon Teaches Us About Collaboration….”
ANG: Yes, that’s why I don’t remember.
RITHOLTZ: Richard Wiseman.
ANG: Yes. There is another one very similar to Sy Montgomery’s book, too, called – by Frans de Waal called I think “Mama’s Hug” “Mama’s Last Hug”.
RITHOLTZ: “Mama’s Last Hug.”
ANG: It’s about the great apes and their intelligence and emotional capacity.
ANG: You might enjoy that one too.
RITHOLTZ: I’m going to put that one, I put all these on my list, but if you like that, have you ever read “Last Ape Standing”?
RITHOLTZ: So it’s basically about the 30 or so proto-human species that had come out you know, you know, Cro-Magnon, you know Neanderthal, but you don’t know there’s 30 others and how close they all came to being wiped out in the Ice Age and how this particular species…
ANG: “Last Ape Standing.”
RITHOLTZ: “Last Ape Standing” the Homo sapiens ended up being the ones who survived and eventually took over, but if you’re at all interested in nonfiction, I always recommend that book.
ANG: Thank you.
RITHOLTZ: I’ve I found that delightful. All right, so we have three books, let’s jump to failure, tell us about the time you failed and what you learned from the experience.
ANG: I turned up at grad school, I went to Stanford and I did pretty well my undergrad, won a University medal, wrote a dissertation, you know, Dunning Kruger kind of effect …
ANG: And you get to grad school …
RITHOLTZ: That is high levels Dunning Kruger.
ANG: Such a humbling experience, I did so badly, I thought about withdrawing I had to take all these classes in the statistics department, that’s actually why have this Masters of Science in Statistics is just because I was in the remedial program to take all these extra things that I should’ve known before I entered my degree.
ANG: That was a really humbling experience.
RITHOLTZ: So that’s very high level Dunning Kruger metacognition, I experienced that in college is like a high school was easy, you get to college and suddenly it’s like oh these people are really smart they work really hard, I can’t just you know phone it in, I don’t know what your experience was like in grad school but it was in hindsight, pure Dunning Kruger.
ANG: What I learned is some you can’t do it on your own, so I thank every one of my class, June and June, Mark, Maria, Eric, without you, I could not have got through my home works and gotten through.
RITHOLTZ: Wow, that’s quite interesting. So what you do for fun? What do you do when you’re not crunching numbers and working on …
ANG: Of course, I play the piano.
RITHOLTZ: That’s your stress release, that’s your…
ANG: That’s my stress release.
RITHOLTZ: Sitting at a keyboard and just working your way through a grand master’s composition.
ANG: Well, right now I’m also trying to do Pilates, I’m very, very stiff so my goal is to try to touch my toes.
RITHOLTZ: Okay, tell us what your most optimistic and pessimistic about today, it could be markets, investing economy, what are you most optimistic and most pessimistic about?
ANG: Oh, I love all the opportunities that are here today specifically for factors, what we have been talking about and the great advances that we will make to put all those benefits in the hands of consumers and clients. What am I pessimistic about? Well my parents were migrants, really glad my parents migrated and gave me opportunities in Australia and then living here in the US and there is this expression I got a fair go.
RITHOLTZ: A fair go.
ANG: A fair go, and I’m a little pessimistic that there’s increasing inequality, lack of mobility and bottom line is we should be trying to give as many people a fair go.
RITHOLTZ: Very reasonable. Let’s — let me get to my two favorite questions, a millennial or someone just beginning their career in finance comes up to you and ask for some advice, what sort of advice would you give them?
ANG: It’s actually advice I’d give myself, it was given to me by Bob Hodrick, a colleague co-author and friend, and he said it’s not your life, don’t presume to suggest that it’s your life either.
RITHOLTZ: Explain that, give me a little more detail on that.
ANG: You make your choices, my preferences aren’t yours and you go and do what you think is best and I will go and support you the best that you can the best I can.
RITHOLTZ: That is quite intriguing. Tell us for a final question, what you know about the world of investing today you wish you knew 30 years ago when you were first getting started.
ANG: I think very often the most important problems in investments are actually not about investing.
ANG: For institutions, they are about management structure, governance, and incentives, and for individuals, well, you’ve had many guests on your show too, all about tackling investors’ behavioral biases.
ANG: And those sometimes are even more important than the actual investment problem, sometimes the investment problem is the easy part right night and then sitting the context of the investment problem in the wider portfolio or the wider structure in someone’s family or an institution, that’s actually the harder problem.
RITHOLTZ: Quite fascinating. We have been speaking with Andrew Ang, he is the head of fact investing at Blackrock and the author of “Asset Management, A Systematic Approach to Factor Investing” if you enjoyed this conversation, well look up an inch or down an inch on Apple iTunes and you could see any of the other 250 such conversations we’ve had over the past five years, be sure and check that out.
We love your comments, feedback, and suggestions, write to us at MIBPodcast@Bloomberg.net. I would be remiss if I did not thank the crack staff that helps put these conversations together. Atika Valbrun is our project manager, Michael Boyle is our head of booking slash/producing, Michael Batnick is my head of research.
I’m Barry Ritholtz, you’ve been listening to Masters in Business on Bloomberg Radio.