When we sat down for a conversation in the Forbes building last week, AQR Capital Management co-founder Cliff Asness gave his take on everything from the fiscal cliff to his favorite way to value stocks to why investors need to get comfortable with lower returns:
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The fiscal cliff is “without a doubt a negative,” Asness said, and he does not endorse the suggestion that going over it would be a good thing for the country, but he is skeptical that doing so would be as cataclysmic as many fear.
In the hedge fund world, guys like Asness will have good years and bad years he says, but ultimately investors will look at the numbers to determine performance. In Washington, “perception” becomes a much more important factor.
He compares it to a Keynesian beauty pageant: “You don’t pick the most beautiful, you pick who everyone else thinks is the most beautiful.”
Politicians have an incentive to kick the can down the road, because their most rational action is to keep their seat in Washington, not necessarily do what is the absolute best thing for the country.
“We’d all love to have courageous politicians who kind of look like Jimmy Stewart and act like Abe Lincoln…but they don’t come along too often,” Asness quips.
Looking past the fiscal cliff, Asness’ investment outlook carries a dose of reality for investors. Price is not the only thing that matters, but buying something cheap – either at a low multiple on the equity side or at rates that aren't ultra-low in fixed income – tends to work out over the long term.
Asness prefers to use a metric known as the Shiller PE, a look at 10-year average of earnings that smoothes out the ebbs and flows of corporate performance.
He is a critic of earnings forecasts, which are “always wildly optimistic,” and thinks the 10-year look (or any longer-term look) lessens the noise in annual results. It could be argued that the current Shiller PE is unfavorable to companies because of the impact of the 2008 financial crisis and subsequent recession. But, Asness says, what about the years preceding the crash?
If 2008 was an outlier to the downside, surely the years prior as the housing market bubble reached its apex were hardly “normal.” Currently, the metric suggests stocks are expensive, albeit not wildly so.
One thing investors need to get real about: expected returns. In the current environment, Asness and AQR think a traditional 60/40 portfolio of stocks to bonds can be expected to beat inflation by about 2.5%, not the 5% historically delivered. That’s fine if investors are willing to accept those type of returns. If not, prices have to fall.
“Here’s where I get to be a coward,” Asness jokes, “and only talk about the long term." Picking between those two scenarios is very hard, he says, but “the whys and the whens don’t matter that much,” if an investor is willing to plan for a lower return than historically anticipated.
“I am advocating using the current valuations in your planning process, acknowledging reality,” and considering whether that means saving more, spending less, or just getting comfortable with weaker performance from an investment portfolio. Another option: get a little less traditional and take a little more risk in the interest of finding better returns.
For a lot more from Cliff Asness, watch the video above and check back in this space for Part Two, where he explains why investors need to have a discerning eye when it comes to paying hefty fees to the people who manage their money.
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