During his recent interview with Tobias, Cliff Asness, Co-Founder of AQR discussed A Correlation Between Value Investing And Interest Rates. Here’s an excerpt from the interview:
Tobias: Last question, and it’s in relation to the value and rates paper. This is a prevailing narrative that one of the reasons that value is not working is because rates have been very low, unnaturally low, perhaps crushed to sort of virtually zero and somehow that has created the conditions for which value doesn’t work. Your colleagues, Maloney and Moskowitz, have– and I find the duration argument theoretically pretty compelling that value stocks tend to be shorter duration and growth stocks are longer duration, so when the interest rates drop, it impacts the growth stocks more and that has created the scenario that we see now. They have gone through that in any implementation that you can possibly think of and they couldn’t find anything that sort of indicated that was the case.
Cliff: Yeah. This is in a series of unsatisfying conclusions where all I end up with is saying, “No, that’s not it.” We certainly and still find it to be a fairly intuitive story, particularly when long-term real rates are lower. Any kind of distant cash flows should be worth more. And I don’t like coining growth versus value, I prefer cheap versus expensive. But there is something to the idea of the expensive are normally stocks with longer projected tails, future growth.
My colleagues point out in the paper, it’s often not that simple. Sometimes, when you have a blow to future growth from low rates, it’s not clear whose growth is affected by more, so the actual numbers can change. But by and large, the real thing is just empirics. They step back and they look at value returns in correlations to interest rates, either alone or adjusting for many other things in the marginal correlation to interest rates, and it varies by specification, but they don’t find much. I keep planning, I haven’t got there. Like you’ve seen before, I often take my colleagues’ great detailed paper and do a brute-force simple blog inspired by it, where I both try to introduce the paper and do it in maybe a little bit more of an accessible way.
I have looked at my value spreads that we’ve been talking about. This is related to returns but not quite the same because remember, you can have eight years of bad returns and not see a big cheapening if it’s fundamentally, so it’s not the same as returns. And I find a little bit more than negative. We don’t force false agreement at AQR. We don’t have a lot of people who think quant is the worst thing in the world and you should buy one stock, you can’t have complete disagreement.
But we share with people when we have different people at the firm who have at least nuanced views. And my research shows statistically, this is dodgier. It’s what’s called levels on levels. It’s harder to be confident in the statistics. You only need an infinite amount of data to asymptote to accurate statistics. It might feel like we’ve been an infinite drawdown, but it is not quite there yet. But I do find at least as a point estimate that interest rates explain why value spreads, a little bit more than my colleagues work. And they don’t literally look at that. So, it’s not a contradiction.
But the spirit that interest rates might explain things– and this is one I want to write up, I find it to be a little bit stronger. But then when I do the exercise that you must do next. All right, what are the spreads look like through time if we adjust for interest rates? What would the spreads be over and above low interest rates or under and below high-interest rates would imply? You find it is still well past the prior historical maximum. So, these are the least satisfying explanations in finance. When someone says, “Yeah, there’s some truth to that, but it’s not nearly enough.” No one walks away happy.
The people who believed in it kind of still believe in it, they grumble, test it– [crosstalk] The people who didn’t believe in it or mad that you conceded that there’s something there, but I do give a little credence to the story, at least in the spreads version, I do find some support for the story. If you want to tell irrational bubble stories, some support that the world then takes way too far is a fairly consistent story. There’s some economics here, people are not totally crazy, but they’ve gone nine times past what low-interest rates would imply. You could also– again, it’s a bubbly inefficient market story, but it may not be literally the… part which is just, can be rational pricing of cash flows, but the speculative environment of such cheap money.
For our story to be true, you have to get to a point of why are people paying crazy—or in our view, crazy prices for the good companies and crazy low prices for the less good companies. So, there’s nothing be some irrationality somewhere.
One simple story, and this is very hard to prove, these are just conjectures, is eight years of irrational loss to value has led to a two-plus year blowoff, get me the hell out of this stuff, that has been an irrational loss to value. Another version is the growth stocks have always had a bit more of a whiff of speculation to them than value stocks. And if we have a world of free money, even if it’s not literally the interest rates that justify it, might that be part of the bubble type environment, absolutely. Not approved, then there may be other explanations.
But, yeah, we think low-interest rates of all of them is probably the one with the most hope before looking at it, because there are inherently reasonable aspects to the story. Again, my colleagues tell you why it’s not quite as simple as you think but we all get the intuition of that. And it’s not nearly enough. If low interest rates are justifying 8% of a wider value spread, the 92% that’s left over still has no story to it, still seems to be a rather extreme mispricing that’s going on today.
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