Two of the mutual fund world’s biggest thinkers square off on factor investing.
It is hard to find two more renowned figures in the mutual fund world than Rob Arnott and Cliff Asness. Arnott is the founder and chairman of Research Affiliates, a Newport Beach, Calif.,-based investment firm and the portfolio manager of funds such as Bronze-rated PIMCO All Asset All Authority
Ben Johnson, director of passive strategies on Morningstar’s manager research team, sat down with Arnott and Asness at this year’s Morningstar Investment Conference in June. Their answers have been edited for length and clarity.
Ben Johnson: I want to start at a theoretical level with a discussion of the efficient market hypothesis. Cliff, as many in our audience know, was a teaching assistant for Eugene Fama at the University of Chicago for two years. Fama was his dissertation advisor. Cliff, what is your take on your mentor’s hypothesis?
Cliff Asness: I get very nervous talking about how efficient markets are in Chicago, because I feel like Gene is close and listening. I don’t think he would be upset by this, but on the coasts, I’m a little more in the behavioralist camp.
The efficient market hypothesis, as Gene puts it, is the idea that prices reflect all available information. Now that we’ve introduced Gene, I’ll defend him a little bit. First, he likes to shock his first-year Ph.D. class. I sat through this class three times. It’s not because I failed it; it’s because I was the TA the next two years. About the third week in, he says to the class something like, “Markets are almost certainly not perfectly efficient.” You get a gasp out of the class. Only in Fama’s class in Chicago could that entail a gasp. Anywhere else in the world, students either don’t care, don’t know, or they say, “Yeah, we know that.”
Second, I wrote my dissertation for Gene on the success of the price momentum strategy. Any of the things we’ll discuss today can have an efficient markets, risk-based, or a behavioralist irrationality-based story. Momentum is still one of the hardest ones to reconcile with efficient markets. I was terrified to ask him if I could write it. I think I mumbled as I said, “Gene, I’d like to write a dissertation on the efficient market hypothesis, and by the way, I find momentum works really well.” And he says something like, “What was that?” I’m like, “Momentum works really well.”
He was very good with me writing it. So, he is clearly on the spectrum pretty far toward efficient markets compared with me—I’m sure with Rob—but he’s not quite the zealot he’s made out to be.
My own view is a wishy-washy, middle one. I think markets are highly efficient in a very broad, long-term sense. But are they anywhere near perfect? No.