Cliff Asness: Value Stocks Still Look Like a Bargain

Episode Summary

Executive Summary: Cliff Asness argues that today’s low expected returns make portfolio construction more important than market timing. He favors diversification, alternatives, and factor tilts over relying solely on stocks and bonds, while stressing that value remains unusually cheap and attractive. He also discusses retirement behavior, tax-efficient alpha/beta separation, ESG’s cost-of-capital mechanism, and why private equity may now be prized for illiquidity and smoothed volatility rather than excess returns.

Main Topics: Low expected returns and portfolio responses (Priority: 5/5): Asness says valuations for both equities and bonds remain high versus history, implying lower future returns. Rather than timing markets, he recommends improving portfolio diversification with non-correlated strategies. Young vs. older investors in a downturn (Priority: 4/5): He argues portfolio allocation should not differ dramatically by age within reasonable limits, but investors at different life stages should root for different market outcomes because younger investors can benefit more from crashes and lower prices. Value investing and the value/growth spread (Priority: 5/5): Asness says the value spread remains near tech-bubble extremes, though it has improved from its peak. He sees value as still cheap on both prices and fundamentals and therefore attractive over a 1–3 year horizon. Retirement planning, fixed income, and alternatives (Priority: 4/5): For retirees, he emphasizes preparation and having a plan that can withstand bad scenarios. Bonds still serve diversification purposes, but he also highlights trend following and other alternatives for improving portfolio resilience. ESG investing and cost of capital (Priority: 4/5): He explains that ESG works by shifting demand away from 'bad guys,' raising their expected returns and cost of capital, which can reduce the number of projects firms undertake. He argues investors may need to give up some return to make a real-world impact. Tax-efficient portfolio design (Priority: 4/5): Asness supports separating alpha from beta for taxable investors, so market exposure remains tax-light while taxes are paid mainly on true alpha. He also says dividend-payer placement matters less than many think compared with total return effects. Private equity and the value of illiquidity/smoothed marks (Priority: 3/5): He suggests private assets may increasingly be valued because they hide risk through illiquidity and infrequent mark-to-market pricing. That may mean investors are paying for lower perceived volatility rather than earning a true excess return.

Key Arguments: When expected returns are low, the best response is often not market timing but building a better portfolio with diversifying, uncorrelated strategies. Young investors can rationally prefer a crash because lower prices raise long-run expected returns; retirees generally cannot recover from major drawdowns as easily. Value remains compelling because the cheap-versus-expensive spread is still historically extreme and fundamentals for value are less bad than during prior underperformance periods. Bonds still matter as diversifiers, even if today’s yields make them less attractive tactically; they help because many investors cannot lever low-risk assets. ESG influences the real economy through price pressure: if investors avoid certain firms, those firms face a higher cost of capital and do fewer marginal projects. Separating alpha from beta can materially improve after-tax outcomes because investors are not forced to pay taxes on broad market appreciation inside an active portfolio. Private equity may earn less of a true illiquidity premium than in the past because investors now pay for the comfort of not seeing volatility as often. Dividend-paying stocks are not necessarily tax-inefficient in taxable accounts; placement depends more on total return characteristics than on dividends alone.

Data Points: Value spread peak timing: Late 2020 / early 2021 - Asness says the cheap-vs-expensive spread peaked then, above the tech bubble peak. Value/growth comparison horizon: 6-12 months trailing growth measures - AQR compared sales, earnings, free cash flow, ROE, and gross profitability to evaluate whether value underperformed for rational fundamental reasons. Duration of possible valuation stagnation: About 60 years - Asness cites a separate paper suggesting valuation effects can work over very long horizons but may require waiting decades. Levered 60/40 outperformance: About 1% per year - He cites early-1990s research suggesting a levered 60/40 portfolio beat all-equity risk-matched exposure by roughly 1% annually. Value underperformance period: 2018–2020 plus subsequent years - He describes this as a bubble-like phase similar to 1999–2000. Value fundamentals gap: 25-year low - He says value is giving up less than normal on trailing and prospective fundamentals versus growth. Relative valuation vs tech bubble: Just below tech-bubble levels - Current value-vs-growth spread is described as slightly below the previous extreme reached during the dot-com era. Worst daily market move example: S&P 500 down 7% in a day - He recounts the 1997 Asian debt crisis as an example illustrating volatility and illiquidity discussions. AQR period of weak vs strong returns: Terrible 2018–2020; wonderful last 1.5 years - Used to contrast transparent mark-to-market investing with private equity’s smoothed reporting. Tax timing example: 11.5 months vs 12.5 months - He uses the classic holding-period example to illustrate tax-aware selling of winners. Holding-period/hurdle-rate effect: Higher expected return means fewer projects pass the hurdle - In the ESG discussion, he explains how higher cost of capital can reduce corporate investment.

Pivotal Quotes: "The central challenge for investors today is what to do about the low expected return environment." — Cliff Asness: He frames the discussion around how investors should respond to expensive markets and subdued future returns. "If you're a young investor, it's almost a certainty that a crash and a long-term buying and investing at much higher expected returns and lower prices is better for your ending wealth." — Cliff Asness: He explains why different life stages have different preferences about market crashes. "The bad guys face a higher cost of capital and make less and do less." — Cliff Asness: He summarizes the mechanism by which ESG investing can change corporate behavior.

Implications: Investors should focus less on predicting markets and more on building resilient, tax-aware portfolios with genuine diversifiers. Current valuations argue for caution, especially in retirement, while value and other factors may offer opportunity if extremes normalize.