Why Value Investing Still Works—If You Do It Right

On this episode of The Long View, Cliff Asness, founder, managing principal, and chief investment officer at AQR Capital Management, discusses how to invest in alternatives, how artificial intelligence is used at AQR, his thoughts on private markets and value versus growth stocks, and his critiques of Donald Trump’s tariffs.

Here are a few highlights from the conversation with Morningstar’s Christine Benz and Dan Lefkovitz.

Why Value Investing Still Works—If You Do It Right

Christine Benz: Want to follow up on our last conversation with you, which was three years ago at the Morningstar Investment Conference—was 2022 bad year for stocks, bad year for bonds. On the equity side, value did hold up a little better than growth in a tough equity market. I’m curious what’s your perspective is on what we’ve seen from value stocks since then.

Cliff Asness: OK, I love this. I appreciate it. This is the second time you’re giving me a little license to brag. Value as a concept we all understand. Pay a low price compared with fundamentals. I think the way quants use the term value is just price to fundamentals. The way active managers—Graham and Dodd type managers use the word value—it is a more holistic concept. They’ll look at how profitable, how risky it is. Quants do the same thing. They just call those other factors. I actually think quants misnamed the value factor like 30 years ago. It should have been called the low price to fundamentals factor. It’s not as piffy, but it’s more accurate. But I am a believer on average over the long term, low price to fundamentals—largely I think because of behavioral reasons. People go too far. The low price to fundamental stocks deserves to be low, but not as low as they are, and the high ones deserve to be high. So I am a believer in that general strategy, even though that is not all I would do by any means.

Now, in 2022, every form of value worked. In other years, it gets much more subtle. For instance, the traditional value indexes are cap-weighted. And we, of course, focus mostly on the United States. Both of those things have led to extreme outperformance of growth. The Magnificent Seven, if you will, they’ve had tough periods, but have trounced the rest of the market. And the traditional kind of indexes way to do it has a huge bet on that. If you are a quant geek forming a long-short portfolio with value as one factor, again, not the whole thing by any means, I won’t speak for every quant. But I think I’m speaking of most of them. You’re going to have something much closer to a thousand—not equal weight, but let’s make it simple, call them equal weight—a thousand stocks equally weighted long, not just in the US, where this phenomenon of the Magnificent Seven has been dominant.

You’re going to do this globally. And this may be more specific to some quants than others, but we have always favored not taking an industry bet when it comes to value. We found historically, and we wrote a paper on this. I’m going back even further. This is 1995—only 30 years ago—we wrote a paper showing that value and most other quant strategies outside of momentum don’t do a particularly good job at the industry decision; do better if you take that out. You do all those things. It still hasn’t been a banner period for values since 2022, but it’s actually held its own. If you do the traditional ways and the index ways, and you actually went short the Magnificent Seven, you have not had a very good time as a value manager of any kind since then. In normal times, these are very different strategies. This construction matters. I will say during wild blow off, plus or minus six months around a bubble peak, how you construct these things matter a lot less.

When value is kind of destruction, peaked or … I don’t know how you want to view that, but when the value destruction hit maximum in late 2020, it didn’t matter. Well-constructed—I can tell you I have scars on my back—well-constructed quant versions that hedge a whole bunch of things out. Don’t take a huge bet on any seven stocks or don’t take a huge industry bet, were in pain right along with the more traditional indexes. But long term, we think the risk-adjusted return is better to do it in the more in the more quantitative way. And in any period that’s not near a panic or a bubble, how you do it starts to matter a lot more.

Are Non-US Equities an Indirect Value Play?

Dan Lefkovitz: Cliff, do you think that non-US equities are an indirect value play?

Asness: Yeah, the rest of the world is cheap compared with the US. Here, I’m using cheap like a quant, just considerably lower multiples. Obviously, there’s a level of US superiority in growth that can justify a higher multiple. But the US has definitely outperformed the world for a long, long time. Let’s call it a quarter of a century. I like saying that instead of 25 years, I think it has more gravitas. But I’ve written on this, Antti Ilmanen at AQR has written on this. You can do it different ways and get slightly different answers, but call it 80%, 85% of the US’ victory has come from multiple expansions. So pick your favorite one. Let’s use the Schiller Cape. I’m not claiming that’s the be-all, end-all method evaluation. And don’t hold me to the specific numbers, but if 25 years ago, the US was considerably cheaper than global stocks, it is now considerably more expensive on this measure. That has driven again, the lion’s share of US outperformance, not all of it.

Again, that 15% to 20% that’s unaccounted for, that is the US actually being exceptional over this period, actually growing earnings, whatever cash flow, whatever measure you want to look at. Better than the rest of the world. So the US’ victory is not 100% from revaluation, but it is 80% from revaluation. And now the US is considerably higher priced. So at the very least, I prefer a diversified portfolio around the world. Looking at it and saying I assume the US will win by the same margin in the next 25 years as it did in the last, is basically saying we’re going to see extreme multiple expansion on a relative basis—US against the world—from here again, which would take us to stratospheric differences that we’ve never ever seen. And I think any level of growth differential would find it very hard to justify. If one is more of a mean-reversion believer, maybe you want a little more global—that is a pretty low Sharpe ratio bet. Pure value to do country selection is not how I’d want to make most of my living. But it is something I would take a very small amount of risk on.

So sorry, long-winded answer to a short question. I do see it as a value bet. But I think there’s some interesting aspects. I think people maybe overextrapolate what we’ve seen the US do in the last 25 years, not realizing how much of it has come from people just willing to pay more and more for the same fundamentals in the US compared with other places.