Reviewing the Asness Peeves

In 2014, Clifford Asness wrote a commentary, “My Top 10 Peeves,” for the Financial Analysts Journal.  While indicating that there were many more “things said or done in our industry or said about our industry that have bugged me for years,” he culled the list to a relative few.

The three characteristics he thought they had in common:

(1) They are about investing or finance in general, (2) I believe they are commonly held and often repeated beliefs, and (3) I think they are wrong or misleading and they hurt investors.

Eight years on, it’s worth revisiting the peeves.  The original subtitles that introduced each one appear in italics below, along with explanations and updates.  In addition, there are thoughts at the end about what you might glean from a more thorough review of the piece.

The peeves

“Volatility” Is for Misguided Geeks; Risk Is Really the Chance of a “Permanent Loss of Capital”

What is “risk”?  Is it volatility or the permanent loss of capital (or something else)?  As Asness wrote of the advocates on one side, “Viewed in their framework, they are right” — and, regarding the other side, “they too are right!”

At bottom, “What we have here is a failure to communicate.”  The quant and the non-quant are from different tribes, but, “I still think this argument is mostly a case of smart people talking in different languages and not disagreeing as much as it sometimes seems.”

The battle rages on today, although it’s more of a skirmish, since risk-as-volatility is the foundation of communication among institutional investors.

Bubbles, Bubbles, Everywhere, but Not All Pop or Sink

Asness thought that the word “bubble” was overused and dumbed down.  His perspective:

Whether a particular instance is a bubble will never be objective; we will always have disagreement ex ante and even ex post.  But to have content, the term bubble should indicate a price that no reasonable future outcome can justify.

If you think back a year, give or take, which (if any of these) featured prices that no reasonable outcome could justify:  meme stocks, bitcoin, NFTs, Tesla, the technology sector, or venture capital?  There will always be debates about how much hype or value exists in a potential investment; calling something a “bubble” for effect usually doesn’t advance a discussion.

Had We But World Enough, and Time, Using Three- to Five-Year Evaluation Periods Would Still Be a Crime

The third peeve addresses what may be the single most damaging investment practice extant:

Nobody, including me in this essay, wants to deal with the very big problem that we often do not have enough applicable data for the investing decisions we make.  We evaluate strategies, asset classes, managers, and potential risk events using histories the statisticians tell us are too short or too picked over.

Often decision makers ignore the limitations and rationalize their selection choices, thinking, “We have to make decisions, and even if historical data are inadequate, you have nothing better to offer, so we’ll use what we have.”

The odd thing, according to Asness (and others):  “Not only are insufficient data often driving our decisions, but the data we have are often used with the wrong sign.  I refer to the three- to five-year periods most common in making asset class, strategy, and manager selection decisions.”  Despite the fact that “you don’t want to be a momentum investor at a value time horizon,” that decision window remains the industry standard and is often codified in investment policy statements and manager selection procedures — an outstanding example of a practice that lingers despite evidence against it.

Whodunit?

This section covers the finger-pointing that followed the financial crisis.  The peeve here is that “the typical narratives and debates conflate two events.  We had (1) a real estate/credit bubble in prices that, upon bursting, precipitated (2) a massive financial crisis.”  (Asness noted parenthetically that he was using the word “bubble” despite his comments about it in the second peeve.)

With the passage of time, the once-hot debate about who was to blame has cooled down, but “we haven’t a prayer of really understanding what happened and making serious headway on reducing the risk of it happening again” given the state of the discourse then (and even now).

I Would Politely Request People Stop Saying These Things

Asness picked three popular market bromides to attack.  For starters, “It’s a stock picker’s market.”  What does that mean, exactly?  You might ask the next time someone tosses out that phrase.

“Arbitrage” has gone from something specific to “a trade we kind of like.”  As with many other common sayings, “it is clear that many use it in the loosest sense and, therefore, strip it of its meaning.”

As for the last of the three cited:

Every time someone says, “There is a lot of cash on the sidelines,” a tiny part of my soul dies.  There are no sidelines.

It’s mostly a shorthand way for someone to talk about market sentiment.  In the long term, net issuance can affect supply, but that’s not the way the phrase is used.  And, if you’re looking specifically at one part of the ecosystem, “there can be a sideline for any subset of investors, but someone else has to be doing the opposite.  Add us all up and there are no sidelines.”

The First Step Is Admitting It

This topic was covered here earlier in the second part of “We Need Some New Terminology.”  Asness reflects on the marketing magic that led to many very active products being called “passive”:

To me, if you deviate markedly from capitalization weights, you are, by definition, an active manager making bets.

I think people should call a bet a bet.  If you own something very different from the market, you’re making a bet and someone else is making the opposite bet.  You might believe in your bet because you are being compensated for taking a risk, because the market has behavioral biases, or because your research is just that good.  Your bet might be low or high turnover.  But, regardless, you aren’t passive.

To Hedge or Not to Hedge?

Another terminology problem stems from the fact that most hedge funds don’t hedge much.  That leads to all kinds of nonsensical performance comparisons to other investments or indexes:

My peeve is that hedge fund reporting, by both the media and industry, is almost always wrong, but in a fascinatingly varied kind of way depending on market direction and the inclination of the commentator.

A good part of the interest in the performance of hedge funds is their high fees (and huge paydays for their managers); Asness points out that “they charge fees — especially performance fees — as if they were providing purely uncorrelated returns.”  (They aren’t.)

I Know Why the Sage Nerd Pings

This is by far the longest peeve in the commentary, but the shortest one in this review.  It delves into high-frequency trading (HFT), which, “as a convenient villain” got “blamed for some bizarre things.”  Mostly HFT has led to “tighter bid-ask spreads than would otherwise be possible,” making it cheaper overall than “the old dealer and exchange cartel.”

These days, concerns about HFT have morphed into concerns about PFOF (payment for order flow).  Is that also “extremely misunderstood and maligned”?

Antediluvian Dilution Deception and the Still-Lying Liars

Here Asness calls out how companies approach the matter of incentive stock options:

Companies with executives who execute stock options still carry out buybacks to “prevent dilution.”  This is still idiocy.  It may be time-honored idiocy, but it is idiocy nonetheless.

It is “a cosmetic silliness” intended “to obscure the fact that option issuance is costly.”  Speaking of which:

On a related note, the forces of good won the battle to expense executive stock options about a decade ago, yet many firms — abetted by some Wall Street analysts who apparently remember 1999–2000 with fondness instead of horror or perhaps remember it only as the year their braces came off — still report pro forma earnings before the necessary and legally mandated act of expensing them and somehow persuade people to use these silly numbers.  It’s amazing how hard it is to kill a scam even after you make it illegal to use it on the front page.

If anything, that practice has shifted into high gear since 2014.

Bonds Have Prices Too (How Do You Think We Price Those Bond Funds?)

This speaks to the belief that owning individual bonds is better than bond funds because you can always get your money back when they mature.  A reminder:  “The day interest rates go up, individual bonds fall in value just like the bond fund.”  And, “in an environment with higher interest rates and inflation, those same nominal dollars will be worth less.  The excitement about getting your nominal dollars back eludes me.”

Appearances to the contrary, “owning only individual bonds does not solve the problem that bonds are risky,” although:

It’s possible that the false belief that individual bonds don’t change in price each day like a bond fund’s net asset value does lead to better, more patient investor behavior.

(In line with other writings by Asness, an updated version of this might substitute “private equity” for “individual bonds” and “an equity fund” for “a bond fund.”  There is no doubt the resulting peeve would be worthy of top-ten recognition.)

Your turn

These are all good constructs for examining beliefs — your own and those of your co-workers.  Take PFOF:  As with HFT in 2014, there are starkly different views among professionals (even after discounting for talking-their-book opinions).

As discussed here before, “passive” and “active” demand care in their usage — and clear communication with others who may be operating with contrasting definitions.  That’s true within an organization (such as between those in product marketing and those doing the investing at an asset management firm) or with clients, prospects, and other stakeholders.

And then there’s “risk,” a word that’s so casually tossed around that it has lost any precision in its meaning.  Don’t use it without defining it, since others may not share your interpretation — and if you are showing standard deviation on a chart, then call it that, not “risk.”  There is often a shortage of clarity, even though people are reluctant to admit it.

What’s on your list of peeves?  Try enumerating your own — or ask others what theirs are (although you might want to make it clear that you mean investment-related peeves, lest you end up with personal issues dominating the discussion).  As Asness demonstrated, the exercise can be revealing.