Key Takeaways
- • Rob Arnott (Research Affiliates) and Cliff Asness (AQR) engaged in a substantive debate on factor investing at the 2016 Morningstar Investment Conference, with particular focus on the efficient market hypothesis and factor timing strategies.
- • Asness, a former teaching assistant and dissertation advisee of Eugene Fama at the University of Chicago, defended his mentor's efficient market hypothesis while acknowledging practical limitations; Fama himself stated that "markets are almost certainly not perfectly efficient."
- • The core disagreement centers on whether factors such as value, momentum, and size effects can be timed based on valuation levels—Arnott advocates for tactical timing to buy factors at low valuations and sell at high valuations, while Asness remains skeptical of systematic factor timing approaches.
- • Asness's dissertation research on price momentum strategy demonstrates that factor outperformance can be explained through either efficient market risk-based frameworks or behavioral irrationality narratives, indicating the theoretical complexity underlying factor investing debates.
- • The factor investing question—whether systematic exposures to value, momentum, and small-cap effects can consistently beat the market—represented a central intellectual pillar of the Morningstar conference discussion.
Summary
Two of the mutual fund industry's most influential thinkers, Rob Arnott of Research Affiliates and Cliff Asness of AQR, convened at the 2016 Morningstar Investment Conference to discuss fundamental questions in factor investing and market efficiency. Ben Johnson, Morningstar's director of passive strategies, moderated the conversation, which opened with theoretical foundations in the efficient market hypothesis.
Asness brought particular credibility to the discussion of market efficiency, having served as a teaching assistant and dissertation advisor under Eugene Fama at the University of Chicago. While acknowledging Fama's intellectual authority on the topic, Asness noted that Fama himself acknowledges practical limitations to perfect market efficiency, telling his Ph.D. classes that "markets are almost certainly not perfectly efficient." Asness positioned himself as somewhat more aligned with behavioral finance perspectives than strict efficient market doctrine, particularly when discussing markets outside Chicago's academic environment.
The intellectual tension between the two figures centered on factor timing—specifically whether investors can systematically exploit factor valuations by purchasing factors when they trade cheaply and selling when expensive. Arnott has long contended that valuations serve as important guides for factor allocation decisions, effectively arguing that factors themselves can become expensive or cheap relative to fair value. Asness, by contrast, remains skeptical of factor timing strategies, questioning whether investors can reliably execute such tactical shifts.
Asness's own research trajectory illuminates this divide: his dissertation on price momentum strategy success, completed under Fama, demonstrated that factor outperformance can be rationalized through either efficient market risk-based explanations or behavioral irrationality frameworks. This duality reflects the broader theoretical challenge in factor investing—determining whether systematic factor returns compensate investors for bearing additional risk or instead represent market mispricings that behavioral dynamics create and sustain.
The debate carries significant practical implications for institutional investors and fund managers allocating capital to factor-based strategies, as it directly addresses whether factor exposure should be treated as static strategic allocation or dynamic tactical positioning based on valuation assessment.
Asness brought particular credibility to the discussion of market efficiency, having served as a teaching assistant and dissertation advisor under Eugene Fama at the University of Chicago. While acknowledging Fama's intellectual authority on the topic, Asness noted that Fama himself acknowledges practical limitations to perfect market efficiency, telling his Ph.D. classes that "markets are almost certainly not perfectly efficient." Asness positioned himself as somewhat more aligned with behavioral finance perspectives than strict efficient market doctrine, particularly when discussing markets outside Chicago's academic environment.
The intellectual tension between the two figures centered on factor timing—specifically whether investors can systematically exploit factor valuations by purchasing factors when they trade cheaply and selling when expensive. Arnott has long contended that valuations serve as important guides for factor allocation decisions, effectively arguing that factors themselves can become expensive or cheap relative to fair value. Asness, by contrast, remains skeptical of factor timing strategies, questioning whether investors can reliably execute such tactical shifts.
Asness's own research trajectory illuminates this divide: his dissertation on price momentum strategy success, completed under Fama, demonstrated that factor outperformance can be rationalized through either efficient market risk-based explanations or behavioral irrationality frameworks. This duality reflects the broader theoretical challenge in factor investing—determining whether systematic factor returns compensate investors for bearing additional risk or instead represent market mispricings that behavioral dynamics create and sustain.
The debate carries significant practical implications for institutional investors and fund managers allocating capital to factor-based strategies, as it directly addresses whether factor exposure should be treated as static strategic allocation or dynamic tactical positioning based on valuation assessment.
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