Asness: Quants maybe have
more powerful tools to data-mine. But on the other hand, to Rob’s point, we
have some hope knowing that we’re data mining and dealing with it. And echoing
what Rob said, there are really two ways to protect yourself from data mining.
One is having an economic story for why what you see works actually works. Now,
of course, it could be a harebrained story just to fit the data, so you should
always look for other things that fit that story, other examples.
What we’ve talked about at my firm for
the last couple of years is why low-volatility investing works. We think we
have a pretty integrated story, which is that it works because of another thing
that scares investors, maybe with good reason: leverage. If investors eschew
leverage, and they’re scared, all else equal, of a leveraged strategy, that
will actually lead to low-beta and low-volatility investing working. That’s a story
we’ve found very consistent around the world.
Arnott: Low volatility has tremendous merit, because the largest anomaly in the
finance world is that the capital asset market line empirically is flat to
inverted instead of upward-sloping. As so often is the case, the biggest
profits in our business are found in areas where finance theory and the real
world part company. Finance theory says, returns should be linearly linked to
beta, and that line should start at the risk-free rate and move linearly upward
to reward more beta with more return. The empirical reality is totally different
from that, creating a wonderful investment opportunity.