Morningstar - Q3 2020 - 59

We are value investors at heart ...
But to be better investors, we do want our
research to evolve.

exposures that lead us to include that into
a timing model.

Andrew Ang

Ang: A paper that we published on factor tilting
in the Journal of Portfolio Management in 2017
argued that the economic regime was the standalone signal that had the highest predictability.2
But you're right, sometimes it's really hard
to call business cycles. The National Bureau of
Economic Research just announced today
that it dates our current recession back to February.
Ex post, even, it's a hard exercise. And ex ante,
it's very difficult. That's why we like to use several
indicators-economic regime, valuations,
relative strength, dispersion, some measures of
crowding-to inform our view, so we get some
diversification across different indicators.

both the risk-based explanation and the
behavioral-based explanation always require
somebody to be taking the other side. So,
when we think about whether a value premium
has deteriorated, we're really thinking
whether or not the number of growth investors
is going up or down. And there's not a
lot of evidence that it's shrinking toward zero.
Ang: This is a really important question on
flows or crowding, and it leads to shortterm cyclicality. We've recently moved to a slight
overweight position in value, and we moved
to an underweight position in momentum at the
beginning of May. For most of 2019 and
all of 2018, we were significantly underweight
value. We never want to disinvest from
a factor, but during those times, we were at the
minimum weight.

We look at valuation and relative strength, which
is a form of momentum that's played against
value over the last couple of years. And we also
look at where we are in the business cycle.
Our business cycle indicator by itself is neutral
to value. Those indicators account for some
of the larger positions we've put on to value over
the past couple of weeks. We're not significantly
overweight, but there is a large risk of being
underweight value. We've seen some of the
snapback in value since the bottom of the COVID
drawdown, and sometimes those snapbacks
can offer great opportunities.

Does Timing Matter?
Bryan: Andrea, you seem a little bit more
skeptical about trying to time exposure to value. What
is the rationale behind always having some exposure
to value?

Frazzini: We are fairly conservative about timing
exposure to factors in our portfolios. We do a small
amount of timing, and we do that in extreme
circumstances. Like Andrew, we look at valuation
ratios and relative strength, what we call factor
momentum. We look at how cheap inexpensive
companies are relative to expensive companies, as
well as movement in those valuation ratios-
whether those spreads are widening or tightening.
It's a balance between the two.

We are currently overweight value. It's not a
secret; [AQR co-founder] Cliff Asness recently put
up a blog piece about it.1 As valuation ratios
are extreme, we do have a value tilt. We don't
have a very large tilt. It's a positive tilt that reflects
how confident we are in our ability to time,
which is not that much. We believe factor timing
is deceptively difficult and that investors are better
off holding a well-diversified portfolio of factors.
Bryan: Are you using any type of cyclical economic

indicators to time your exposure to value?

Frazzini: This is probably where Andrew and
I disagree. This is not for lack of trying.
We would like to be able to time those factors, but
we haven't found data on macroeconomic

Bryan: Andrew, it seems intuitive that value stocks
should do better during the early stages of an economic
cycle, especially if they have more operating
leverage, as you suggest. But can you actually tell in
real time where we are in the business cycle?

I'd like to go back to crowding and flows.
There is an area of the market that I think does
have significant crowding; our forthcoming
research in the Journal of Investment Management
looks at areas of crowding and what happens
when there are more funds than stocks. In an
analysis of crowding and style factors in individual
equities, it turns out that one area that really
does have significant crowding is large-cap
growth. That's the complete opposite of where
value is today.
Bryan: How has your view of value investing evolved
over the past decade?

Frazzini: We constantly innovate our investment
process-the measures that we use for value,
refinements in portfolio construction, the way we
think about the risk exposure, all these are areas
where we've made changes in order to make
our process as effective as possible. However, we
have not changed our thinking on value. Buying
companies that are trading at a cheap price
relative to their fundamentals is associated with

1 Asness, C. 2020. Is (Systematic) Value Investing Dead? May 8. https://www.aqr.com/Insights/Perspectives/Is-Systematic-Value-Investing-Dead
2 Hodges, P., Hogan, K., Peterson, J.R., & Ang. A. 2017. "Factor Timing With Cross-Sectional and Time-Series Predictors." The Journal of Portfolio Management, Fall, 44 (1), PP. 30-43.
https://jpm.pm-research.com/content/44/1/30

morningstar.com/lp/magazine

https://www.aqr.com/Insights/Perspectives/Is-Systematic-Value-Investing-Dead https://jpm.pm-research.com/content/44/1/30 http://www.morningstar.com/lp/magazine

Morningstar - Q3 2020

Table of Contents for the Digital Edition of Morningstar - Q3 2020