Rob Arnott, the founder of Research Affiliates valued at $130 billion, is renowned for his “smart beta” strategies aimed at slightly outperforming competitors. In a conversation with Unhedged, he delves into topics like active trading, the challenges of value investing versus growth, market efficiency, and his skepticism towards Nvidia’s market dominance. The dialogue has been condensed for clarity.
Unhedged: Has business efficiency improved since you entered the industry?
Rob Arnott: I believe the opposite. Price movements driven by irrationality have grown, offering more opportunities but taking longer to materialize.
In a 2021 report, we highlighted the concept of “Big Market Delusion,” exemplified by the Electric Vehicles industry hype. This phenomenon occurs when a few industry pioneers drive significant changes, creating a narrative of inevitable success. However, investing solely based on narratives is futile as market dynamics can swiftly change, leading to inaccurate valuations and unrealistic growth expectations.
An example is the dotcom bubble where companies like Qualcomm soared in value but took years to generate actual returns. Similarly, the current AI hype may not materialize as swiftly as anticipated, resembling another instance of market delusion.
Unhedged: Why have traditional players like Franklin Templeton struggled in the evolving market?
Rob Arnott: Active managers face challenges due to the sheer scale of passive investing inflows, distorting market valuations. The influx of trillions into index funds has created pricing disparities, disadvantaging active managers seeking value outside these indices.
Unhedged: Can value investing still succeed?
Rob Arnott: Despite recent fluctuations, value investing has historically outperformed growth. The underperformance of value stocks is primarily attributed to their comparative cheapness rather than fundamental weaknesses. Currently, the valuation gap between value and growth stocks is historically wide, presenting potential opportunities for value investors.
Unhedged: What drives low valuation of value stocks?
Rob Arnott: Factors like low interest rates and market uncertainties contribute to the undervaluation of value stocks. Investors’ preference for safety and stability amid economic fluctuations leads to the underpricing of value stocks relative to growth stocks.
Unhedged: What causes synchronized declines in quantitative methods’ effectiveness, like in 2007 and 2018–20?
Rob Arnott: Quantitative strategies relying on historical performance for factor selection can lead to misjudgments. Factors that have become expensive due to past success may not continue to perform well. It is crucial to assess factors based on their underlying fundamentals rather than past returns to avoid potential pitfalls.
In essence, Arnott’s insights shed light on the complexities of market dynamics and the importance of prudent investing strategies in navigating evolving financial landscapes.
