Victor Haghani from Elm Partners (previously founding partner of Long Term Capital Management) sat down with NYU Stern School of Business professor Aswath Damodaran to discuss a myriad of hotly debated topics that are at the forefront of present-day investment management. Embedded in this view is how he believes that even investment managers that qualify themselves as “value investors” are far more dependent on momentum than they realize, effectively needing a shift in momentum for the price of that investment to move to its intrinsic value. When discussing factor investing in general, Damodaran outlines that when a factor is discovered, it shouldn’t necessarily be seen as a way of generating excess returns, but as a missing risk factor in the pricing model for expected return analysis. However, if there is a more efficient way to build a model for expected returns (e.g. factor-based investing), this could be looked at as a source of higher risk-adjusted returns relative to another portfolio construction methodology (e.g. market capitalization weighting). While it appears as if Damodaran is supporting a factor-based approach to investment management, the important distinction he makes is that much of the research and data for factor investing has been derived from the second half of the 20th century in the U.S. market. With the U.S. being the most stable and mean-reverting market over that time period, the tilted approach based on past data is not guaranteed to provide the same risk profile moving forward.

In our opinion, the only thing that might be missing from this great conversation is a discussion on behavioural biases, and the associated consequences for how this can effect the concept of mean reversion on a go-forward basis.