Odd Lots

Cliff Asness on How Markets Got Dumber in the Last 10 Years

November 13, 2025

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  • Cliff Asness contends that markets have become more susceptible to bouts of irrationality and greater deviations from fundamental value over the last decade, a concept he terms "The Less Efficient Market Hypothesis." 
  • The increased prevalence of passive investing and the rise of social media/gamification are cited as primary drivers contributing to market inefficiency by eroding the 'wisdom of crowds' through reduced independence. 
  • Sticking to rational, value-based convictions during periods of market irrationality is extremely painful due to funding costs, client pressure, and the extended duration of drawdowns, even if the underlying process is sound. 
  • The shift from independent decision-making to interconnected social networks may be the factor that flips the "wisdom of crowds" into the "madness of crowds" in markets. 
  • For managers of other people's money, the length of a performance drawdown can be more psychologically painful and indicative of outdated assumptions than the sheer depth of the drawdown. 
  • Even established quantitative patterns, like the outperformance of cheap stocks over expensive stocks, face disputes regarding the underlying economic rationale for their persistence. 

Segments

Podcast Anniversary and Market Changes
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(00:01:39)
  • Key Takeaway: The ten-year run of the Odd Lots podcast coincides with a period where traditional value investing concepts, like PE ratios mattering, feel increasingly antiquated.
  • Summary: The hosts marked the tenth anniversary of the Odd Lots podcast, noting that topics once considered current news are now historical context. They specifically highlighted that the concept of value investing, where price ratios dictated decisions, feels quaint today. This shift is part of a broader trend where markets seem to have grown ‘more stupid’ due to gamification and speculative behavior.
Introducing Cliff Asness and Market Irrationality
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(00:05:01)
  • Key Takeaway: Cliff Asness, co-founder of AQR, frames his current investment philosophy as operating under “The Less Efficient Market Hypothesis.”
  • Summary: Asness, a student of Eugene Fama, wrote a piece arguing that markets are prone to greater bouts of inefficiency than previously assumed. He noted that his early dissertation work on price momentum already suggested a drift from strict Efficient Market Hypothesis (EMH) views. Historically, extreme deviations in value spreads, like those seen in the dot-com bubble, were rare but have recurred, forcing investors to endure harrowing periods.
Pain of Sticking to Convictions
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(00:15:58)
  • Key Takeaway: The difficulty in maintaining rational positions during market extremes is driven significantly by the emotional stress of client interaction and the business risk of redemptions, not just funding costs.
  • Summary: Even with deep pockets, managers face emotional trauma from explaining losses when the market is punishing rational positions. The length of a drawdown is often perceived as much worse than its severity, leading to client attrition and necessary firm shrinkage. Stan Druckenmiller’s decision to manage only his own money underscored how painful running client capital can be, even for the most successful managers.
Impact of Retail Trading and Zero-Day Options
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(00:22:00)
  • Key Takeaway: The increased presence of retail investors, particularly through zero-day options, exacerbates market dislocation because retail traders, on average, transfer wealth to institutions.
  • Summary: The rise of retail participation using sophisticated instruments like zero-day options contributes to market irrationality, as retail investors, on average, lose money net of trading costs. This influx of less fundamentally-driven capital allows speculative manias to persist longer than they might have previously. The dynamic is likened to fan duels, where the house (institutions) profits from the average participant’s activity.
Reasons for Increased Market Inefficiency
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(00:25:36)
  • Key Takeaway: Market inefficiency is driven by the decline in active price discovery due to passive investing and the breakdown of independent thought caused by social media algorithms.
  • Summary: The shift toward passive, market-cap-weighted investing means fewer participants are actively determining security prices, leading to weird market behavior near the 100% passive threshold. Furthermore, social media creates confirmation bias and pushes individuals toward extremes, turning the ‘wisdom of crowds’ into the ‘craziness of mobs’ by destroying decision independence. Markets function as voting mechanisms, and when the crowd is linked, the price can deviate significantly from fundamental value.
AI Integration and Loss of Intuition
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(00:37:05)
  • Key Takeaway: Integrating machine learning (AI) into quantitative processes necessitates sacrificing some level of intuitive understanding of the underlying factors, as the resulting data representations (vectors) are often opaque.
  • Summary: AQR uses Natural Language Processing (NLP) to analyze corporate statements, achieving better predictive power than older word-count methods by converting text into numerical vectors. However, asking what those vectors mathematically represent often yields an uninterpretable answer, representing a loss of intuition compared to traditional factor modeling. This trade-off between empirical performance and interpretability is a key challenge in adopting advanced ML techniques.
Multi-Strat vs. Multi-Manager Models
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(00:41:44)
  • Key Takeaway: AQR operates as a multi-strat firm, building diverse, philosophically consistent models internally, contrasting with multi-manager firms that outsource strategies and often fire managers quickly based on short-term performance.
  • Summary: Multi-strat involves combining various low-correlated strategies (like global equities, commodities, trend following) under a common philosophy, which AQR believes is superior to relying on a single factor. Multi-manager firms rely on external talent, often exhibiting a short-term focus that AQR finds problematic for strategies requiring patience through bad periods. Competition for quantitative talent is now intense between internal multi-strat builders like AQR and firms like Citadel.
Factor Explanations and Sports Betting
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(00:46:21)
  • Key Takeaway: The rationale behind successful factors like value and momentum is still debated between rational risk-based explanations (Fama) and behavioral biases (Shiller), but empirical evidence drives investment decisions.
  • Summary: The fundamental debate in finance remains whether factor returns stem from uncompensated risk or systematic investor errors like underreaction and overreaction. While momentum can be explained by both rational underreaction and irrational chasing, both explanations can be true at different times. AQR is exploring sports betting markets, which share similarities with quantitative investing in that they often involve mispricing due to behavioral factors, though they remain cautious about the extent of this application.
Interest Rates and Value Spread
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(00:56:13)
  • Key Takeaway: Low interest rates contributed minimally (about 2%) to the extra value spread observed, suggesting they were not the unified explanation.
  • Summary: The effect of low interest rates on asset valuation was mathematically quantified as explaining only about 2% of the extra value spread. Unlike the 1999-2000 period when rates were high, the recent era of zero interest rate policy (ZIRP) loosened the bounds of rationality. Even when the 10-year yield approached 5% in 2022, the impact of rising rates on market behavior was less pronounced than anticipated.
Wisdom vs. Madness of Crowds
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(00:57:37)
  • Key Takeaway: Crowd wisdom theories break down when participants are tied together in the same social network, leading to herding behavior.
  • Summary: The wisdom of crowds theory relies on independent decision-making; this breaks down when individuals are interconnected, fostering herd mentality. Recent market years have been dominated by investors piling into the same positions due to this interconnectedness. This concept explains market and political dynamics in a globally connected village where constant communication occurs.
Drawdown Pain and Market Efficiency
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(00:58:35)
  • Key Takeaway: The duration of a performance drawdown is often more painful for managers than the depth because prolonged underperformance forces a re-evaluation of fundamental assumptions.
  • Summary: A multi-year drawdown, even if shallow, prompts questions about whether an investment manager’s core ideas are obsolete. Investors exhibit limited patience, making long periods without gains more damaging than sharp, short corrections. Markets do not always function as perfect arbitrage mechanisms, as the reward to compress prices to the absolute rational limit may not exist.
Quant Patterns and Interpretability
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(00:59:34)
  • Key Takeaway: High-frequency trading firms prioritize the proven existence of a profitable pattern over developing a complete economic story explaining why it works.
  • Summary: There is a distinction between identifying a profitable pattern and having an interpretable economic story for it, especially across different timeframes. Firms like Hudson River Trading focus on pattern efficacy rather than deep interpretability, contrasting with longer-term quantitative approaches. Even well-established factors, like value, have ongoing disputes regarding the precise reason for their long-term outperformance.
Human Edge in Regime Change
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(01:00:27)
  • Key Takeaway: The remaining edge for human investors may lie in the difficult task of spotting significant market regime changes, rather than pure pattern recognition.
  • Summary: Spotting regime changes represents a difficult but potentially crucial area where human insight can still provide value against automated systems. This task is distinct from the pure pattern recognition employed by quantitative models. The hosts conclude the discussion after reflecting on these complex market dynamics.