Andrew Ang Thinks Innovation Starts Small

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“Innovation has generally come from the smaller players—endowments that were smaller than other institutional investors, for example, pioneered alternatives. Hedge funds were originally vehicles for private investors long before institutions jumped on the bandwagon. For pension funds, especially in the public sector, Canadians and Europeans are generally way ahead of their US counterparts. Partly this is because of regulatory pressure, and partly because of fund structures in Canada and Europe allowing for much more independence than US institutions. Many US public pension funds are very disadvantaged by political interference. Sovereign wealth funds represent tremendous opportunities, and these players will only continue to grow in importance. I love being a professor. I sit around and someone pays me to think and people pay to listen to me—there are few jobs like this. I grew up in Australia and came to the US to do a PhD at Stanford University. Upon graduation in 1999, I ended up at Columbia University and have been here since—I feel like part of the furniture. I am a financial economist and most of my work deals with asset management issues. My research focuses on practical asset management problems, and is influenced by my interaction with practitioners. I have consulted most regularly for the Norwegian sovereign wealth fund, but I have worked with many fund managers and a few investment banks. Currently I am working on factor investing: Just as eating right requires looking through food labels to understand nutrient content, investing right requires looking through asset class labels to the underlying factor risks. It’s the nutrients in the food that matter and similarly it’s the factors, not the asset labels, that matter. Which factors are appropriate for which investors? What are the most efficient ways to harvest these risk premiums? Ideally, we should do factor allocation, not asset allocation. Another current area of research is illiquidity risk in investors’ portfolios and what role illiquid assets should play. We don’t have very good models of how to allocate assets with illiquidity risk. Everyone essentially uses technology from the 1950s—Markowitz’s mean-variance formulas that do not have illiquidity risk factored in—and then people make ad-hoc adjustments. We need to directly account for how illiquidity affects the investor. I’ve developed a portfolio choice model over both liquid and illiquid assets that does that. It also handles illiquidity risk over various horizons. It shows how to allocate to liquid and illiquid assets over time: it derives optimal strategies when a portfolio can and cannot be rebalanced. The model allows an investor to compute an illiquidity risk premium—an illiquidity hurdle rate, or the compensation required by the investor to bear illiquidity risk. I am particularly interested in the perspectives of asset owners. Owners range from very big to very small, to governments and individuals, and to collective owners like pension funds, and they are more similar than they are different. They all have money to invest and they want to earn risk premiums: all of them trade off risk and return. Only the rare and lucky ones don’t have liabilities. It is usually just the types of liabilities that differ. Asset owners usually don’t manage assets themselves and delegate instead, which creates agency issues. I focus on factor risk premiums they should collect, the level of risk they should take, the governance structures they should put in place, and how to stay the course. Overall, I want to help asset owners make the best choices. How can asset owners make better portfolio decisions? How can they match their factor risks across their assets and liabilities? What are robust governance structures? And how can we hire portfolio managers that will make the best decisions at the lowest costs for asset owners? I put a lot of importance on how to improve the welfare of asset owners.”