Is There Alpha or No Alpha?

For this week’s episode (our longest to date), we get together with the legendary Professor Campbell R. Harvey and take a deep dive into a diverse range of topics that draw on his incredible breadth of knowledge and extensive research. Campbell is the Professor of International Business at Duke University and is also a Research Associate at the National Bureau of Economic Research. In 2016 he served as the President of the American Finance Association, and from 2006 to 2012 he occupied the incredibly demanding role of Editor for the Journal of Finance. One of his earliest achievements was identifying the inverted yield curve’s ability to predict a recession, a highly regarded metric that is near-ubiquitous in its implementation. For the first half of our conversation, we focus on his research in areas like skewness and emerging economies. We cover specific topics like the factor zoo, why it’s problematic, and how Campbell, along with his student Yan Lui, found through their research that approximately half of the published empirical research in finance at the time was, in fact, false. We also unpack his most downloaded paper entitled The Golden Dilemma and get into the intricacies of why gold is an unreliable inflation hedge. For the latter half of our conversation, we hear about Campbell’s latest book DeFi and the Future of Finance along with his most recent research. Discover how Campbell first became interested in the topic several years ago and decided to put together a course for his students. We also delve into the rise of decentralized finance (DeFi) and how we can expect it to shape global finance, trading, and the future of the internet. Join us today for this essential episode on everything from the pitfalls of academia, to emerging markets, to Bitcoin, and much more!

Key Points From This Episode:

• Introducing this week’s guest Professor Campbell Harvey. [00:02:46]
• How Campbell’s research brought him to Chicago's Ph.D. program. [00:03:55]
• How Campbell identified that an inverted yield curve had preceded the past four recessions and could be a reliable economic predictor. [00:07:03]
• Hear about Campbell’s research on skewness, as opposed to simply mean and variance, which is often the focus of portfolio theory. [00:11:40]
• Why it’s surprising that skewness is still largely disregarded in favor of mean and variance. [00:16:42]
• Why mean and variance are insufficient for measuring risk when comparing a concentrated portfolio with a more diversified portfolio. [00:20:45]
• Some of the special considerations that Campbell prioritizes when assessing emerging markets in context and managing an overall portfolio.[00:22:04]
• Observations on the cost of capital being higher before integration and liberalization. [00:25:11]
• The implications that Campbell’s research on emerging markets has on asset allocation. [00:26:51]
• Dynamic asset allocation, Campbell’s research in emerging markets, and how those lessons can be applied when investing in emerging markets at a time when the cost of capital is high. [00:30:04]
• The factor zoo, why it’s problematic, and how it is caused by data mining. [00:32:26]
• How Campbell and his student Yan Lui estimated that half of the published empirical research in finance was false and how this has occurred in other industries due to data mining. [00:33:02]
• How economic incentives from the investment industry inform research. [00:39:38]
• The important distinction between academic research and practitioner research, and asset management. [00:44:15]
• The extent to which asset management research could be considered to be more reliable than academic research. [00:47:23]
• Some of the mistakes that investors make when they pursue these factor premiums that have been identified [00:49:29]
• Machine learning and its impact on investment decisions for retail and institutional investors. [00:56:06]
• Whether the benefits of potential alpha from machine learning will be passed on to investors or remain within a firm as their scale increases. [01:00:22]
• Campbell’s research on traditional active management within the context of a firm’s ability to continue delivering alpha in the future, and how that incrementally decreases as their asset base increases. [01:06:23]
• The arguments in favor of allocating gold to a portfolio, especially at times of higher inflation, and whether it holds up to scrutiny. [01:09:54]
• How technological changes can affect the real expected return. [01:16:51]
• Why gold can be a valuable asset in diversifying your portfolio. [01:17:22]
• How Campbell became interested in DeFi, cryptocurrency, and blockchain technology. [01:19:19]
• How digitized finance cuts out the inefficiency of having a middle person and fosters inclusion and financial democracy. [01:26:35]
• Harvey’s thoughts on how cryptocurrencies facilitate criminal and fraudulent activity. [01:31:07]
• How DeFi could disrupt traditional asset management and how to prepare for those changes. [01:36:43]
• How to invest in DeFi even though it’s decentralized. [01:38:33]
• How companies can increase their revenue by using cryptocurrencies in their transactions. [01:43:24]
• Why the current wave of FinTech will be replaced by DeFi. [01:44:58]
• Why it’s important to have a very diverse portfolio when investing in DeFi. [01:51:22]
• How DeFi will allow people to monetize their content and disrupt the money that Google and Facebook make from their users’ data. [01:52:22]
• Some of the risks of DeFi and investing in cryptocurrencies. [01:55:27]
• How Campbell defines success: positively impacting the world. [02:00:17]