I t hasn’t been a good year for hedge funds. Returns years. Successful managers who have faltered are working to get have been elusive, and raising money has been back in the game. Philip Falcone, who runs Harbinger Capital nearly impossible. Almost 3,000 funds have shut Partners, is risking an investor mutiny as he sinks his remaining down since the beginning of 2008, and if this year’s first-half assets into a wireless broadband network. Clifford Asness of pace continues, another 400 will close up by December, accord- AQR Capital Management, whose assets fell to $17 billion from ing to Hedge Fund Research Inc. Funds climbed an average of $39 billion, has rebounded partly by seeking mutual fund inves- only 1.45 percent through August. They pulled in a net $23.3 bil- tors. Going forward, Asness says, the challenge is “to build a lion in the first half, a fraction of the industry average over 20 more diversified and stable business model.”
November 2010 bloomberg markets 51 photograph by nathaniel welch/redux won’ By r Richa cover Storie Shu telbaum d Tei After losses of more than 50 percent in 2007 and 2008, s Cliff who ::
hedge funds new hedge and mutual funds—and sounding off on on off sounding funds—and mutual and hedge new of AQR Capital Management is starting starting is Management Capital AQR of Asness The everything from taxes to Tea Partiers. a sne ss Up t t
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Month 2010 bloomberg markets 53 lifford Asness, who runs AQR Capital Management LLC, one of the world’s biggest hedge funds, says fellow fund managers gouge C and computerized models to trade stocks, their clients by charging exorbitant fees for just track- ing the markets. He also takes a dim view of the admin- bonds, currencies and commodities. Many quant funds got hit hard in 2007 and then istration of President Barack Obama, calling his again in the 2008 market crash. “AQR has economic team “Cossacks on a shtetl,” a reference to to fight against this current that’s going the Russian cavalrymen who sacked Jewish villages in against them,” says Daniel Celeghin, a Eastern Europe in the 19th century. partner at Casey, Quirk & Associates LLC, a consulting firm in Darien, Connecticut. The hedge fund manager—who is both a University “They are one of the few quant firms that of Chicago Ph.D. and a Marvel COMIC BOOK collector— have managed to come back.” is well known for his impolitic outbursts. “What kind AQR’s $1 billion Delta fund, opened in of coward doesn’t share his views?” asks Asness, 44, as late 2008, returned 19.3 percent in 2009, an investor says—beating Hedge Fund he paces his office overlooking Long Island Sound in Research Inc.’s Fund of Funds Composite Greenwich, Connecticut. “I believe strongly that the Index, which returned 11.5 percent. The world is going on the wrong course.” fund was up 3.9 percent in 2010 through Asness went the wrong way three years ago. AQR’s August versus a 0.3 percent loss for the HFRI index. flagship Absolute Return fund fell more One version of AQR Global Risk Premium, a $3.9 billion asset allocation fund—meaning it divides its investments than 50 percent over calendar 2007 and 2008—the kind across myriad markets—surged 21.2 percent in 2009 and of drawdown that’s often a death warrant for a fund. was up 17.2 percent this year through August, according Firmwide assets tumbled to $17.2 billion in March 2009 to investors. from a peak of $39.1 billion in September 2007, according to AQR has also created a portfolio of seven mutual funds for AQR investors. retail investors since 2008, with total assets in September of “I heard the Valkyries circling,” quips Asness, who says he $2.3 billion. Three of them focus on momentum investing— identifies with action heroes like Captain America and exploiting the tendency of securities to continue in their Spider-Man. “I saw the grim reaper at my door.” most recent trajectories. One invests in futures, and another AQR survived. It did so by launching a campaign of diplo- bets on various kinds of arbitrage. Two trade foreign stocks. macy with its clients and offering a host of new funds and The firm markets the funds, which use quantitative models, strategies. Asness’s funds have recovered smartly. Though through financial advisers. the Absolute Return fund’s assets are now down to $1.6 bil- Year to date, AQR has added $5.8 billion to its assets, lion from a peak of $4 billion, the fund rose 38 percent in which totaled $26.8 billion in August, according to inves- 2009 and more than 10 percent through mid-September of tors. “It’s extraordinary to have had that kind of drawdown this year, investors say. and then see them pull in their belts and come back so As a quantitative investment firm, AQR uses algorithms strongly,” says Tom Healey, founder of private investment
54 bloomberg markets November 2010 matthew gilson EVestment Alliance LLC, an Atlanta-based research firm. to according percent, 9.51 of return cumulative a had prices— share and prospects companies’ on based picking stock techniques—traditional fundamental using Those percent. 1.15 minus of return cumulative a had strategies ment firms actively trading U.S. equities using quantitative 2010,investJune - through 2005 of start Fromthe 2005. says their number fell to 240 in July from 374 at the end of prices collapsed. commodity and bond stock, when 2008 in again plunge to kets short-circuited. Most funds quickly bounced back, only losing stock positions—briefly costing them billions as mar same the of many into them directed had programs their fund returns for this article. according to a former employee. AQR declined to provide any record from its 1998 inception to its nadir in the market crash, negative a fund Return Absolute the gave 2008 and 2007 of firm Healey Development LLC, which invests with AQR. The August 2007 quant rout unfolded over four days, four over unfolded rout quant 2007 August The funds, quant tracks which Inc., Lipper firm Research August2007,found early quants otherIn some and AQR devastation The suffered. AQR investorsin longtime Still, - 20 percent typical of hedge funds. The fee rises or falls or rises fee The funds. hedge of typical percent 20 and percent 2 the versus earns it anyprofits of percent 10 plus fee management percent 1 a pay they which in ment their low fees. The Delta fund offers investors- an arrange tors and make sure his perform. algorithms inves back win to overtime working Now,is tors.Asness Absolute Return fell about 40 percent, according to inves - globally.markets commodity and bond stock, the down brought assets mortgage-related of collapse The during. its positions. ished the month down only 3.4 percent because it stuck with which had a peak-to-trough loss of 13 percent in August, fin- Return, Absolute AQR rebounded. markets 10, Aug. On One reason some of AQR’s funds attract investors is investors attract funds AQR’s of some reason One The calamity of 2008 was far more wide ranging and en- market hypoth- f 57 percent in 18 esis lost some 500 index ama’s efficient when the of its luster on his thesis. advised Asness E Chicago’s The University of November 2010 ugene Fama months. scrambled to cover short positions. betting against soared as managers were they those while sold, they as collapsed quants with popular there was a rush to the exits. Stocks studied the quant crash. On Aug. 6, has who Engineering, Financial for Laboratory Technology’s of director of Massachusetts Institute Lo, Andrew to according sitions, tried to close out some of their po- firms more or one after probably fell S&P bloomberg markets 55 -
depending on how closely the fund tracks its benchmark. rationally act like a team, then you have a beautiful thing.” AQR mutual funds charge as little as 0.49 percent, on a AQR’s trading is mostly automated, so there is little of par with some of those offered by low-cost Vanguard Group the shouting and tumult that characterize some hedge Inc. Vanguard founder John Bogle says he’s impressed. funds. Partners, traders and analysts sit on a trading floor “He’s proved his point that he can do it at a reasonable cost,” in a dozen rows, with some senior researchers taking the says Bogle, who’s a fan of AQR research. “If I were a betting windowed offices. Academics are invited to give talks on person, I’d bet he gives competitive returns.” Asness’s low fees, positive performance and powers of persuasion have reassured investors. “His ability to commu- nicate in front of trustees is phenomenal,” says Jeff Scott, chief investment officer of the $36 billion Alaska Permanent Fund Corp., which invested $500 million with AQR in January, now spread among Absolute Return, Delta and asness’s ‘abil- Global Risk Premium. “These are people who are trying to ity to communi- solve our problems and not just raise money.” cate in front of On an August morning, Asness walks to his sun-dappled of- trustees is phenomenal,’ fice windowsill and picks up a Captain America action figure. the alaska per- The hedge-fund mogul owns a panoply of action heroes, from manent fund’s the Hulk to the Silver Surfer, and the comic books that spawned jeff scott says. them. “I like to think of it as a much, much more affordable version of a money manager collecting art,” he says.
subjects ranging from behavioral finance to ac- counting rules. AQR manages some 65 funds of various stripes— and often tailors core strategies to meet client needs, using more or less leverage, for example. The firm has adapted its models to trade in everything from the Polish zloty to Japanese bonds, to oil, gold and wheat. Asness says the myriad strategies and mar- kets provide the extra safety that comes with spread- ing one’s bets. Example: AQR uses its models to run traditional long-only funds, seeking to beat a bench- mark by a few percentage points while limiting risk. “We really believe in diversification of all kinds,” Asness says, adding that it especially helped during the meat grinder of 2008. “It did make it a lot easier Though the wisecracks never stop, Asness is at the same to stay the course.” time a demanding boss, two former employees say. One Even as he works to outsmart volatile markets, Asness recalls being questioned about profit-loss updates on continues offering opinions on everything from Broadway Thanksgiving. And Asness admits to a temper: He’s musicals to overhauling U.S. health care. Asness performs knocked his ViewSonic computer monitor to the floor on across all media, writing opinion pieces for newspapers and three occasions, though it never broke. “Either they’re magazines, talking on television shows and at conferences building good computer screens or my punch isn’t what it and contributing to websites. “It’s almost like he can’t help used to be,” he says. himself,” says Theodore Aronson of Philadelphia quant firm Asness calls the decor at AQR—with its wood-paneled walls Aronson + Johnson + Ortiz. “He’s afraid of no one and is not and spare furnishings—“Goldman Sachs circa 1997.” In tone, capable of telling a lie. It’s not the usual pablum.” however, the research process hums more like a finance grad- Asness sounds off most frequently in e-mail blasts to a uate school. “We try and run it like an applied academic semi- personal network of friends, family and investors. One sar- nar,” Asness says. “If you can get savage capitalists to castic example, from March, concerned a U.S. Senate move
56 bloomberg markets November 2010 58 e noss h American the endorses he the country.” At the same time, small government has inspired gressive stand for freedom and ag- “Your March, in blogging praised the Tea Party activists, has He predictable. ways sins of government.” banks, of sins individuals, of sins were “There says.ots,” he idi- frigging like acted public the this; on ball the dropped “Everyone crisis. the for alone banks blame to commentators of tendency the and regulators powers Congress gave financial increased the medicine, ized social calls he law, which care up, even if it’s not in his best interest.” stand to duty his is it feels he pizza, or investments, politics to related be it whether dishonest, or incorrect is feels Cliff that opinion an offers someone “When Asness. of classmate managing director at Goldman Sachs Group Inc. and a former a Beinner, Jonathan says ignorance,” and dishonesty intellectual are supervillains “His arm. left his on tattooed as an indestructible weapon. Asness has an image of the shield used be secretcan a shield of whose help and the serum with comic book character is Captain America, who gains strength ernment salary.” gov a for all And Promise. right. it get will geniuses These bubbles. more “No wrote. he work,” to going definitely is “This crises.financial predict to office federal a create to sess iw ae o al not are views Asness’s Obama’sabout health- complaining was Asness August, In Asness admits to a superhero complex. His favorite Marvel bloomberg markets November 2010 - -
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Asness says. While that punished AQR in the sell-off, it left left it sell-off, the in AQR punished that While says. Asness models,” the in believed “We models. its on plug the pull and 2008, Asness says. For example, the firm didn’t panic and University of alum, Chicago is on medical leave. a also Krail, Robert partner, founding fourth The team. Ph.D.s in finance. He heads AQR’s global asset allocation asset global AQR’s heads He finance. in Ph.D.s Chicago Graduate School of Business, where they both earned of University the at classmate Asness former a is 43,Liew, John blazers. FordTom favors and relations client heads champion, tennis University Northwestern former a 47, two of the three other founding AQR partners. David Kabiller, are table room conference a AQR’sAround at offices. noon he bites into a piece of tuna spicy roll sushi one August after Civil Liberties Union’s campaigns to guard civil liberties. AQR was buttressed by some key decisions during 2007 2007 during decisions key some by buttressed was AQR With AQR in comeback mode, Asness is in good humor as as humor good in is Asness mode, comeback in AQR With certain stocks. a mass exit from August 2007 to quant crash of Lo MIT attributes the h efcet akt yohss o EMH, or hypothesis, market efficient the back on risk and raise cash. cut thresholds, various at leverage reduce that systems trigger automatically will sell-off stock investor redemptions, as many funds did. box.” The firm didn’t impose new restrictions on black a of view negative a have “People says. Kabillerus,” from hear to want “Clients moil. ’s Andrew Like many quant firms, AQR is grounded in big Now,a changes. some make did firm The o btln te akt tur market the battling for strategies its of informed well them keeping by loyal vestors stone to come back to helps.” beast,” he says. “Having a lode- statistical a 2009.riding“It’s March in beginning bound re- the for positioned firm the AQR has tried to keep its in- - -
jason grow aibe ta oe tm gnrt hge returns—or higher generate time over that variables examine researchers AQR them. from profit and markets 2008 were real blows to that idea.” in culminating bubble real-estate the and crash tech the information,’says.all think reflect saysI ‘prices “EMH and markethypothesis shouldn’tand have it,”defend to Asness efficient the of form extreme the in believers aren’t “We That’s been discredited.” out. things sussing at effective was market the that idea MarketRational asset should be,” says Justin Fox, author of an of valuation the what out figure to trying in lacking “Fromwoefullybeen market has the perspective, macro a Poor’s& Standard months.18 in percent 57 fell Index 500 and setting the right price for it. tive at digesting the available information about an asset effec- is market stock the that say adherents his and 71, Asness’swas who Chicago,Ph.D. of adviser.Fama,thesis promulgated by professor Eugene Fama of the University 60 AQR’s business, in fact, is to find inefficiencies in the in inefficiencies find to is fact, in AQR’sbusiness, efficient. perfectly is marketany believe doesn’t Asness the when sell-off, the in luster its of lot a lost EMH bloomberg markets November 2010 (HarperBusiness, 2009). “People had an had “People2009). (HarperBusiness, of a black box.’ ‘People have a kabiller says. negative view ‘clients want to hear us,’ A QR’s from
The Myth of the
from what is now the School of Engineering and Applied and Engineering of School the now is what from other the and School Wharton the from one Pennsylvania, yearbook: “Rich.” girls interested in geeks.” His destiny, according to the 1984 get to trying desperately was “I says. Asness school,” high in record mediocre a had York.“I New Park, Hyde New in graying beard. a with bald is He kilograms). (90 pounds 200 weighs and tall meters) (1.8 inches 10 foot 5 is Asness Cliff deadpans. “He’s 6 foot 2, has all his blond hair, and I am bitter,” Asness AQR. at counsel general now is and law up took he steps; younger brother Bradley would follow in their father’s foot- Asness’sManhattan. in attorney district assistant an was father,Barry,His firm. education medical a ran who Carol, mother,his from streak entrepreneurial his inherited have Asness says. ing it. “We think they all make money more often than not,” share count tend to outperform those of companies increas- asserts that the stocks of companies that are reducing their AQR’suse of they half model says.Anotherreturns, Asness of a premium tied to momentum, Fama says. Ph.D. dissertation, was among the first to show the existence 1994 his in Asness, falling. it’s if downward and rising is tum—the tendency of a stock’s price to continue upward if it conclude that one of the countries’ stocks are undervalued. with the earnings or book values of the listed companies and FranceGermany,in and them stocks compare of valuation ses and w BS dges t h Uiest of University the at degrees B.S. two earned Asness School High Herricks at star academic an wasn’t Asness may York,Asness New Queens, of borough the in Born than more drive premiums momentum and value The momen- is premium a generates that variable Another client relations. K allocation while handles asset Liew, left, Asness partner abiller heads colleagues might add up the market the up add might colleagues and Asness countries. whole even or bonds— and currencies like classes, asset and markets different to mium pre- value the apply to ways found caps.large outperformed stocks italization same research found that small-cap- The worth. net its is company a of value book The premium. value the ference between the two is known as lowwith values.those book dif- The relative to their prices outperformed values book high with stocks that showing research published 1992 Quants such as those at AQR have AQR at those as such Quants ot Clee in College, mouth Dart at teaches now who French, Kenneth and Fama premiums.
nathaniel welch/redux (2) A summer job at Goldman Sachs, engineered with help from Beinner, sent Asness in a different direc- tion. In 1992, he signed on for a one-year research job. In 1993 and 1994, the Ph.D. candidate found himself struggling to complete a 150-plus-page the- sis while logging 80-hour weeks for Goldman. In 1994, the investment bank hired him to build a quant research department. Although they’re friends, Fama says he remains irked that Asness didn’t pursue an academic career. “We invested a lot of time and effort in Cliff,” he says. Asness donated $1 million to name a classroom after Fama. “He should name another,” Fama says. At Goldman, Asness recruited future AQR part- ners Liew and Krail, two former classmates from the University of Chicago who worked at Trout Trading Co. In addition to building trading mod- els, Quantitative Research Group crunched num- bers and drew charts to help guide the bank’s traditional stock pickers and other managers. Asness also started what was then a small hedge fund for Goldman called Global Alpha—which would grow to $11 billion in assets by 2007. Under Asness, Global Alpha scored gains of 111 percent in 1996 and 42 percent in 1997. He grew frustrated with his other duties. “We thought it was crazy that they wouldn’t let us focus on investing alone,” Asness says. Science, graduating summa cum laude. “I believed in diversi- Asness, Liew, Krail and Kabiller, who had worked in fication even then,” he says. Goldman’s pension services group, decamped to start AQR The future hedge fund mogul made his presence felt on in 1998. In 1999, Asness married Laurel Fraser, a former campus. “He was the king of the geeks,” says Beinner, a Christie’s International salesperson, who before they dated dorm mate in Asness’s freshman year who’s now chief in- had been his executive assistant at Goldman. They are par- vestment officer of Goldman Sachs Asset Management’s ents of two sets of twins, born 18 months apart. fixed-income unit. “Cliff just had a following. People were AQR started with $1 billion, Asness says. It began trading always asking him questions when he was hanging around in August 1998—when the bubble in Internet and other the computer lab.” technology stocks was in full bloom. AQR followed its mod- Lo, then a Wharton School professor, hired Asness as els, betting against expensive stocks and buying cheap ones. an assistant. Lo eventually started his own quant firm, That meant Absolute Return hemorrhaged money until the AlphaSimplex Group. “He would run regression analyses for market turned against tech in March 2000. “We began with me,” says Lo, referring to the process used to find relation- $1 billion and through hard work and acumen turned that ships between variables for the purpose of predicting future into $400 million,” Asness jokes. values. “Given his background in computer programming The founders toured the world, trying to persuade inves- and finance, he was perfect.” tors that the tide would turn. In 2000, Asness penned a Lo wrote Asness a recommendation to the University of paper called “Bubble Logic,” in which he picked apart the Chicago Graduate School of Business, now the Booth School arguments supporting sky-high technology stock valua- of Business, and soon he was off to America’s citadel of free- tions. “When fallacies rule the land, somebody has to point market thinking. out the naked emperor,” he wrote. Asness became one of Fama’s favorites. “Cliff was among the In March 2000, the market turned and Absolute Return smartest students to pass through,” Fama says. In 1990, Asness began making money. The fund finished 2000 up 16.7 per- became the efficient-markets guru’s teaching assistant, putting cent, investors say. The Nasdaq Composite Index lost 77.9 him on track for an academic career. “I thought he had the percent of its value between March 2000 and October 2002. potential to make an excellent professor,” Fama says. From there, AQR flourished, with assets rising to $12 billion in 2004, when the firm moved to Greenwich. A key lesson of 1998 to 2000 was replayed less than 10 years later. “No strategy is so good that it can’t have a bad ‘no strategy is year or more,” he says. “You’ve got to guess at worst cases: so good it can’t have a bad No model will tell you that. My rule of thumb is double the year,’ asness worst that you have ever seen.” says. ‘my rule The firm has also redoubled its effort to develop new of thumb is strategies for boosting returns and improve existing ones. double the John Cochrane, the AQR Capital Management professor worst you have of finance at the University of Chicago, says many quants ever seen.’ just mine past data and extrapolate returns. “AQR is really analytical,” he says. “They put a lot of academic research to work—and they create a lot of academic research.” The Delta fund is one result. Drawing on years of analy- sis, the fund is based on the notion that some of the in- vesting techniques used by hedge funds, such as merger and 40 percent bonds—are actually unbalanced in terms of and convertible bond arbitrage, aren’t as sophisticated as risk. That’s because stocks, which are much more volatile, they’re cracked up to be. Merger arb hedge funds typi- may account for 85 to 90 percent of such a portfolio’s risk. cally buy the stock of possible acquisition targets and sell The Risk Premium fund puts money to work in a variety of short that of acquirers. Convertible arbitrage often in- asset classes—stocks, bonds, commodities and others—to volves buying a convertible bond and shorting the corre- spread risk more evenly. The amount of volatility a pension sponding stock, locking in the yield. investor wants in order to get to a desired return is adjusted AQR’s research showed that with the right formulas pro- with leverage. grammed in, the buying and selling of stocks and bonds for Asness and colleagues say they’re tweaking formulas at merger and convertible bond arbitrage could be automated. the fortified Absolute Return fund so that it can return to its And that’s what the Delta fund is: a kind of systematic hedge former prominence in the firm. fund using multiple strategies. “It’s sexy in a wonkish sort of “AQR believes in preserving capital by managing risk,” way,” Asness says. says the Alaska Permanent Fund’s Scott, who’s targeting re- The Global Risk Premium fund is another example. turns of 5 percentage points above inflation going forward. Research showed that pension funds that use traditional, “The returns are working, but the bigger picture is working balanced asset allocation formulas—say, 60 percent stocks too. What we found with Cliff is, he rolls up his sleeves and teaches us.” Around the developed world, expec- Bloomberg Tips aqr’s mutual funds tations for future investment returns have withered following the financial crisis and the drawn-out recession. Asness realizes that AQR won’t soon re- turn to the fat margins of pre-crash days. “The whole industry is less lucrative than it used to be,” he says. How will AQR define its own success in an era of tempered hopes? More as- sets? Higher profits? Asness—father of four, self-declared family man—gives an Tattoo? answer he knows will get him in trouble For information on AQR Capital’s seven mutual funds, type FL
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