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Momentum bets that whatever has AQR’s principals, Cliff Asness and David Kabiller: We have spent millions of dollars been going on will keep going on a little Kabiller, in Greenwich. The outspoken As- a year on income statements and balance- more. Over the past 70 years in the U.S, ness gained some attention this year with sheet data on companies. We process that it wins in about two-thirds of the years.ii When his criticism of President Obama after information. We try to isolate those fac- doesn’t it win? Whenever you have sharp the nation’s chief executive had attacked tors that are leading indicators of security reversals. March to April was pretty hedge-fund investors who felt that they prices and most of them are fundamental much the ultimate whip-saw. This doesn’t had gotten a raw deal as creditors in the factors and some technical. change our belief in momentum. Chrysler bankruptcy. He’s also criticized Asness: I won’t paint it all as entirely pos- How is the diversified arbitrage fund Obama’s health-care proposals. But in our itive, We give up the ability to have magi- structured? interview, Asness focused on investing, cal insight into one company. Having said not politics. that, it can be risky to have a lot riding Kabiller: It does convertible arbitrage, on one stock if you happen to be wrong. merger arbitrage, dual-share-class struc- Barron’s: What’s AQR all about? tures, closed-end funds and SPACs [which Asness: It started back in 1994 when I It’s unfashionable to say you like momen- let investors participate in private-equity was at , and they asked tum investing because it’s often perceived deals]. This year, convertible arbitrage me to form a quantitative-research group. to be a mechanical, dumb-money strategy. and SPACs have been more important and Where our process might have consisted Asness: One of the scariest moments of a larger portion of our risk than merger of a few measures of value and price my life was telling University of arbitrage. momentum 15 years ago, it now gener- professor Gene Fama that I wanted to Asness: This year, an equal allocation ally consists of many factors from more write a dissertation on price momentum. among the strategies would have been subtle measures of value and momentum And I think I mumbled the part where I silly. We were able to take money out to signals obtainable from the actions of said it works really well because it’s not a of mergers and put it into convertibles, management, short-selling activity and very Chicago idea. To his credit, he said; which were selling incredibly cheaply. inventory changes for commodities. Our “If it is in the data, write the disserta- The fund has very low leverage because models form a diversified systematic opin- tion.” of its mutual-fund structure. ion on what we like and don’t like in all liquid assets. Then, a different portfolio is Why do you think What arbitrage strategies now look attrac- built for each client. For a traditional cli- works? tive? ent seeking to beat EAFE [MSCI’s inter- Asness: No one has nailed down why. Asness: Converts are still very cheap. If national equity benchmark), we use our We have a lot of theories. When I say you ignore the end of last year, which you stock-picking around the world and our “we,” I don’t just mean AQR. I mean the absolutely can’t because it did happen, country and currency tilts. academic community and the practitio- converts are the cheapest they have been in 25 years. iii You employ about 200 people. But none ner community. Underreaction is prob- Having said that, they are as third as of them do fundamental research and ably our universally favorite story. Good cheap as they were in the insanity levels follow companies like General Electric or news comes out. There is a phenomenon after the Lehman bankruptcy. Ours is an Nestle, right? in behavioral finance called anchoring and adjustment, where people go, “Oh, that’s arbitrage strategy. It’s not same thing as Asness: It’s actually just me and David great news,” and they move halfway but the Vanguard convertible fund. We buy and one really big computer. This comes they don’t move all the way to incorporate the convertible, sell the stock and use up all the time. We don’t have analysts the great news. So if you buy what’s gone credit-default swaps and bond futures to who cover each of the individual compa- up, there’s a little more to go. I won’t hedge the interest-rate and credit risks. nies. We don’t visit companies. A lot of pretend I have told you all the different Kabiller: Most individuals have a very big what we do is asset-allocation work. To theories. bet. They are betting on financial health— the extent that we visit countries, it’s usu- that the stock market goes up and credit ally called vacation. You brought out a momentum mutual does well. This is a fund that is actually Having said that, a tremendous amount fund, but not a value fund. not betting strictly on financial health be- of work goes into our models. If someone Kabiller: The world doesn’t need another cause it’s long and short. asks why we’re long a stock, we would list value stockpicker. 17 reasons for it. We would list its valu- What can we learn from last year? ation on 10 different scales: its valuation One of your ideas is to keep fees low. Kabiller: We have to be careful of learn- in the absolute sense, its valuation against Asness: If you think momentum will build ing too much from last year because last its peers and its industry group, its health a better portfolio, you shouldn’t be pay- year set up unbelievable opportunities for in terms of its improving margins, its mo- ing 200 basis points [2%] in fees annually. this year, including the convertible mar- mentum. A lot of what we do is value plus You should be paying someone more like ket. But what are the great lessons we momentum. We try to buy cheap things 40 basis points. [The net expense ratio on learned? It’s that deleveraging can hap- that are starting to get better. You can the AQR Momentum fund is capped at 49 pen, that you should be sure to have some get a lot from corporate managements basis points through April 2011.] Treasuries, and that the world had a delu- without talking to them. Are they buying sion of diversification. back shares or are they issuing shares? How is momentum investing doing this So when you ask if we do fundamental year in the U.S.? Thanks. n i AUM data as of August 2009 ii AQR Capital Management iii AQR Capital Management The Morgan Stanley Capital International EAFE Index is a market capitalization weighted index composed of companies representative of the market structure of 21 Developed Market countries in Europe, Australasia and the Far East. One cannot invest directly in an index.

An investor should consider the investment objectives, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus containing this and other information, please call 1-866-290-2688 or download the file from www.aqrfunds.com. Read the prospectus carefully before you invest. There is no assurance the stated objective(s) will be met.

An investment in any of the AQR Funds involves risk, including loss of principal. The value of the Funds’ portfolio holdings may fluctuate in response to events specific to the companies in which the Fund invests, as well as economic, political or social events in the United States or abroad. The use of derivatives exposes the Funds to additional risks including increased volatility, lack of liquidity, and possible losses greater than the Fund's initial investment as well as increased transaction costs. Please refer to the prospectus for complete information regarding all risks associated with the Funds.

Diversified Arbitrage Fund. This Fund has the risk that the anticipated arbitrage opportunities do not play out as planned, resulting in potentially reduced returns or losses to the Fund as it unwinds its trades. This fund enters into a short sale by selling a security it has borrowed. If the market price of a security increases after the Fund borrows the security, the Fund will suffer a potentially unlimited loss when it replaces the borrowed security at the higher price. Short sales also involve transaction and other costs that will reduce potential Fund gains and increase potential Fund losses.

Momentum Funds. An investor considering the funds should be able to tolerate potentially wide price fluctuations. Securities with positive momentum generally will be more volatile than a broad cross-section of securities. In addition, there may be periods when the momentum style is out of favor, and during which the investment performance of a Fund using a momentum strategy generally will suffer. The funds are subject to high portfolio turnover risk as a result of frequent trading, and thus, will incur a higher level of brokerage fees and commissions, and cause a higher level of tax liability to shareholders in the funds. The funds may attempt to increase its income or total return through the use of securities lending, they may be subject to the possibility of additional loss as a result of this investment technique.

Small Cap Momentum Fund. Funds that emphasize investments in smaller companies generally will experience greater price volatility.

International Momentum Fund. Foreign investing involves special risks such as currency fluctuations and political uncertainty.

The Funds are new and have limited operating history. The Funds are not suitable for all investors.

Past performance does not guarantee future results

Cliff Asness and David Kabiller are Registered Representatives of ALPS Distributors, Inc.

AQR Funds distributed by ALPS Distributors, Inc. AQR 161 9/24/2010