How does a PhD student at Chicago become a successful entrepreneur? Like all good companies, AQR had an interesting beginning. Heres their story; Cliff Asness co-founded AQR Capital Management in 1997 with ex-Goldman Sachs colleagues Robert Krail, John Liew and David Kabiller. Mr. Asness et al left their lucrative jobs at Goldman Sachs to start AQR, short for Applied Quantitative Research, to replicate the success that they had achieved with Goldman Sachs Asset Management (GSAM). In 1997, with an eyebrow raising one billion in initial assets, they set up shop in New York City. Nowadays, the fund manages roughly $40 billion in assets, with Mr. Asness at the helm leading a team of twenty nine PhDs at AQR’s offices in Greenwich, Conn. Mr. Asness, born in Rosalyn, NY, was not exactly an academic prodigy but somewhat of a slacker who barely got into the University of Pennsylvania, only thanks to his unexpectedly high SAT scores. After graduating with a dual degree in economics and engineering in the mid-80s, Mr. Asness was accepted in the PhD program at the University of Chicago’s school of business. At the U of C, Mr. Asness came under the wing of Eugene Fama (who is renowned for his efficient market theory) by working for him as a research assistant. It was the late 1980s, the field of portfolio theory was being fomented, and the long-accepted academic tenets of efficient market hypothesis came under scrutiny. Mr. Asness, inspired by his thesis advisors, Gene Fama and Ken French, jumped right into the fray. While doing research for his dissertation, Mr. Asness discovered that it was possible to beat the market consistently by exploiting value and momentum. Even though the idea was not an original one, Mr. Asness was the first to develop empirical evidence to exact the thesis. While still working on his dissertation, Mr. Asness joined Goldman Sachs Asset Management (GSAM) where he traded mortgage-backed securities on the fixed-income desk and, after two years, upon his employer’s behest, he set up a “quantitative research desk.” Hiring Mr. Krail and Mr. Liew, both of whom he knew at the University of Chicago, Mr. Asness built a model that would embody both Fama and French’s value insights with his own momentum insight. The resultant model worked not only for stocks but, as Mr. Asness and his colleagues soon discovered, with currencies, commodities and even entire economies. In 1995, Mr. Asness’ team launched an internal hedge fund for Goldman Sachs using the new model. The fund was one of the earliest “quant vehicles” and as thought to be one of the most influential quantitative hedge funds ever. The main premise of the fund was to generate outstanding returns irrespective of market performance. Mr. Asness and his team achieved this goal by utilizing their computerized trading model to scour for investment tools and deploying leverage and short-selling with a dose of momentum. Within three years the fund, named Global Alpha, had blossomed from $100 million under management to $7 billion. The returns, to say the least, were impressive: Only one month down and the best year returning more than 100% after fees. Global Alpha’s éclat not only spawned a surge of quant funds but also led to the establishment of AQR Capital Management. With $1 billion as initial investment capital, AQR was able to make money in the first month after the launch. However, after the first month, they faced the arrival of the internet bubble. None of the extensive research or the complex models of Mr. Asness and his colleagues were able to work under the market circumstance which were not simply inefficient but instead were extremely inefficient. The firm went from having $1 billion in assets to just $400 million over the next twenty months. Despite the fact that most market participants were accumulating internet stocks, Mr. Asness refrained from following the herd as he believed the economy would crash once the bubble bursts. As predicted by Mr. Asness, when the internet bubble burst, large institutions, which had been loading up on internet stocks during the bubble, were losing a lot of money. Following Yale’s footsteps, AQR started investing in hedge funds which, during the time of the dot-com crash, proved to be reaping better gains than the rest, or at least in most cases generating breakeven returns. Mr. Asness’ sanguine attitude protected him from redemptions, and after the bubble burst, the firm resumed its methodology that was initially promised to its investors. During the next five years, from 2000 till 2005, AQR managed to realize impressive annualized returns of 13.2%. When the financial crisis of 2008 occurred, however, assets under management at AQR plunged. The firm’s assets sank from $39 billion in 2007 to $17 billion by the end of 2008. ”We were looking the grim reaper in the face,” recalls Mr. Asness. He and his partners personally visited with investors to give an explanation of the events that led to their dismal performance. Mr. Asness was able to convince investors to stay the course by arguing that his funds had high volatility and that these sort of short-term shocks were inevitable but will still result in excellent long-term results. AQR’s returns quickly rebounded. The record of the firm’s flagship Absolute Return Fund, the successor to Global Alpha, showed that over the past 16 years it has produced annual gains of 10.8% after fees compared to 6.8% for the S&P 500. In 2009, going against the grain of high-brow hedge funds only catering to a select clientele AQR, with Mr. Asness’ blessing, launched an array of mutual funds. The roster included funds that employ merger arbitrage strategies, buying shares of takeover targets and profiting if and when the deals close, and others that apply classic long-short hedging strategies. Three funds were (and continue to be) dedicated to the momentum approach: AQR Momentum, AQR Small Cap Momentum, and AQR International Momentum. The funds are sold through fee-only financial advisers. AQR Momentum is a prime example of how Asness implements his strategy, which focuses on large-cap stocks. In building the portfolio, AQR screens the 1,000 largest U.S. stocks by market capitalization and buys the 33% that have performed the best over the past 12 months. The fund rebalances every three months, generally selling stocks that did the worst in the most recent period, and adding new winners. It is a simple formula (though its optimal execution requires Ph.D.-level algorithms). But the numbers show that it works. Simple because complex analyses of numbers prove that the method works – this is indeed the formula of AQR across all platforms. hedgefundletters/aqr/
Posted on: Thu, 03 Jul 2014 10:50:12 +0000
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