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Asness on Mixing Value with Momentum

Kathryn Young

Kathryn Young: Hi. I am Kathryn Young. I am a Mutual Fund Analyst with Morningstar. I am here at the Morningstar Investment Conference in Chicago, and I am joined by Cliff Asness, Co-Founder of AQR Capital Management.

Hi, Cliff. Thanks so much for being here with us today.

Clifford Asness: Hi. Thank you for having me.

Young: So, first off, I want to say, your firm is, obviously, very well known for the hedge funds it started, and you've recently brought some hedge fund strategies into the mutual fund space, but I'm curious about one of your a bit more traditional strategies, AQR Global Equity, that launched earlier this year and has garnered a good number of assets. So, I was wondering if you could tell us, what exactly about that fund makes it a good alternative to other strategies in the world stock category?

Asness: Sure. I think you are 100% right. We are probably more well known as a hedge fund firm, though the same group has been together since Goldman Sachs, and this has been true for about 16 years, that we've been almost always more than half assets in the traditional space. I think hedge funds are either sexier when they are doing well or more evil when they are doing poorly. So, you're always known as a hedge fund firm. So, we've always also run more traditional – beat the benchmark kind of assets.

What sets our approach apart, at least somewhat is, first of all, taking what has become a fairly well known quantitative approach of value and momentum investing. We would argue, like many would, we've been doing it now for a decade and a half. We think our approach is pretty good, but probably the biggest difference in what we do and maybe some others, is, we use the same philosophy, looking for cheap things that have started to improve and expensive things that have started to deteriorate, to over and underweight, not just at the stock level, but also at the country and the currency level.

We've found, and I think the last 15 years bear this out, that the method works about as well to choose where in the world to invest and whether to hedge your currency as it does to pick stocks. So, the simple idea is, if you have something that works, but nothing works all the time, do it in three places, not just one. So, if I had to pick one thing that makes our fund maybe a little more consistent and a little different is making three types of bets, using a consistent philosophy, not really one type of bet.

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Young: Okay. Would you find that the three types of bets do they work, work well in separate times or do they work well sort of in the same time?

Asness: You're trying to induce me to be a quant geek and start talking about correlations; it doesn't take much. What we found over time is, currencies are actually the least related. They really move through their own drummer more. Choosing what country to be in and choosing what stock to be in, say, within a country, are in geek speak, correlated, but far from perfectly correlated. They have a positive.

If you look at the tech bubble, remember back when that was the biggest bubble we ever saw. If you look at the tech bubble, obviously, growth stocks beat value stocks, tech stocks beat other stocks, but it was also true if you looked across countries.

Countries that were more tech stock oriented versus natural resources countries or financial like a Belgium or something that was very dominated by insurance and finance, that was an extreme example, but there was a correlation there. Growth countries beat and then lost to when it came down, but the correlation is far from one. It's less than 0.5. You get a lot of diversification but currencies are really the place where you get a lot of diversification.

Young: About the momentum part of your strategy, a lot of quantitative funds that use momentum strategies have struggled through 2008 and 2009, those different types of markets. Can you tell me why that might be and how your funds have fared?

Asness: Yeah, It's a very complex explanation first of all. Momentum didn't really work that well. I'm kidding. To start off, that is the simple explanation. Globally speaking, there is always a yin and yang to it. We try to combine value with momentum strategies. Times that are good for momentum are often poor for value and vice versa. We actually saw total performance that was pretty decent over the period.

We are not immune, too. If you broke up our models, this would have been a great time to say, God, I wish never did momentum and only did the value side. We don't think anyone, including us, is too good at predicting which one of those is going to work better going forward. We think they both work on average and they hedge each other. This is not hedge fund, but they hedge each other quite well, even for beating a benchmark, when one is helping you, one is often detracting and vice versa, and it usually adds up to something good.

So, by and large, it's not satisfying of an answer to say it just didn't work. To get a little more specific, particularly, we saw a huge reversal occur not just for individual stocks, but in almost everything in investing from March to April of 2009. Momentum -- and we can try to make it sound more complicated, but really is a bet that what has been occurring will continue to occur.

So when the world gets its transmission thrown out of gear and starts going the other way very abruptly, it's a very good time often to be a value investor, but not the time you want to be a momentum investor.

Last thing I'd say on it, and this we avoided, and I hope it's skill, maybe it's luck, you never know when you avoid something, but what came into vogue maybe post 2007 was trying to be what's called, 'more dynamic,' about your factors. In the in the quant world tilting more towards value at times, more towards momentum at times. We don't think that's hopeless, and we do a little of it, but I think we do a decent not less than other people. I think we have more faith in the basics.

And a lot of what people who do that do it based on its recent performance, and momentum did very well until it didn't. So, I think a fair amount of people got kind of lead down a bad path there...