%The dow jones business and Financial weeklywebreprints.djreprints.com/2296531456875.pdfOne of the largest firms in the field is AQR Capital Management of Greenwich, Conn. Founded

Jord

an H

olle

nder

for

Barron’s

%www.barrons.comThe dow jones business and Financial weekly auGusT 31, 2009

The Publisher’s sale Of This rePrinT DOes nOT COnsTiTuTe Or imPly any enDOrsemenT Or sPOnsOrshiP Of any PrODuCT, serviCe, COmPany Or OrganizaTiOn.Custom Reprints (609)520-4331 P.O. Box 300 Princeton, N.J. 08543-0300. DO NOT EDIT OR ALTER REPRINT••• /REPRODUCTIONS NOT PERMITTED #41267

!

(over please)

Interview With Cliff Asness and David KabillerPrincipals, AQR Capital Management

QUANTITATIVEINVESTMENTSTRATEGIESARESHROUD-ed inmystery.Most investorsdon’t even try tounderstandthem, andmany practitioners won’t discuss them, fearingthat doing so could cost them their competitive edge.One of the largest firms in the field is AQR Capital

Management of Greenwich, Conn. Founded in 1998, itoversees more than $20 billion, primarily for institu-tional investors. AQR, which stands for Applied Quan-titative Research, seeks to use some of best ideas ofacademic finance in the real world. It applies itsproprietary models across a range of assets, includingstocks, bonds and currencies.Backed by a wealth of historical data, the firm

believes in often-derided momentum investing, whichfavors buying stocks that have been doing well, rela-tive to their peers or the overall market, and avoidingthose with poor price momentum. AQR calls momen-tum investing an “undiscovered style” and a bettercomplement to value investing than growth-orientedstrategies. The firm seeks to overweight cheap securi-ties that have strong momentum and underweightexpensive ones that have weak momentum. Unlikemost investment managers, AQR employs no funda-mental analysts to cover companies. Instead, it seeksto hone its quantitative models and develop new ones.The firm last month started three momentum-ori-

ented equity mutual funds.The first, AQR Momentum (ticker: AMOMX),

which invests in the third of the 1,000 largest U.S.stocks with the best total return over the preceding12 months. It will be rebalanced quarterly. The othertwo funds, AQR Small Cap Momentum (ASMOX)and AQR International Momentum (AIMOX), aresimilar. The funds are up since their inception buttrail the overall market.Earlier, in January, the firm launched AQR Diversi-

fied Arbitrage (ADANX). It focuses on five areas:convertible arbitrage, merger arbitrage, dual-share-class arbitrage, closed-end-fund arbitrage and special-

i i i i SPAC SPAC

by Andrew Bary

Preaching the Gospel of Momentum

“A tremendous amount of work goes into our models. If someone

asks why we’re long a stock, we would list 17 reasons for it.” Cliff Asness








i i i i SPAC SPAC

by Andrew Bary











i i i i SPAC SPAC

by Andrew Bary




Quantitative investment strategies are shrouded in mystery. most investors don’t even try to understand them, and many practitioners won’t discuss them, fearing that doing so could cost them their competitive edge.

One of the largest firms in the field is aQr Capital management of greenwich, Conn. Founded in 1998, it oversees more than $20 billion,i primarily for institution-al investors. aQr, which stands for ap-plied Quantitative research, seeks to use some of best ideas of academic finance in the real world. it applies its proprietary models across a range of assets, including stocks, bonds and currencies.

Backed by a wealth of historical data, the firm believes in often-derided momen-tum investing, which favors buying stocks that have been doing well, relative to their peers or the overall market, and avoiding those with poor price momentum. aQr calls momentum investing an “undiscov-ered style” and a better complement to value investing than growth-oriented strategies. the firm seeks to overweight cheap securities that have strong mo-mentum and underweight expensive ones that have weak momentum. unlike most investment managers, aQr employs no fundamental analysts to cover companies. instead, it seeks to hone its quantitative models and develop new ones.

the firm last month started three mo-mentum-oriented equity mutual funds.

the first, AQR Momentum (ticker: amOmX), which invests in the third of the 1,000 largest u.s. stocks with the best total return over the preceding 12 months.

it will be rebalanced quarterly. the other two funds, AQR Small Cap Momentum (asmOX) and AQR International Mo-mentum (aimOX), are similar. the funds are up since their inception but trail the overall market.

earlier, in January, the firm launched AQR Diversified Arbitrage (aDanX). it focuses on five areas: convertible arbi-

trage, merger arbitrage, dual-share-class arbitrage, closed-end-fund arbitrage and special-purpose acquisition companies, or sPaCs. sPaC shares typically are pur-chased when they trade at a deep dis-count to their net-asset value.

these funds might be unique. We know of no other mutual funds that employ a pure momentum strategy or pursue multi-

ple arbitrage strategies. the no-loads are available through some fund supermar-kets, including Fidelity’s and schwab’s.

Barron’s sat down last week with two of aQr’s principals, Cliff asness and David Kabiller, in greenwich. the outspoken as-ness gained some attention this year with his criticism of President Obama after the nation’s chief executive had attacked hedge-fund investors who felt that they had gotten a raw deal as creditors in the Chrysler bankruptcy. He’s also criticized Obama’s health-care proposals. But in our interview, asness focused on investing, not politics.

Barron’s: What’s AQR all about?

Asness: it started back in 1994 when i was at goldman sachs, and they asked me to form a quantitative-research group. Where our process might have consisted of a few measures of value and price momentum 15 years ago, it now gener-ally consists of many factors from more subtle measures of value and momentum to signals obtainable from the actions of management, short-selling activity and inventory changes for commodities. Our models form a diversified systematic opin-ion on what we like and don’t like in all liquid assets. then, a different portfolio is built for each client. For a traditional cli-ent seeking to beat eaFe [msCi’s inter-national equity benchmark), we use our stock-picking around the world and our country and currency tilts.

You employ about 200 people. But none of them do fundamental research and follow companies like General Electric or Nestle, right?

Asness: it’s actually just me and David and one really big computer. this comes up all the time. We don’t have analysts who cover each of the individual compa-nies. We don’t visit companies. a lot of what we do is asset-allocation work. to the extent that we visit countries, it’s usu-ally called vacation.

Having said that, a tremendous amount of work goes into our models. if someone asks why we’re long a stock, we would list 17 reasons for it. We would list its valu-ation on 10 different scales: its valuation in the absolute sense, its valuation against its peers and its industry group, its health in terms of its improving margins, its mo-mentum. a lot of what we do is value plus momentum. We try to buy cheap things that are starting to get better. You can get a lot from corporate managements without talking to them. are they buying back shares or are they issuing shares? so when you ask if we do fundamental

research, i would say it is absolutely fun-damental. very few of the variables in our model would be called technical, except maybe pure price momentum.Kabiller: We have spent millions of dollars a year on income statements and balance-sheet data on companies. We process that information. We try to isolate those fac-tors that are leading indicators of security prices and most of them are fundamental factors and some technical.Asness: i won’t paint it all as entirely pos-itive, We give up the ability to have magi-cal insight into one company. Having said that, it can be risky to have a lot riding on one stock if you happen to be wrong.

It’s unfashionable to say you like momen-tum investing because it’s often perceived to be a mechanical, dumb-money strategy.

Asness: One of the scariest moments of my life was telling university of Chicago professor gene Fama that i wanted to write a dissertation on price momentum. and i think i mumbled the part where i said it works really well because it’s not a very Chicago idea. to his credit, he said; “if it is in the data, write the disserta-tion.”

Why do you think momentum investing works?

Asness: no one has nailed down why. We have a lot of theories. When i say “we,” i don’t just mean aQr. i mean the academic community and the practitio-ner community. underreaction is prob-ably our universally favorite story. good news comes out. there is a phenomenon in behavioral finance called anchoring and adjustment, where people go, “Oh, that’s great news,” and they move halfway but they don’t move all the way to incorporate the great news. so if you buy what’s gone up, there’s a little more to go. i won’t pretend i have told you all the different theories.

You brought out a momentum mutual fund, but not a value fund.

Kabiller: the world doesn’t need another value stockpicker.

One of your ideas is to keep fees low.

Asness: if you think momentum will build a better portfolio, you shouldn’t be pay-ing 200 basis points [2%] in fees annually. You should be paying someone more like 40 basis points. [the net expense ratio on the aQr momentum fund is capped at 49 basis points through april 2011.]

How is momentum investing doing this year in the U.S.?

Asness: it’s having a lousy year. i think it’s because of the very sharp stock-mar-ket reversal we saw in march going to april. momentum bets that whatever has been going on will keep going on a little more. Over the past 70 years in the u.s, it wins in about two-thirds of the years.ii When doesn’t it win? Whenever you have sharp reversals. march to april was pretty much the ultimate whip-saw. this doesn’t change our belief in momentum.

How is the diversified arbitrage fund structured?

Kabiller: it does convertible arbitrage, merger arbitrage, dual-share-class struc-tures, closed-end funds and sPaCs [which let investors participate in private-equity deals]. this year, convertible arbitrage and sPaCs have been more important and a larger portion of our risk than merger arbitrage.Asness: this year, an equal allocation among the strategies would have been silly. We were able to take money out of mergers and put it into convertibles, which were selling incredibly cheaply. the fund has very low leverage because of its mutual-fund structure.

What arbitrage strategies now look attrac-tive?Asness: Converts are still very cheap. if you ignore the end of last year, which you absolutely can’t because it did happen, converts are the cheapest they have been in 25 years. iii

Having said that, they are as third as cheap as they were in the insanity levels after the Lehman bankruptcy. Ours is an arbitrage strategy. it’s not same thing as the vanguard convertible fund. We buy the convertible, sell the stock and use credit-default swaps and bond futures to hedge the interest-rate and credit risks.Kabiller: most individuals have a very big bet. they are betting on financial health—that the stock market goes up and credit does well. this is a fund that is actually not betting strictly on financial health be-cause it’s long and short.

What can we learn from last year?

Kabiller: We have to be careful of learn-ing too much from last year because last year set up unbelievable opportunities for this year, including the convertible mar-ket. But what are the great lessons we learned? it’s that deleveraging can hap-pen, that you should be sure to have some treasuries, and that the world had a delu-sion of diversification.

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

Documents

%The dow jones business and Financial weeklywebreprints.djreprints.com/2296531456875.pdfOne of the largest firms in the field is AQR Capital Management of Greenwich, Conn. Founded