Review of AQR Equity Market Neutral & Long-Short Equity

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Robert T
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Review of AQR Equity Market Neutral & Long-Short Equity

Post by Robert T » Sat Apr 02, 2016 5:23 pm

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For those interested -

A review of AQR Equity Market Neutral (QMNIX) and AQR Long-Short Equity (QLEIX) by Sam Lee.
http://www.mutualfundobserver.com/2016/ ... ity-qleix/

His bottom line: AQR’s long-short global stock-selection strategy is well worth the money and a better deal than its long-only stock funds.

And here is his earlier review of the AQR Style Premia Alternative Fund
http://www.mutualfundobserver.com/2015/ ... mber-2015/

His bottom line: One of the best alternative funds available to mutual-fund investors.

Some interesting extracts from the first article:
When AQR started up, it was hot. It had one of the biggest launches of any hedge-fund up to that point. Then the dot-com bubble inflated. The widening gap in valuations between value and growth stocks almost sunk AQR. According to Asness, had the bubble lasted six more months, he would have been out of business. When the bubble burst, the firm’s returns soared and so did its assets. The good times rolled on and the firm was on the verge of an IPO by late 2007. According to the New York Post, AQR had to shelve it as the subprime crisis began roiling the markets. The financial crisis shredded its returns, with its flagship Absolute Return fund falling more than 50 percent from the start of 2007 to the end of 2008. Firm-wide assets from peak-to-trough went from $39.1 billion to $17.2 billion. The good times are back: As of December-end, AQR had $142.2 billion in net assets under management.

The two near-death experiences have instilled in AQR a fear of concentrated business risks. In 2009, AQR began to diversify away from its flighty institutional clientele by launching mutual funds to entice stickier retail investors. The firm has also launched new strategies at a steady clip, including managed futures, risk parity, and global macro.
AQR’s use of volatility targeting and drawdown control are common practices among quantitative investors. As a group these investors will tend to cut and add risks at the same time. It is unclear whether they are influential enough to alter the nature of markets and perhaps render these methods obsolete or even harmful (think of portfolio insurance and its contribution to Black Monday in 1987, when the Dow Jones Industrial Average fell 22.6%). My guess is quantitative investors aren’t yet big enough because many more investors are counter-cyclical rebalancers over the short-run, particularly institutions. This is speculation, of course. The market is a big and wild herd that will sometimes stampede in a direction it had never gone before—a lesson AQR itself learned at least twice: during the madness of the dot-com bubble and during the great quant meltdown of 2007.
FWIW - and related to the above extracts - a concern I have about the equity market neutral fund is negative skewness. If you look at the long-short value-profit-momentum series from Novy-Marx data it had rare but large negative return (-20+% in 2008 depending on deciles used for long-short).

Robert
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Last edited by Robert T on Sat Apr 02, 2016 5:40 pm, edited 1 time in total.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by matjen » Sat Apr 02, 2016 5:35 pm

I found this section and the accompanying chart interesting.
In the chart below I plotted the cumulative active returns of AQR Long-Short Equity I against a sum of the active returns of AQR Large Cap Multi-Style I QICLX and AQR International Multi-Style I QCELX. The long-only funds have stagnated, while the long-short fund has consistently made lots and lots of money. Even though investors in the long-only funds paid much lower expense ratios, they lost out on the superb returns generated by the long-short’s strategy’s superior strategy diversification. While I do think the magnitude of this divergence will not persist indefinitely, I’m confident that it’s well worth paying up for AQR’s long-short strategy.
Not sure how/if this relates to your earlier analysis on long only being sufficient to get the factor loads you want Robert T.
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Sat Apr 02, 2016 5:46 pm

Does anybody know why their long/short equity funds have done so well relatively compared to the long-only funds?

Presumably this would follow from the short side doing well, but how exactly and why? A long-only fund that excludes the stocks the long-short funds are shorting (assuming these will underperform the market) should have the advantage against the broad market, all other tilts and considerations aside. Now, if the stocks on the long side underperform the broad market but the stocks on the short side get crushed by the broad market (this is possible if there is a third group of stocks in the market), then you'd have a long-only fund that underperformed and a long-short fund doing well. Is that what's happening? Or is this from differences in screens used or perhaps security weightings?

edit: looks like the long side of the market neutral and long/short equity funds have different stocks than in say the multi-style long-only equity funds. The former two have Pepsi, Ameren (a mid cap), Delta among top long holdings. Doesn't seem market cap weighted. The long-only fund is cap weighted and has top holdings like Apple, Google, Microsoft, Wells Fargo, etc.

Though the market neutral and long/short fund holdings don't even match up, at least where I'm checking at Morningstar. Time to check the annual reports...

edit2: another big difference is the currency hedging in the long/short funds that is not used for the international long-only funds.

Robert T wrote:FWIW - and related to the above extracts - a concern I have about the equity market neutral fund is negative skewness. If you look at the long-short value-profit-momentum series from Novy-Marx data it had rare but large negative return (-20+% in 2008 depending on deciles used for long-short).
A lot of that was from momentum, and historically that has not been as much of an issue (much less skewness) if doing volatility targeting. No guarantees in the future of course.
Last edited by lack_ey on Sat Apr 02, 2016 6:18 pm, edited 3 times in total.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Yesterdaysnews » Sat Apr 02, 2016 6:01 pm

AQR Long-short equity fund may be one of the rare examples of an expensive fund that is worth what they charge. It performed admirably in the recent stock market correction. Keep this fund in tax-deferred space and couple it with index funds in taxable and you have a reasonable average portfolio cost with tax-efficiency.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Robert T » Sun Apr 03, 2016 2:58 am

matjen wrote:I found this section and the accompanying chart interesting.
In the chart below I plotted the cumulative active returns of AQR Long-Short Equity I against a sum of the active returns of AQR Large Cap Multi-Style I QICLX and AQR International Multi-Style I QCELX. The long-only funds have stagnated, while the long-short fund has consistently made lots and lots of money. Even though investors in the long-only funds paid much lower expense ratios, they lost out on the superb returns generated by the long-short’s strategy’s superior strategy diversification. While I do think the magnitude of this divergence will not persist indefinitely, I’m confident that it’s well worth paying up for AQR’s long-short strategy.
Not sure how/if this relates to your earlier analysis on long only being sufficient to get the factor loads you want Robert T.
I have a simple approach. Choose a long-term portfolio factor load target. Construct a portfolio to match these targets at lowest cost (minimize expenses, taxes, negative alpha). Then stick with it.

So the question for QCELX is can it help achieve my factor load targets at lower cost? I don't know the long term factor loads of the fund (only a couple of years of data), and it has a high expense ratio, and high turnover (low tax efficiency). So not really possible to fully answer the question, i.e. it is not a definitive yes, so don't include QCELX. In addition, it would add greater negative skewness (particularly with the short side of momentum), which I don't particularly want. Now AQR may have risk controls to limit the negative skewness, but it showed up in the 2007-08 returns of AQR's Absolute Return flagship fund (that also used value, quality, momentum screens), as per the extracts in my first post (50 percent decline), and it shows up in Novy-Marx's historical data. The prospectus also has the following statement " If the Fund uses leverage through activities such as entering into short sales or purchasing derivative instruments,the Fund has the risk that losses may exceed the net assets of the Fund." illustrating negative skewness.

Robert
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by larryswedroe » Sun Apr 03, 2016 7:33 am

Robert
One thought for you--the negative skewness of the fund due to momentum shouldn't be a concern because it shows up in reversals when equity returns are strongest and thus would mix with the risks of the rest of your portfolio well

Larry

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Robert T » Sun Apr 03, 2016 7:52 am

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Agree Larry, but I think there are also other negative skewness risks i.e. the large negative returns of the AQR absolute return fund (that also used value/quality/momentum screens) showed up more in 2007 and 2008, than in 2009 when momentum tanked. Perhaps it was a liquidity/deleveraging crunch with mass exits following simultaneous triggering of risk control measure from many institutional investors? Don't really know - but it was a real event.

http://www.nowandfutures.com/download/Q ... sAug07.pdf An extract from the link
"However, this isn’t about models, this is about a strategy getting too crowded, as other successful strategies both quantitative and non-quantitative have gotten many times in the past, and then suffering when too many try to get out the same door. We knew this was a risk factor but, like most others, in hindsight, we underestimated the magnitude and the speed with which danger could strike.
Robert
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by wije » Sun Apr 03, 2016 10:01 pm

Yesterdaysnews wrote:AQR Long-short equity fund may be one of the rare examples of an expensive fund that is worth what they charge. It performed admirably in the recent stock market correction. Keep this fund in tax-deferred space and couple it with index funds in taxable and you have a reasonable average portfolio cost with tax-efficiency.
I'm surprised to see a plug for a long-short fund on Bogleheads. Too bad Maynard Speer is missing this! :( I'm guessing for those of us already having a lot invested in stocks and bonds, QMNIX would be a better diversifer than QLEIX?

Is Fidelity the only brokerage that allows a $2,500 minimum in an IRA account for these funds?

I'm confused on the N vs I shares (no, I've never bought a mutual fund in my life!). On Fidelity, you'd have to spend about $50 transaction fee each time you contribute to the fund for I shares, whereas you'll have to pay a .25% 12b-1 fee (no transaction fee) for N shares. I'm guessing the best approach for someone broke like me is to make an initial $2,500 purchase of N-shares and later switch to I-shares if/when additions to the fund make the 12b-1 fee too high...

I'm also confused by the gross vs net expense ratio. If I were to go the Fidelity route, would I have to pay 2.5% gross ER or 1.6% net ER?

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Sun Apr 03, 2016 10:31 pm

wije wrote:I'm guessing for those of us already having a lot invested in stocks and bonds, QMNIX would be a better diversifer than QLEIX?
The market neutral fund is much less correlated with stocks than the long/short fund by nature of not having net stock exposure, but that might not be the best way to look at it.

If total factor exposure for both is the same other than the long/short fund having about 0.5 market beta, then you just need to decide how much overall market beta you want across all your holdings and pick the one that gets you there. Let's say if you use 10% of the market neutral fund you end up with overall 0.6 market, 0.2 value, 0.2 momentum, etc. If you use 10% of the long/short fund you instead end up with overall 0.65 market, 0.2 value, 0.2 momentum, etc. All the same except 0.05 more market beta.

Of course, the market exposure isn't free in the long/short fund—it's through futures so you can think of it as effectively shorting short-term bonds/cash (at a rate a couple dozen bp above 3-month LIBOR or so) to finance the stock exposure.

That's all something of an oversimplification too because they do some market timing with the long stock position in the long/short fund, bouncing between 0.3 and 0.7 according to whatever it is their algos demand.
wije wrote:Is Fidelity the only brokerage that allows a $2,500 minimum in an IRA account for these funds?
As far as I know, yes. Scottrade used to offer these for cheap too.
wije wrote:I'm confused on the N vs I shares (no, I've never bought a mutual fund in my life!). On Fidelity, you'd have to spend about $50 transaction fee each time you contribute to the fund for I shares, whereas you'll have to pay a .25% 12b-1 fee (no transaction fee) for N shares. I'm guessing the best approach for someone broke like me is to make an initial $2,500 purchase of N-shares and later switch to I-shares if/when additions to the fund make the 12b-1 fee too high...
At small amounts, say $2500 this honestly isn't making all that much difference anyway but yeah, it might make sense to use N shares over I shares depending on purchase size, length of holding, when you're adding more and how much, etc.
wije wrote:I'm also confused by the gross vs net expense ratio. If I were to go the Fidelity route, would I have to pay 2.5% gross ER or 1.6% net ER?
You don't pay anything directly. It's periodically taken out of fund earnings or assets. The portion effectively taken annually is the net ER.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Angst » Mon Apr 04, 2016 3:17 pm

lack_ey wrote:
wije wrote:I'm confused on the N vs I shares (no, I've never bought a mutual fund in my life!). On Fidelity, you'd have to spend about $50 transaction fee each time you contribute to the fund for I shares, whereas you'll have to pay a .25% 12b-1 fee (no transaction fee) for N shares. I'm guessing the best approach for someone broke like me is to make an initial $2,500 purchase of N-shares and later switch to I-shares if/when additions to the fund make the 12b-1 fee too high...
At small amounts, say $2500 this honestly isn't making all that much difference anyway but yeah, it might make sense to use N shares over I shares depending on purchase size, length of holding, when you're adding more and how much, etc.
I shares are no longer available for purchase in an IRA at Scottrade and it's my understanding that the same is true at Fidelity (correct me if I'm wrong). Unless perhaps if you happen to have a very, very large IRA. :wink:

Btw, thank you very much Robert T for posting this newest link to a Sam Lee AQR funds review.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by tarheel » Mon Apr 04, 2016 10:47 pm

The article's fine, but pretty ridiculous to compare long-short or equity market neutral to any of the long only multi-style funds over a 2-3 period range and then suddenly conclude "they are a better deal" out of nowhere.

1. You're comparing apples to oranges, (although probably not screwdrivers?)
2. The time period is laughably short
3. No quantitative analysis whatsoever

The chart he posts makes no sense.

FWIW, I own AQR funds in both types of categories.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Tue Apr 05, 2016 12:44 am

tarheel wrote:The article's fine, but pretty ridiculous to compare long-short or equity market neutral to any of the long only multi-style funds over a 2-3 period range and then suddenly conclude "they are a better deal" out of nowhere.

1. You're comparing apples to oranges, (although probably not screwdrivers?)
2. The time period is laughably short
3. No quantitative analysis whatsoever

The chart he posts makes no sense.

FWIW, I own AQR funds in both types of categories.
What about the chart doesn't make sense? Agreed that 2-3 years is short and doesn't say all that much, but it also doesn't say nothing. How do you interpret the long/short fund outperformance over its long market exposure level over a period in which the long-only funds didn't really perform over the market? I mean this as an open-ended question for discussion and not to make any point here.

If you own both, could you describe in detail what both do and what the differences are? What have I missed, if anything? I'm just curious if anyone has different takes and analyses.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by tarheel » Tue Apr 05, 2016 5:35 am

The funds are constructed in very different ways. It is not like the long-short fund is one of the multi-style long funds with an additional short position.
They are two totally different animals. I would compare the long-short fund to QSPIX (still not a great comparison, but at least no net beta exposure in either), which I own and returned 9% last year or something like that. A good diversifier.

The chart doesn't make sense because it is not a valid comparison.

One of the mantras of us tilters is that even 10 years is barely long enough to start to expect outperformance over beta. You have to be in for the long run to benefit from your exposure to the factors. So to the lack of outperformance of the long-only multistyle funds over the past 3 years or so, I say *yawn*.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Tue Apr 05, 2016 12:00 pm

tarheel wrote:The funds are constructed in very different ways. It is not like the long-short fund is one of the multi-style long funds with an additional short position.
So what is it like, instead? How does for example the market neutral fund differ from the multi-style long combined with a hypothetical multi-style short?

What are the differences in security selection and then weighting, and then overall exposure?
tarheel wrote:The chart doesn't make sense because it is not a valid comparison.
What makes the comparison not valid? Do you disagree with the mechanics of the comparison (if so, what would you change about the benchmarks or anything else?) or the premise itself of any comparison—adjusted or not, and here it's adjusted for beta exposure—between funds of differing types?

The underlying point is that one has delivered a lot of CAPM alpha while the other has not, despite theoretically loading on largely the same factors over largely the same universe of stocks. Why and how did this happen, and is it more likely than not to continue on average in the future? The author makes an additional leap to recommend the recent winner, but for starters it's worth explaining why something won or lost over a given period in the first place. If something can win by a lot in a couple years, it can also lose by a lot too.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by garlandwhizzer » Tue Apr 05, 2016 12:51 pm

The AQR long short option fund has done quite well since its inception, but the short time frame is short. I do not know whether this success is due to luck or skill. Nor do I know, even if it is due to skill, will this out-perfmance persist going forward? If due to luck, one suspects that it will not persist because luck is notoriously fickle and favors no one. Coin flips do not always come up heads. If due to skill, there is also a serious question whether it will carry forward into the future. The aggregate history of active management (of which this is an extreme example, using options) suggests that fund past out-performance is not a reliable indicator of future out-performance. Past fund under-performance tends to persist, but past out-performance tends not to.

The options market is dominated by professional players who presumably are not fools. In order for AQR to be persistently successful at it, there has to be a reliable and constant stream of less savvy investors taking the other side of the options from AQR. So far, so good, but I submit that it is not clear that such misinformed professional investors are not in inexhaustible supply. AQR's options insight superiority may persist or it may not. If not, at some point the increased costs and decreased tax efficiency os such strategies relative to index funds will raise their ugly heads. Investing history contains graveyards full of active funds that started out spectacularly but ultimately fizzled while index funds relentlessly took more and more market share as the years marched on.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by larryswedroe » Tue Apr 05, 2016 1:00 pm

Garland
Re options the logic is actually very simple, you are earning a premium for taking risk, and historically investors have overpaid on both sides of these trades
A) they overpay buying call options (willing to do so to hit the lottery) and
b) they overpay when buying put options (willing to do so to avoid the downside)

So sellers collect premiums with expected profits in long term.

It's interesting that they both buy insurance and lottery tickets at the same time--one is risk avoidance and one is risk taking.

Same thing with selling volatility, realized volatility has historically been less than the pricing of it in futures. That makes sense as you are buying insurance against volatility which is negatively related to stock returns. So selling VOL is historically profitable as well.

Interesting strategy is selling vol, both puts and calls at same time (cannot lose on both at same time). But you have to delta hedge the strategies.

Now of course many have blown up with these strategies when adding too much leverage, see Victor Neiderhofer.

Hope that helps
Larry

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Tue Apr 05, 2016 1:14 pm

garlandwhizzer wrote:The AQR long short option fund has done quite well since its inception, but the short time frame is short. I do not know whether this success is due to luck or skill. Nor do I know, even if it is due to skill, will this out-perfmance persist going forward? If due to luck, one suspects that it will not persist because luck is notoriously fickle and favors no one. Coin flips do not always come up heads. If due to skill, there is also a serious question whether it will carry forward into the future. The aggregate history of active management (of which this is an extreme example, using options) suggests that fund past out-performance is not a reliable indicator of future out-performance. Past fund under-performance tends to persist, but past out-performance tends not to.

The options market is dominated by professional players who presumably are not fools. In order for AQR to be persistently successful at it, there has to be a reliable and constant stream of less savvy investors taking the other side of the options from AQR. So far, so good, but I submit that it is not clear that such misinformed professional investors are not in inexhaustible supply. AQR's options insight superiority may persist or it may not. If not, at some point the increased costs and decreased tax efficiency os such strategies relative to index funds will raise their ugly heads. Investing history contains graveyards full of active funds that started out spectacularly but ultimately fizzled while index funds relentlessly took more and more market share as the years marched on.

Garland Whizzer
Sorry, color me confused, but which fund are you even talking about? Ticker symbol? Which funds are heavily using options?

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by tarheel » Wed Apr 06, 2016 12:10 pm

lack_ey wrote: The underlying point is that one has delivered a lot of CAPM alpha while the other has not, despite theoretically loading on largely the same factors over largely the same universe of stocks. Why and how did this happen, and is it more likely than not to continue on average in the future? The author makes an additional leap to recommend the recent winner, but for starters it's worth explaining why something won or lost over a given period in the first place. If something can win by a lot in a couple years, it can also lose by a lot too.
Here is my basic understanding of the long-short fund QLEIX as gleaned from the AQR fund prospectus: there are actually THREE sources of return.

1. Equity market exposure - they target a MSCI World Index beta of 0.5. So there is a "long" component here.
2. Tactical variation of exposure - they vary the beta of 0.5 (up or down) based on indicators related to value, momentum, quality, etc.....this appears to be very much an "active" source of returns.
3. Long-Short - the pure alpha part of the portfolio following their tactical variation with a beta of 0.

AQR explains the fund as having these three different sources of return in their prospectus (fund fact sheet). My read is that this is far more of an active fund than the long only equity multistyle funds.

The multistyle funds simply invest in stocks with good value, momentum, and profitability characteristics as defined by algorithms. There is virtually no active management of the fund. AQR also lets us know that they target a 40% value, 40% momentum, and 20% profitability weighting. Also, plenty of beta here.

So while there may be some overlapping themes here, I have no idea what the value or momentum exposure of the long-short funds are, how they are actively managed, nor what the other indicators they use are. The beta exposure of the long-short is also very different.

I am by no means an expert on the long-short fun, however, and am happy to be corrected.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Elbowman » Wed Apr 06, 2016 12:51 pm

Man, I would have to be so confident in the persistence of these strategies going forward to pay a 1.34% ER. I'm somewhat skeptical of size and value, but that's OK because they only cost me four BP (VBR - VTI), and if the premiums disappear due to increased exploitation... Oh well, I guess I slightly over-payed for beta. But to pay 1.3% for market neutral, that takes conviction :shock: .

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Wed Apr 06, 2016 1:57 pm

tarheel wrote:
lack_ey wrote: The underlying point is that one has delivered a lot of CAPM alpha while the other has not, despite theoretically loading on largely the same factors over largely the same universe of stocks. Why and how did this happen, and is it more likely than not to continue on average in the future? The author makes an additional leap to recommend the recent winner, but for starters it's worth explaining why something won or lost over a given period in the first place. If something can win by a lot in a couple years, it can also lose by a lot too.
Here is my basic understanding of the long-short fund QLEIX as gleaned from the AQR fund prospectus: there are actually THREE sources of return.

1. Equity market exposure - they target a MSCI World Index beta of 0.5. So there is a "long" component here.
2. Tactical variation of exposure - they vary the beta of 0.5 (up or down) based on indicators related to value, momentum, quality, etc.....this appears to be very much an "active" source of returns.
3. Long-Short - the pure alpha part of the portfolio following their tactical variation with a beta of 0.

AQR explains the fund as having these three different sources of return in their prospectus (fund fact sheet). My read is that this is far more of an active fund than the long only equity multistyle funds.

The multistyle funds simply invest in stocks with good value, momentum, and profitability characteristics as defined by algorithms. There is virtually no active management of the fund. AQR also lets us know that they target a 40% value, 40% momentum, and 20% profitability weighting. Also, plenty of beta here.

So while there may be some overlapping themes here, I have no idea what the value or momentum exposure of the long-short funds are, how they are actively managed, nor what the other indicators they use are. The beta exposure of the long-short is also very different.

I am by no means an expert on the long-short fun, however, and am happy to be corrected.
The article states that (2) tactical variation of exposure added pretty much zero over the period and accounted for (1) equity market exposure in the chart that you panned.

This means that CAPM alpha was significant from (3) long-short exposure for the long-short fund. (This fact is confirmed in the annual report. Also, the market neutral fund doesn't have equity market exposure or tactical variation of that, and it gained a lot too.) But CAPM alpha was virtually zero for the long-only funds.

The question remains: If CAPM alpha over the period is largely from individual security selection (some from the industry bets), which is based on loading on momentum, value, profitability, etc., how did the long-short funds outperform their benchmarks by so much while the long-only funds didn't? If for example value does well (value beats growth) over a certain period, you expect long-only value funds to beat the market, while long-short value funds (long value, short growth) to beat cash. If long-short value gains 15%+ while long-only value funds lose to the market, something is really weird.

Based on the annual reports, it's looking like a lot of the discrepancy is explained by stock selection screens other than momentum, value, and profitability. Some of it also appears to be from currency hedging vs. not hedging, I think. Anyway, from the market neutral fund:
Fund returns were driven by strong performance of most of our investment themes. Investor Sentiment, Stability, Country-Industry Pairs, and all of our Momentum-related themes (within industry, across industry and indirect Momentum) worked particularly well in 2015, with the exposure gained through the use of Total Return basket swaps. Valuation signals within and across industries underperformed slightly. These valuation themes tend to be negatively correlated with momentum signals. Geographically, stocks in the U.S. and Canada contributed the most to overall returns, while in Spain and the Netherlands stock selection detracted most from returns. At the sector level, the stock selection strategy worked best in industrials and energy in 2015.
In other words, alpha over what loadings on value/momentum/profitability would give. As always, any time there's positive alpha based on security selection, it can easily be negative over some other period. Over the long run, who knows? Also consider that investor sentiment etc. are not as well researched as say Fama-French factors.

AQR discusses some of these additional investment themes here:
https://www.aqr.com/~/media/files/paper ... rategy.pdf

Presumably these additional screens are not covered in some of their other funds like the long-only funds and the style premia fund. That is probably the primary value add over other options, whatever that's worth to you: 100 bp, 20 bp, 0 bp, -500 bp.

They also have many other researched investment themes and strategies—many from the classic hedge fund playbook—such as merger arbitrage, convertible arbitrage, global macro, trend following, fixed income relative value, etc. Many of these are offered in mutual fund format with a mixed track record at best.

Elbowman wrote:Man, I would have to be so confident in the persistence of these strategies going forward to pay a 1.34% ER. I'm somewhat skeptical of size and value, but that's OK because they only cost me four BP (VBR - VTI), and if the premiums disappear due to increased exploitation... Oh well, I guess I slightly over-payed for beta. But to pay 1.3% for market neutral, that takes conviction :shock: .
If premiums average zero, that is not quite the same thing as disappearing. Presumably they don't disappear, but they could average zero or lower over some finite stretch of time we're interested in. If you have that overweighting over a period where they average zero, you're still picking up increased volatility, so it's not quite the same as just paying 4 bp extra for beta. In fact, if making regular contributions, the extra volatility would slightly increase long-term returns on average though honestly it's largely a wash. And most people would interpret higher volatility as overall a bad thing. When taking withdrawals, extra volatility hurts on average rather than helps numerically given a certain level of returns.

But yes, your main point is right on the money. Paying 1.3% or so takes a much larger commitment and imposes a significant yearly handicap to overcome.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by LikeYouImagine » Wed Apr 06, 2016 8:14 pm

larryswedroe wrote:Robert
One thought for you--the negative skewness of the fund due to momentum shouldn't be a concern because it shows up in reversals when equity returns are strongest and thus would mix with the risks of the rest of your portfolio well

Larry
Wouldn't QLEIX, unlike QNMIX, also mitigate this by having exposure to market beta?

I'm curious for those who have looked into these two funds which they believe has the highest expected returns?

I'm looking into using one to gain better exposure to the short side of multi-factor equity and overall increase my factor loads. I'm currently leaning towards QLEIX as it seems like I'll get a little less factor exposure while not having to totally give up market returns as it would come from the equity side of my portfolio. This also appears like it would have the highest expected returns as a little less factor premia+.5 * equity risk premium (QLEIX) should have long term higher returns vs a little more factor premia with no ERP (QMNIX).

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Wed Apr 06, 2016 8:52 pm

LikeYouImagine wrote:
larryswedroe wrote:Robert
One thought for you--the negative skewness of the fund due to momentum shouldn't be a concern because it shows up in reversals when equity returns are strongest and thus would mix with the risks of the rest of your portfolio well

Larry
Wouldn't QLEIX, unlike QNMIX, also mitigate this by having exposure to market beta?
At a fund level, sure, but on the portfolio level it doesn't really matter all that much where the market beta is gotten from, barring some extremes where you suppose that the market neutral fund would be forced to unwind (before it hits their risk controls and volatility targeting) in some scenario the long-short fund could squeak through by virtue of the long market exposure.
LikeYouImagine wrote:I'm curious for those who have looked into these two funds which they believe has the highest expected returns?
I haven't looked much but as far as I can tell the weightings and strategy are similar between the two except the long-short fund gets the beta exposure on top, so that should have higher expected returns.
LikeYouImagine wrote:I'm looking into using one to gain better exposure to the short side of multi-factor equity and overall increase my factor loads. I'm currently leaning towards QLEIX as it seems like I'll get a little less factor exposure while not having to totally give up market returns as it would come from the equity side of my portfolio. This also appears like it would have the highest expected returns as a little less factor premia+.5 * equity risk premium (QLEIX) should have long term higher returns vs a little more factor premia with no ERP (QMNIX).
It's very possible I missed something, but now the previous question makes more sense, but why do you think the long-short fund has less non-market factor exposure?

As of the 2015 annual report, the long-short fund had -$2,316,522 in Enbridge, $3,007,071 in Freenet AG, and $3,512,882 in Prysmian SpA, compared to total assets of $722,158,766. That would be -0.32%, 0.42%, and 0.49% weightings respectively. The market neutral fund had -$1,046,428 in Enbridge, $1,103,018 in Freenet AG, and $1,732,702 in Prysmian SpA compared to total assets of $344,115,070. Those weightings are -0.30%, 0.32% and 0.50%. Looks like it's keeping about the same for both.

The long-short fund adds long futures contracts as an overlay to get beta. Other than that, they look pretty much the same? Or is there something I don't know about how the weightings are allowed to drift?

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by LikeYouImagine » Thu Apr 07, 2016 10:21 am

I had been looking at the exposure summary sheets:
QMNIX: https://funds.aqr.com/~/media/files/fun ... /emnmf.xls
QLEIX: https://funds.aqr.com/~/media/files/fun ... /elsmf.xls

Which do show the market neutral funds as having more long/short exposure. But since these aren't formal documents, maybe they aren't exactly snapshots of each fund on the same day. I see the annual report and factsheets for each indicate very similar long/short exposure. So my concerns are not be valid. In which case, QLEIX would have the higher expected returns.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Thu Apr 07, 2016 12:10 pm

LikeYouImagine wrote:I had been looking at the exposure summary sheets:
QMNIX: https://funds.aqr.com/~/media/files/fun ... /emnmf.xls
QLEIX: https://funds.aqr.com/~/media/files/fun ... /elsmf.xls

Which do show the market neutral funds as having more long/short exposure. But since these aren't formal documents, maybe they aren't exactly snapshots of each fund on the same day. I see the annual report and factsheets for each indicate very similar long/short exposure. So my concerns are not be valid. In which case, QLEIX would have the higher expected returns.
Maybe there's something to it, and the year-end allocations were anomalously close.

In any case in the interim it may be possible for there to be some drift based on fund flows if significant, if they're committed to trading slowly to reduce transaction costs. Maybe that's what's showing up in the informal fund snapshots for the summary sheets?

But there doesn't seem to be any notice (that I've seen) of a systemic bias for one fund to be more leveraged than the other, the long futures in the long-short fund aside.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by garlandwhizzer » Thu Apr 07, 2016 8:48 pm

lack_ey wrote in response to my post:

Sorry, color me confused, but which fund are you even talking about? Ticker symbol? Which funds are heavily using options?
Sorry, the fund I was describing was QLEIX, AQR'S LONG SHORT EQUITY FUND. It has done quite well since inception relative to long only or other beta related funds, with a long short equity strategy in global markets using a combination of value, momentum, and according to them "other economic indicators" to select what to short and what to go long. They use options which can magnify returns or losses and derivatives as well. They also target a portfolio with much less beta than the market as a whole, targeting 0 beta but rising to .3 - .7 beta when market conditions warrant. It has the goal not to move in lockstep with the market. If this strategy sounds complicated, it is. Thus far, a bit less than 3 years I believe, it has done quite well and carried off this complex strategy with impressive results. In a market like ours, basically stuck in a trading range for the better part of 2 - 3 years, this fund has the potential to do considerably better (which it has done) or considerably worse (which it may do in the future if the bull market re-ignites).

Most of us have difficulty with making a few rather simple straightforward investment decisions. I know I do. In the QLEIX strategy there are many variables: whether to go long or short, the timing and duration of options, how much exposure to US versus international equity, how many eggs to put in each country or sector or factor basket and whether to choose long or short options on that country, sector, or factor. Then add to this complex mix financial derivatives not only in currency markets but equity markets as well. Wow, the permutations of all these choices are so numerous as to be mind boggling. The exact opposite of the 3 fund portfolio. They have done this job quite well up to now but it seems to me a daunting task to consistently make all the right decisions and all the right calls on so many fronts when sitting on the other side of each of AQR's option positions is a knowledgeable professional. It is possible that AQR is consistently wise and savvy and other option players are consistently dim-witted and naive, but I think this is unlikely. I take my hat off and salute AQR thus far on QLEIX but, personally, I wouldn't touch QLEIX with a ten foot pole.

Added complexity does not automatically produce improved long term results. My experience has been that the increased costs and tax inefficiency of added complexity has often reduced rather than improving my long term investing results. My expectation is that the stellar returns of QLEIX will revert to the mean at some point but even if it doesn't, even if they have a monopoly on options genius, I'm not buying it because its strategy is too complex for me to understand and be comfortable with.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Thu Apr 07, 2016 9:37 pm

Okay. AQR Long/Short Equity Fund (QLEIX, QLENX, QLERX) doesn't use options, though, which you have repeatedly mentioned, unless I've missed something. Larry played along with that, talking about options strategies, so I thought that meant something. Or does it?

Many funds in the broad category do use options, and that would be another complication if applicable that would be worth discussing. You've made a characterization of AQR needing to exploit other market participants in options trading and have options genius in order for the fund to be successful. But that's not what's what's going on and as such doesn't need to happen in the future either.

It does use futures and swaps, in addition to some foreign currency forwards for hedging.

The futures are stock index futures, which are used for beta exposure. At least at a passive level this doesn't involve beating anybody. The market timing component so far has contributed about zero; market timing is about beating other people and that hasn't happened anyway so not much mean reversion to talk about.

The swaps are total basket return swaps used to get access to long and short performance of many of the stocks. They're just the tools for investing in those stocks and don't much represent any additional complication except for I guess some counterparty risk with Goldman Sachs, Deutsche Bank, whoever. The point of the funds is to go long some stocks and short others, and that's what's happening here.

The currency forwards and futures are for currency hedging, same as in a lot of other funds. Again, the forwards have counterparty risk. This is not really about exploiting another market participant. They say they're patient traders in the vein of say a DFA and minimize costs there, and they have experience—including near-death experiences—with what these types of strategies entail including using derivatives and leverage.

For better or worse, looks to me like performance different from the benchmark is primarily driven by security selection for the long and short stock positions. The market timing overlay for beta is another contributing factor for the long/short fund but not the market neutral one. Their trading costs and frictions would be a drag on top of all of that.

In other words, the fund's "alpha" (be it positive or negative over any period) should come primarily from doing algorithmic sorts on stocks by value/momentum/profitability/other things. (Do you normally call a value index fund investor in 2000-2002 exploiting growth stock investors? In some sense yes?) The "other things" seems to include aspects outside of the usual Fama-French-plus factors, including investor sentiment and management signaling among others. Like the market timing, it may be a value add or value detractor depending on your perspective.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by exeunt » Fri Apr 08, 2016 1:34 am

lack_ey wrote:The underlying point is that one has delivered a lot of CAPM alpha while the other has not, despite theoretically loading on largely the same factors over largely the same universe of stocks. Why and how did this happen, and is it more likely than not to continue on average in the future? The author makes an additional leap to recommend the recent winner, but for starters it's worth explaining why something won or lost over a given period in the first place. If something can win by a lot in a couple years, it can also lose by a lot too.
First of all, thanks for your contributions to this thread. You've answered most of posters' criticisms and objections the same way I would have. I wrote the two articles in question.

Good catch on me making the "leap" to recommend the better-performing fund. I didn't lay out my reasoning for this other than to cite the better recent performance. I have access to AQR's longer-term track record for these strategies as well as the back-tested returns for more recent iterations of their models. Judging from the admittedly selective bits of data AQR has made to me, it seems AQR's long-short stock selection has done much better than its long-only stock selection. Even in the back-test, AQR's Large-Cap Multi-Style strategy does far worse than the live performance of its global long-short stock selection strategy. (Of course, it should be noted that the live track record AQR provided me was not reflective of AQR's overall performance over this period, as I did not see big drawdowns in '99 and '08). It's clear AQR's additional signals have helped its more expensive and complicated long-short strategies. AQR's multi-style funds are relatively stripped down ways to get exposure to value, momentum and profitability/quality. AQR's long-short funds are leveraged ways to get those factors plus more.

It seems logical to me that AQR would ration its limited-capacity, better-performing signals for its smaller, higher-fee funds.

One thing to note is there seems to be a fair amount of autocorrelation in the performance of AQR's long-short stock selection strategy. AQR seems to exploit this autocorrelation through its drawdown control methodology and vol targeting. When the strategy does poorly, they scale down its risk.

Finally, I'd like to point out that it's perfectly valid to draw inferences from shorter track records if you believe the track record was created by many independent bets and isn't simply the result of pushing risk to the left tail of the return distribution. The length of a track record is a crude proxy of the number of independent bets made. At the extremes, you can have a multi-year track record that is reflective of one big bet and a multi-week track record that is reflective of thousands of independent bets. The best HFT firms rarely have losing quarters or even days because they can quickly identify profitable strategies with a high degree of statistical significance based on rather short live track records.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by tarheel » Fri Apr 08, 2016 6:16 am

exeunt wrote: Good catch on me making the "leap" to recommend the better-performing fund. I didn't lay out my reasoning for this other than to cite the better recent performance. I have access to AQR's longer-term track record for these strategies as well as the back-tested returns for more recent iterations of their models. Judging from the admittedly selective bits of data AQR has made to me, it seems AQR's long-short stock selection has done much better than its long-only stock selection. Even in the back-test, AQR's Large-Cap Multi-Style strategy does far worse than the live performance of its global long-short stock selection strategy. (Of course, it should be noted that the live track record AQR provided me was not reflective of AQR's overall performance over this period, as I did not see big drawdowns in '99 and '08). It's clear AQR's additional signals have helped its more expensive and complicated long-short strategies. AQR's multi-style funds are relatively stripped down ways to get exposure to value, momentum and profitability/quality. AQR's long-short funds are leveraged ways to get those factors plus more.

It seems logical to me that AQR would ration its limited-capacity, better-performing signals for its smaller, higher-fee funds.

One thing to note is there seems to be a fair amount of autocorrelation in the performance of AQR's long-short stock selection strategy. AQR seems to exploit this autocorrelation through its drawdown control methodology and vol targeting. When the strategy does poorly, they scale down its risk.

Finally, I'd like to point out that it's perfectly valid to draw inferences from shorter track records if you believe the track record was created by many independent bets and isn't simply the result of pushing risk to the left tail of the return distribution. The length of a track record is a crude proxy of the number of independent bets made. At the extremes, you can have a multi-year track record that is reflective of one big bet and a multi-week track record that is reflective of thousands of independent bets. The best HFT firms rarely have losing quarters or even days because they can quickly identify profitable strategies with a high degree of statistical significance based on rather short live track records.
It is abundantly clear from the discussion above that the long-short equity fund is NOT simply a long-short version of the long-only multi-style funds. There are many other moving parts involved. As you state above, "multi-style funds are relatively stripped down ways to get exposure to value, momentum, and profitability/quality." That is EXACTLY why I invest in them. I understand the logic, and I want exposure to JUST those factors in a long-only style. If I wanted a multialternative fund with much less correlation to the market, I would think about the long-short funds. I do in fact, but have chosen QSPIX instead.

As I said before, this is not a valid comparison. It is like saying, "I looked at the return of total bond and total stock over the last three years, and total bond did better, so I recommend investing in bonds." And I don't care about how many bets are made in a three year window - the market context of the bets may or may not provide a favorable tail-wind for one strategy or another.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by long_gamma » Fri Apr 08, 2016 8:15 am

lack_ey wrote:Okay. AQR Long/Short Equity Fund (QLEIX, QLENX, QLERX) doesn't use options, though, which you have repeatedly mentioned, unless I've missed something. Larry played along with that, talking about options strategies, so I thought that meant something. Or does it?

Many funds in the broad category do use options, and that would be another complication if applicable that would be worth discussing. You've made a characterization of AQR needing to exploit other market participants in options trading and have options genius in order for the fund to be successful. But that's not what's what's going on and as such doesn't need to happen in the future either.

It does use futures and swaps, in addition to some foreign currency forwards for hedging.

The futures are stock index futures, which are used for beta exposure. At least at a passive level this doesn't involve beating anybody. The market timing component so far has contributed about zero; market timing is about beating other people and that hasn't happened anyway so not much mean reversion to talk about.

The swaps are total basket return swaps used to get access to long and short performance of many of the stocks. They're just the tools for investing in those stocks and don't much represent any additional complication except for I guess some counterparty risk with Goldman Sachs, Deutsche Bank, whoever. The point of the funds is to go long some stocks and short others, and that's what's happening here.

The currency forwards and futures are for currency hedging, same as in a lot of other funds. Again, the forwards have counterparty risk. This is not really about exploiting another market participant. They say they're patient traders in the vein of say a DFA and minimize costs there, and they have experience—including near-death experiences—with what these types of strategies entail including using derivatives and leverage.

For better or worse, looks to me like performance different from the benchmark is primarily driven by security selection for the long and short stock positions. The market timing overlay for beta is another contributing factor for the long/short fund but not the market neutral one. Their trading costs and frictions would be a drag on top of all of that.

In other words, the fund's "alpha" (be it positive or negative over any period) should come primarily from doing algorithmic sorts on stocks by value/momentum/profitability/other things. (Do you normally call a value index fund investor in 2000-2002 exploiting growth stock investors? In some sense yes?) The "other things" seems to include aspects outside of the usual Fama-French-plus factors, including investor sentiment and management signaling among others. Like the market timing, it may be a value add or value detractor depending on your perspective.
Very good post.

Many people think "Options" in pariah status and option players as either as dim witted or super savvy.

Short equity indices vol has been consistent good strategy. This is what Antti Illmanen says in Expected Returns "The best-known insurance strategies involve various methods of selling equity index volatility. Doing so earns good long-run returns but at the risk of huge losses when bad times occur".
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Fri Apr 08, 2016 1:03 pm

tarheel wrote:
exeunt wrote: [...]
It is abundantly clear from the discussion above that the long-short equity fund is NOT simply a long-short version of the long-only multi-style funds. There are many other moving parts involved. As you state above, "multi-style funds are relatively stripped down ways to get exposure to value, momentum, and profitability/quality." That is EXACTLY why I invest in them. I understand the logic, and I want exposure to JUST those factors in a long-only style. If I wanted a multialternative fund with much less correlation to the market, I would think about the long-short funds. I do in fact, but have chosen QSPIX instead.

As I said before, this is not a valid comparison. It is like saying, "I looked at the return of total bond and total stock over the last three years, and total bond did better, so I recommend investing in bonds." And I don't care about how many bets are made in a three year window - the market context of the bets may or may not provide a favorable tail-wind for one strategy or another.
You still haven't explained why the comparison is not valid or how you would make it more valid.

This one example has many important differences that are not featured in the original comparison. In yours, you are comparing funds with different underlying universes of securities to choose from. Furthermore, you're comparing absolute performance rather than relative performance compared to a passive benchmark as in the original.

The original formulation compares (1) a long/short equity fund's performance relative to its passive beta exposure to (2) a long-only equity fund's performance relative to its passive beta exposure. Or rather, a combination of two equity funds so we cover both US and ex-US like the long/short fund does. The striking result is not that (1) was able to use leverage to beat (2) in magnitude over the period, but (2) wasn't even positive over a period in which (1) was very positive, well over 10% a year.

If you directly compare a bond fund to a stock fund, the majority of the difference can usually be attributed to the bond fund's passive bond exposures vs. the stock fund's passive stock exposure.

I share reservations about using a three-year period to judge investment returns, though, as behaviors and relationships can shift within a market cycle and frankly between them as well. The additional information provided here (thanks for that, exeunt) sheds some additional light on the previous history of live trading data, for what that is worth.

There is something to be said about success based on many independent bets even in a short time window, but again, these are potentially not all that independent by nature of occurring in the same time period. But certainly it lends more credibility over a shorter time than say the other fund highlighted by the Mutual Fund Observer, Otter Creek Long Short Opportunity (OTCRX), which holds a few dozen securities long and short as opposed to AQR's many hundreds long and short.

long_gamma wrote:Many people think "Options" in pariah status and option players as either as dim witted or super savvy.

Short equity indices vol has been consistent good strategy. This is what Antti Illmanen says in Expected Returns "The best-known insurance strategies involve various methods of selling equity index volatility. Doing so earns good long-run returns but at the risk of huge losses when bad times occur".
Yeah, that's the second part.

The main point I was making is just that they're not even using options strategies. The more general point you make is that options can be used for systematic risk exposure in a long-term profitable matter (at least, in the same sense that we expect most long-term profitable risks in the past to probably make money in the future).

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by garlandwhizzer » Fri Apr 08, 2016 3:00 pm

lack_ey wrote:
AQR Long/Short Equity Fund (QLEIX, QLENX, QLERX) doesn't use options, though, which you have repeatedly mentioned, unless I've missed something.
AQR's QLEIX strategy information for investors mention that they employ derivatives and that those derivatives may lose more principal than the original investment, i.e. leverage. In AQR's SEC filing on QLEIX of June 21 2013, AQR states their use of derivatives: "may include futures contracts, forwards, options, and swaps"

<http://www.sec.gov/Archives/edgar/data/ ... 0d497k.htm>

I don't know if QLEIX has used options or not in practice up to now, or if so, by how much, but their official filing with the SEC clearly mentions that options are one of their potential instruments. The following is a direct quote from AQR to the SEC on their use of derivatives and its associated risks.
Derivatives Risk: In general, a derivative contract typically involves leverage, i.e., it provides exposure to potential gain or loss from a change in the level of the market price of a security, currency or commodity (or a basket or index) in a notional amount that exceeds the amount of cash or assets required to establish or maintain the derivative contract. The use of derivative instruments also exposes the Fund to additional risks and transaction costs. These instruments come in many varieties and have a wide range of potential risks and rewards, and may include futures contracts, forwards, options and swaps. A risk of the Fund’s use of derivatives is that the fluctuations in their values may not correlate perfectly with the overall securities markets.
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Fri Apr 08, 2016 3:19 pm

garlandwhizzer wrote:
lack_ey wrote:
AQR Long/Short Equity Fund (QLEIX, QLENX, QLERX) doesn't use options, though, which you have repeatedly mentioned, unless I've missed something.
AQR's QLEIX strategy information for investors mention that they employ derivatives and that those derivatives may lose more principal than the original investment, i.e. leverage. In AQR's SEC filing on QLEIX of June 21 2013, AQR states their use of derivatives: "may include futures contracts, forwards, options, and swaps"

<http://www.sec.gov/Archives/edgar/data/ ... 0d497k.htm>

I don't know if QLEIX has used options or not in practice up to now, or if so, by how much, but their official filing with the SEC clearly mentions that options are one of their potential instruments. The following is a direct quote from AQR to the SEC on their use of derivatives and its associated risks.
Derivatives Risk: In general, a derivative contract typically involves leverage, i.e., it provides exposure to potential gain or loss from a change in the level of the market price of a security, currency or commodity (or a basket or index) in a notional amount that exceeds the amount of cash or assets required to establish or maintain the derivative contract. The use of derivative instruments also exposes the Fund to additional risks and transaction costs. These instruments come in many varieties and have a wide range of potential risks and rewards, and may include futures contracts, forwards, options and swaps. A risk of the Fund’s use of derivatives is that the fluctuations in their values may not correlate perfectly with the overall securities markets.
Garland Whizzer
But options don't appear anywhere in their descriptions of their investing strategy (outside of broad descriptions of what the fund is allowed to do for legal purposes) or in portfolio breakdowns in the annual reports and so on. If anything it should stand that options usage would be incidental and not key to characterizing performance or lack thereof.

A statement like "the fund might use some options" or "the fund is allowed to use options" to execute its long/short positions is completely different from the gist of what was suggested by what you wrote earlier:
garlandwhizzer wrote:The AQR long short option fund has done quite well since its inception[...]

The options market is dominated by professional players who presumably are not fools. In order for AQR to be persistently successful at it, there has to be a reliable and constant stream of less savvy investors taking the other side of the options from AQR. So far, so good, but I submit that it is not clear that such misinformed professional investors are not in inexhaustible supply. AQR's options insight superiority may persist or it may not.
That sounds like a fund specializing in trading in options and making money from that options trading. It doesn't seem to have any bearing on the current discussion.

And even if you read all the docs about what the fund can do at face value and expect them to do all of it, how do you go from figuring that a fund that can use futures, forwards, options, and swaps is an options fund? Why focus on options as opposed to the futures, forwards, and swaps? It's kind of strangely coincidental and bizarre that you only really talked about the options, whereas the fund actually does significantly use swaps, futures, and forwards.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by garlandwhizzer » Fri Apr 08, 2016 7:42 pm

lack_ey wrote:

It's kind of strangely coincidental and bizarre that you only really talked about the options, whereas the fund actually does significantly use swaps, futures, and forwards.
I used the word options a lot but all the derivatives potentially used by QLEIX (swaps, futures, forward contacts, and options) add expense and risk. Returns from these instruments go both ways, up and down. From the AQR document:
Derivatives Risk: In general, a derivative contract typically involves leverage, i.e., it provides exposure to potential gain or loss from a change in the level of the market price of a security, currency or commodity (or a basket or index) in a notional amount that exceeds the amount of cash or assets required to establish or maintain the derivative contract. The use of derivative instruments also exposes the Fund to additional risks and transaction costs.
I think the last line says it all: The use of derivative instruments also exposes the Fund to additional risks and transaction costs. Futures contracts, forwards, and swaps, just like options, are not without risk. Basically AQR is betting that their specific mixture of chosen derivatives in different currencies, securities, or commodities and in different countries will add up to improved risk adjusted returns. It has worked so far, but so did Long Term Capital Management for a while until their bullet-proof complex model created by Nobel Prize winning economists and renowned Wall Street traders went bust.

For me personally, the bottom line is that QLEIX uses a very complex strategy with many moving parts all over the world, a strategy that I don't really understand. I don't invest in things I don't understand, hence the decision not to invest in this one is easy for me. I'll stick with the KISS principle.

Garland Whizzer

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by tarheel » Fri Apr 08, 2016 8:05 pm

garlandwhizzer wrote: For me personally, the bottom line is that QLEIX uses a very complex strategy with many moving parts all over the world, a strategy that I don't really understand. I don't invest in things I don't understand, hence the decision not to invest in this one is easy for me. I'll stick with the KISS principle.

Garland Whizzer
This is EXACTLY what I am trying to say. Thanks Garland. There are a ton of moving parts in these strategies. There is much more involved than value/ momentum/profitability 40/40/20. I am fine with my general understanding of what is going on with the multialternatives/long-short/neutral - that's why I have a 7.5% QSPIX allocation. I do not claim to understand all that is going on, just broad strokes.

My point is that we are comparing opaque strategies to ones that are much clearer. If I knew exactly what was involved with QLEIX - that it was just a long-short 40/40/20, ok. BUT IT'S NOT. It outperformed over 3 years. WHY? Are you sure it will over the next 3? At least with the multi-style long funds I know exactly what I am getting.

This is why I thought the chart was so ridiculous. All it proved was that QLEIX outperformed over the past three years. You don't need a graph to show that.

By the way, I thought it was interesting that QLEIX has a 0.7 correlation to the S&P 500 while QSPIX has 0.07. This is precisely why I am QSPIX.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Fri Apr 08, 2016 10:29 pm

garlandwhizzer wrote:
lack_ey wrote:

It's kind of strangely coincidental and bizarre that you only really talked about the options, whereas the fund actually does significantly use swaps, futures, and forwards.
I used the word options a lot but all the derivatives potentially used by QLEIX (swaps, futures, forward contacts, and options) add expense and risk. Returns from these instruments go both ways, up and down. From the AQR document:
Derivatives Risk: In general, a derivative contract typically involves leverage, i.e., it provides exposure to potential gain or loss from a change in the level of the market price of a security, currency or commodity (or a basket or index) in a notional amount that exceeds the amount of cash or assets required to establish or maintain the derivative contract. The use of derivative instruments also exposes the Fund to additional risks and transaction costs.
I think the last line says it all: The use of derivative instruments also exposes the Fund to additional risks and transaction costs. Futures contracts, forwards, and swaps, just like options, are not without risk. Basically AQR is betting that their specific mixture of chosen derivatives in different currencies, securities, or commodities and in different countries will add up to improved risk adjusted returns. It has worked so far, but so did Long Term Capital Management for a while until their bullet-proof complex model created by Nobel Prize winning economists and renowned Wall Street traders went bust.

For me personally, the bottom line is that QLEIX uses a very complex strategy with many moving parts all over the world, a strategy that I don't really understand. I don't invest in things I don't understand, hence the decision not to invest in this one is easy for me. I'll stick with the KISS principle.

Garland Whizzer
First of all, every single fund has listed risks because they all invest in something. I kind of disagree with using legal boilerplate as a starting point for analysis, as that doesn't tell you much about magnitudes and actual effects, what can go wrong. There are real risks here but a discussion at this level, never mind a reference to LTCM, don't much advance real understanding. With LTCM and with these funds it matters what kinds of trades are being made and the amount of leverage, among other things.

Also, I think you're getting excessively bogged down in details of implementation rather than strategy. Both the equity market neutral and long/short funds go long a certain group of global stocks and short a different group of global stocks. The long/short fund adds some long equity exposure on top of that. It's all that's happening, other than the currency forwards like a lot of funds have to hedge currency exposure (like on Vanguard's international bond index fund).

In general you can go long and short stocks without derivatives. It's not like AQR doesn't know how to do that. The fund also holds some of the stocks directly. But a lot of the exposure is gotten through the total return swaps presumably because that's cheaper and more efficient. The swaps are just agreements with a JPMorgan that more or less say, if the performance of this list of 100 Japanese stocks minus this other list of 100 Japanese stocks is negative then I owe you money on the difference and if it's the reverse then you owe me money (adjusted for short-term benchmark rate like FFR plus a spread). Likewise, they could buy all the constituent stocks for the passive stock exposure on the long/short fund but they just go long equity index futures instead.

They're not, for better or worse, doing anything like running an inverse split strike butterfly conditioned on a reversal in currency movements based on some kind of proprietary algos. Or whatever it is some people are doing. On a level of complexity, funds like these are a lot more complex than index funds and most any long-only funds, but definitely less complex than a lot of things out there.

Much of the perceived complexity is about implementation rather than strategy. Implementation is important too, of course, but doesn't really tell you all that much about why the fund performed or didn't.

tarheel wrote:
garlandwhizzer wrote: For me personally, the bottom line is that QLEIX uses a very complex strategy with many moving parts all over the world, a strategy that I don't really understand. I don't invest in things I don't understand, hence the decision not to invest in this one is easy for me. I'll stick with the KISS principle.

Garland Whizzer
This is EXACTLY what I am trying to say. Thanks Garland. There are a ton of moving parts in these strategies. There is much more involved than value/ momentum/profitability 40/40/20. I am fine with my general understanding of what is going on with the multialternatives/long-short/neutral - that's why I have a 7.5% QSPIX allocation. I do not claim to understand all that is going on, just broad strokes.
But isn't this basically the same thing as the multialternatives fund except it only uses stocks (so no bonds, commodities, etc.) and then uses metrics in addition to value, momentum, and profitability?
tarheel wrote:My point is that we are comparing opaque strategies to ones that are much clearer. If I knew exactly what was involved with QLEIX - that it was just a long-short 40/40/20, ok. BUT IT'S NOT. It outperformed over 3 years. WHY? Are you sure it will over the next 3? At least with the multi-style long funds I know exactly what I am getting.
Okay, then maybe we're in agreement if you're wondering about the other metrics used for the stock selection. I wouldn't really say there's much additional complexity, but these other things are presumably less researched, and they're not telling us (maybe they're telling advisers) exactly what they use and how exactly they generate numbers to do the sorting on. e.g. for value if you say you sort on p/b that is pretty unambiguous and there's a lot of research on that.

Agreed that anything that outperforms can just as well underperform. But I think it's interesting that you're actively avoiding the funds that outperformed. It seems a bit counter-intuitive but it's probably a good strategy in general not to performance chase.
tarheel wrote:This is why I thought the chart was so ridiculous. All it proved was that QLEIX outperformed over the past three years. You don't need a graph to show that.
I don't really get this sentiment. If you want to analyze and quantify what happened (for example to answer "how much outperformance?" in a fair or meaningful way), presumably you would want to use a graph? What's wrong with a graph unless the contents are not relevant or are misleading? You don't really need a graph in general to show most things but some kind of analysis may be helpful. That said, the piece could have used some additional explanations, sure, as we've already discussed.
tarheel wrote:By the way, I thought it was interesting that QLEIX has a 0.7 correlation to the S&P 500 while QSPIX has 0.07. This is precisely why I am QSPIX.
This doesn't explain why you're not using the market neutral variant. The long/short fund has a high correlation with the S&P 500 because it has long stock exposure. I mean... what else do you expect? All funds with substantial long stock exposure are going to show some correlation.

For reference,
https://www.portfoliovisualizer.com/ass ... TWSX+VBTLX

And there's much more to it than correlation anyway. Let's say you had an allocation of 40% S&P 500, 60% Vanguard Balanced Index (60% US stocks, 40% US bonds; 0.99 correlation to S&P 500). That's basically the same thing as owning 76% S&P 500, 24% Vanguard Total Bond Index (-0.33 correlation to S&P 500 for daily returns the last 15-odd years). Okay, there are minor differences because of the automatic internal rebalancing and the fact that the stocks in the balanced index aren't exactly the same as the S&P 500 but you get the point. The exposures are effectively the same.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Robert T » Sat Apr 09, 2016 6:37 am

.
As with all good recent performance, you need to be cautious of performance chasing. IMO there are three key questions: (i) are these strategies likely to generate sustainable positive alpha beyond factor exposure? (ii) do they provide a unique combination of factor exposure? and (iii) are these worth the additional cost? Some thoughts on each:

(i) are these strategies likely to generate sustainable positive alpha beyond factor exposure?
  • We don’t have an available long back-tested series of these strategies to see the magnitude of past (simulated) alpha after controlling for momentum, value, quality, and size exposure - as indicative of future alpha. However, what we do have is the Novy-Marx long-short data for momentum, value and profitability (MVP) from 1963 to 2013 – he provides decile data on MVP sorts. The results below are derived from simply taking the average of the lowest 3 deciles and highest 3 deciles, and their long-short. The performance of the highest 3 declies (MVP long-only) is similar to the simulated performance of the long-only MVP series in the AQR article on ‘A New Core Paradigm’.

    The long-short series is more similar to the AQR market neutral fund than the AQR long-short equity, however both had fairly similar performance to date.

    Here are the factor load, and performance data from 7/1963 to 12/2013.

    A = MVP Long-only
    B = MVP Long-short
    C = MVP Long-only minus market
    D = (MVP Long-Short) minus (MVP Long-only minus market)

    A / B / C / D

    +0.16 / +0.20 / +0.16 / +0.03* = Alpha
    +1.02 / +0.00 / +0.02 / -0.01 = Market
    +0.39 / +0.42 / +0.39 / +0.03 = Size
    +0.12 / +0.24 / +0.12 / _0.12 = Value
    +0.29 / +0.58 / +0.29 /+ 0.29 =Momentum
    +0.11 / +0.19 / +0.11 / +0.08 =Quality

    17.4 / 10.2 / 6.6 / 3.6 = Annualized return
    17.2 / 11.3 / 7.2 / 5.6 = Annualized standard deviation

    +6.7 / -3.0 / -1.8 / -1.1 = 2007 return
    -23.9 / +31.8 / +18.9 / +11.3 = 2008 return
    +20.0 /-26.5 / -7.7 / -19.4 = 2009 return

    * t-stat = 0.75

    Some observations:

    • MVP long-short did not have a statistically significant additional alpha to MVP long only (even when market return was take out of the latter). The MVP long-only had a positive and significant alpha. This was due to the greater non-linearity in decile returns of MVP relative to the those of the individual factors (momentum, value, quality). MVP long-short has a slightly higher alpha than MVP long only, but was not statistically different (+0.03 additional alpha, but t-stat = 0.75). The slightly higher alpha was due to the non-linearly on the short-side.

    • MVP long-short annualized returns were 3.6 percent higher than MVP long only minus the market return from 7/1963 to 12/2013. This was due to the higher factor exposure, not significantly larger alpha.

    • About 65 percent of the MVP long-short returns came from the long side (6.6/10.2).

    If the above analysis is indicative of the future, the answer to the initial question is probably no (or clearly not a resounding yes). While AQR may add a myriad of other overlays to the above simple strategies it is more difficult to assess them. The underlying strategy long "high MVP" and short "low MVP" will likely drive much of the long-short return, just as the "high MVP" will drive returns of their long-only multistyle funds.
(ii) do they provide a unique combination of factor exposure?
  • IMO a prudent approach for investors is to select a long-term factor load target, then construct a portfolio to match these targets – so answering this question seems specific to an individual’s choice of factor exposure and other funds available to him/her. This could potentially be helpful to someone who only has beta exposure choices in 401k etc such as Vanguard Total Market. Adding a long-short fund can arguably provide a reasonable way to achieve there factor load targets i.e. it doesn’t add more beta (which the investor already has) but only adds factors that the investor doesn’t already have.
(iii) is it worth the additional cost?
  • Comparing expense ratios: 1.30 – 0.45 = 0.85%. You will be paying more for greater factor exposure, not alpha. To the extent you can match your target factor exposure with long-only funds, it will likely be cheaper to use only long-only funds. This does not factor in other costs such as market impact and bid-ask spreads which will likely be higher on the long-short funds due to higher turnover, or the likelihood for infrequent, but large negative relative returns which may also be higher for the long-short fund (as AQR experienced in 2007/8 for the Absolute Return strategy, and in 2009 in the Novy-Marx simulated series).
Obviously no guarantees.

Robert
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Sat Apr 09, 2016 11:40 am

Robert T, thanks for that. You didn't mention it, but the long/short series quoted there are 1x (of notional value) long and 1x short, right?

So here is a list of the key differences between the MVP long/short data series and AQR's equity market neutral fund—and of course the long/short fund too, the beta exposure via futures aside:
  • Additional screens on top of MVP such as investor sentiment, management signalling may add or subtract alpha over traditional factor exposures (so far seems to have contributed meaningfully positively) but also reduce exposure to pure MVP
  • Potentially higher leverage and thus higher factor loads; it's 1.9x/-1.7x as of the end of February
  • Volatility targeting based on strength of signals and market volatility, targeting around 6% annualized, causing leverage and thus factor loads to drift up and down over time (less when markets more volatile)
  • Trading frictions, expense ratio, and other costs
The large cap multi-style fund costs 0.45%, while the international developed version costs 0.60%. On average, combining them for global factor exposure to match the market neutral fund's coverage, about 0.52%. If the equity market neutral fund has about 3.6x net exposure (right now; at other times it will probably be significantly lower or potentially even higher) at a cost of 1.3% then that is more exposure for the money spent on expense ratios. Of course the market neutral fund sees higher internal frictions too, not just a higher fee.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by Robert T » Sat Apr 09, 2016 12:49 pm

.
Just to add:
  • • Volatility targeting and leverage are related. The MVP long-short series used earlier already had an annualized standard deviation of 11.3% which is above the AQR market neutral fund target of 6%, and even above the funds 9% upper range target. Leveraging would only increase this further. So the market neutral fund likely uses a larger universe than the upper and lower one third sorts on MVP. Even if you take the upper and lower halves of MVP sorts, the resulting MVP long-short annualized standard deviation is still 8.2%. Adding international stocks could get it closer to 6%, with the added diversification. The corresponding annualized returns for MVP long-short (using upper and lower halves of MVP sorts) come down from 10.3% annualized to 6.9% annualized (3.4% lower).

    • Deviations from MVP sorts: There seems to be two main deviations (i) “the Adviser may use a number of additional quantitative indicators based on the Adviser’s proprietary research”, and (ii) “the Fund may, but is not required to, hedge exposure to foreign currencies using foreign currency forwards or futures”. So the question is: do you think these two deviations will, net of costs, add significant alpha above expense ratio differences (if you are indeed buying the fund to get additional alpha, rather than simply more factor exposure beyond beta)? If so then related questions are – what is the additional alpha you are expecting, what share of your expected portfolio returns does this comprise, and what is your confidence in this relative to factor exposure? As Bernstein says “There is no certainty [apart from costs], only probabilities, and you go where they are highest.”
Robert
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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Sat Apr 09, 2016 2:32 pm

Part of the discrepancy in volatility from Novy-Marx MVP compared to AQR seems to be from the investment universe. For most of these funds AQR excludes small caps, where the factors are usually larger and more volatile. Also where the transaction costs are higher.

Another potential difference I forgot a couple posts above, and one between the long/short funds and the long-only funds, is the security weighting. The long-only funds are cap weighted, whereas the long/short funds are not. If anything, this might increase volatility, though.


I would think the long-term expectation for currency hedging would be close to zero or slightly negative, so a lot of it does come down to the additional indicators, which they don't talk much about. I wonder if the adviser types are told more about what's going on, the relative weightings they get compared to MVP, and what kind of expected returns even AQR thinks they add.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by wije » Sat Apr 09, 2016 10:38 pm

lack_ey wrote:
tarheel wrote:By the way, I thought it was interesting that QLEIX has a 0.7 correlation to the S&P 500 while QSPIX has 0.07. This is precisely why I am QSPIX.
This doesn't explain why you're not using the market neutral variant.
QSPIX is now closed to new investors, but elsewhere you pointed out Style Premia Alternative II will be coming out soon. What should investors consider when choosing between it and QMNIX? You had mentioned it won't have commodities, which is fine with me, but will include bonds and currencies. The new fund presumably will also incorporate "carry" which I have to confess I don't understand.
Last edited by wije on Sat Apr 09, 2016 11:00 pm, edited 1 time in total.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by wije » Sat Apr 09, 2016 10:44 pm

Robert T wrote:This could potentially be helpful to someone who only has beta exposure choices in 401k etc such as Vanguard Total Market. Adding a long-short fund can arguably provide a reasonable way to achieve there factor load targets i.e. it doesn’t add more beta (which the investor already has) but only adds factors that the investor doesn’t already have.
This is exactly why I'm considering market neutral funds. I have a lot in Bogleheads-friendly TSP funds and am looking for ways to diversify beyond them with my Roth IRA. If I were to put $5,000 in QMNIX for this year, it would only come out to about 2% of my total portfolio, so I don't think I'm missing much by passing up other equities or bonds.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Sun Apr 10, 2016 10:52 am

wije wrote:
lack_ey wrote:
tarheel wrote:By the way, I thought it was interesting that QLEIX has a 0.7 correlation to the S&P 500 while QSPIX has 0.07. This is precisely why I am QSPIX.
This doesn't explain why you're not using the market neutral variant.
QSPIX is now closed to new investors, but elsewhere you pointed out Style Premia Alternative II will be coming out soon. What should investors consider when choosing between it and QMNIX? You had mentioned it won't have commodities, which is fine with me, but will include bonds and currencies. The new fund presumably will also incorporate "carry" which I have to confess I don't understand.
http://www.sec.gov/Archives/edgar/data/ ... 85apos.htm

No short-term interest rates (deposit rates) or commodities. Yes stocks, bonds, currencies. Same four styles as before: value, momentum, carry, defensive. To read more about them, including carry, check their paper, Investing with Style, for starters, especially the section 2 and subsection 3.2:
http://faculty.chicagobooth.edu/tobias. ... LISHED.pdf

The big question would be how you value these relatively well-published styles and asset classes in the style premia fund over their proprietary, beyond-MVP exposures in the market neutral fund. The latter is more of a wildcard, as far as I'm concerned. Most quant investors have their own proprietary signals that may or may not work. Vanguard's own market neutral fund, which has also been successful of late after switching to all internal management by their quant team, is based on this. Some presumably have caught on to something that does seem to be working.

In the original style premia, over half of the fund's risk weighting is related to stocks. That percentage is even higher with the new version.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by wije » Mon Apr 11, 2016 12:34 am

lack_ey wrote:The big question would be how you value these relatively well-published styles and asset classes in the style premia fund over their proprietary, beyond-MVP exposures in the market neutral fund. The latter is more of a wildcard, as far as I'm concerned.
I had assumed QMNIX had the same equity exposures as QSPIX; in other words, QSPIX has proprietary beyond-MVP exposures as well. What does it have that the style premia fund does not?

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by lack_ey » Mon Apr 11, 2016 12:50 am

wije wrote:
lack_ey wrote:The big question would be how you value these relatively well-published styles and asset classes in the style premia fund over their proprietary, beyond-MVP exposures in the market neutral fund. The latter is more of a wildcard, as far as I'm concerned.
I had assumed QMNIX had the same equity exposures as QSPIX; in other words, QSPIX has proprietary beyond-MVP exposures as well. What does it have that the style premia fund does not?
Nah, even the baseline exposures are different.

Recall that the style premia fund is value, momentum, carry, and defensive. For stocks it's just value, momentum, and defensive, with defensive being low beta (betting against beta).

For the market neutral fund, it's value, momentum, and profitability, plus other stuff. Not the same things, even if you ignore the other stuff.

The performance attribution for the style premia fund I saw posted had data for the four styles and breakdowns across asset classes. Not much room for additional secret sauce, though who knows, maybe they toss in some extra screens anyway—they have to consider liquidity and transaction costs anyway, among other things. But it doesn't seem to be mentioned much. In the annual reports they don't talk about anything but the styles.

On the other hand, for the 2015 annual report for the market neutral and long/short funds, they do explicitly talk about non-MVP components like investor sentiment and stability contributing to returns.

If you look at the stock holdings in the funds in an annual report, you see slightly different names between the style premia fund and the other two and sometimes with significantly different weightings. But the market neutral and long/short equity funds hold virtually the same stocks.

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Re: Review of AQR Equity Market Neutral & Long-Short Equity

Post by wije » Mon Apr 11, 2016 6:52 pm

lack_ey wrote:The performance attribution for the style premia fund I saw posted had data for the four styles and breakdowns across asset classes. Not much room for additional secret sauce, though who knows, maybe they toss in some extra screens anyway—they have to consider liquidity and transaction costs anyway, among other things. But it doesn't seem to be mentioned much. In the annual reports they don't talk about anything but the styles.
Thanks lack_ey. I also took a look at the fees and was amazed to see 3.15% "all other expenses" for QMNNX compared to only .26% for QSPNX (most of which are waived or expense capped away). I guess the market neutral fund is doing some extra-special secrety stuff the style premia isn't.

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