Morningstar - AQR: The Vanguard of Alternative Investing?

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matjen
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Morningstar - AQR: The Vanguard of Alternative Investing?

Post by matjen » Sat Nov 18, 2017 9:07 am

John Rekenthaler has a nice article on AQR's success up at Morningstar.

http://beta.morningstar.com/articles/83 ... sting.html
AQR won the old-fashioned way: Its funds beat everybody else's. AQR Long-Short Equity (QLEIX) finished first in its category. AQR Equity Market Neutral (QMNIX) was first in its category. AQR Style Premia Alternative (QSPIX) was first in its category. ( AQR Managed Futures Strategy (AQMRX) finished in the middle of the pack.) Outgaining other funds succeeds in the mutual fund industry. That was true when grandpa drove the Oldsmobile, true when your father did so, and it remains true today.

Its expenses haven't been bad, either. Three of the four funds are cheaper than the norm, with AQR Managed Futures Strategy being among its category's lowest. Clearly, though, the funds' performance has been their main attraction. Also, this illustration favors AQR, because three of those fund share classes are institutional, and the fourth is an R6 share class, which is priced even below the institutional classes. (R6 is a "clean" share class, meaning that it does not share any revenue with the companies that distribute AQR funds.) If retail funds are removed from the picture, AQR's cost advantage declines.
What is interesting to me is that we haven't even entered an environment where these types of funds should really shine. When we do, if they perform as expected AQR will explode. If they falter and prove no/little better than beta then major trouble.
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by jhfenton » Sat Nov 18, 2017 9:28 am

When AQR funds are widely available to retail investors at reasonable minimums, wake me up. Until then, they might as well be DFA or Stone Ridge. They don't exist in my non-advisor retail investor world.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Theoretical » Sat Nov 18, 2017 10:01 am

At Fidelity, many of them are available for a $2500 minimum in an IRA.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by jhfenton » Sat Nov 18, 2017 11:35 am

Theoretical wrote:
Sat Nov 18, 2017 10:01 am
At Fidelity, many of them are available for a $2500 minimum in an IRA.
Thanks. That is good to know.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by midareff » Sat Nov 18, 2017 11:58 am

matjen wrote:
Sat Nov 18, 2017 9:07 am
John Rekenthaler has a nice article on AQR's success up at Morningstar.

http://beta.morningstar.com/articles/83 ... sting.html
AQR won the old-fashioned way: Its funds beat everybody else's. AQR Long-Short Equity (QLEIX) finished first in its category. AQR Equity Market Neutral (QMNIX) was first in its category. AQR Style Premia Alternative (QSPIX) was first in its category. ( AQR Managed Futures Strategy (AQMRX) finished in the middle of the pack.) Outgaining other funds succeeds in the mutual fund industry. That was true when grandpa drove the Oldsmobile, true when your father did so, and it remains true today.

Its expenses haven't been bad, either. Three of the four funds are cheaper than the norm, with AQR Managed Futures Strategy being among its category's lowest. Clearly, though, the funds' performance has been their main attraction. Also, this illustration favors AQR, because three of those fund share classes are institutional, and the fourth is an R6 share class, which is priced even below the institutional classes. (R6 is a "clean" share class, meaning that it does not share any revenue with the companies that distribute AQR funds.) If retail funds are removed from the picture, AQR's cost advantage declines.
What is interesting to me is that we haven't even entered an environment where these types of funds should really shine. When we do, if they perform as expected AQR will explode. If they falter and prove no/little better than beta then major trouble.
Being first in category (QSPIX) is great except when that means you have considerably under performed the S&P500 Index.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by MarkRoulo » Sat Nov 18, 2017 12:10 pm

From the article:
Which, rather neatly, brings us to the conclusion. Is AQR the Vanguard for alternative investing? Yes and no. Yes, in that AQR rules its (much smaller, albeit highly profitable) roost. The nonconformity of alternatives has enabled somebody besides Vanguard to prevail within that portion of the industry, and AQR has become that somebody. No, in that AQR's formula is different. It relies on performance, not costs, which means that AQR faces the greater challenge of the two firms in maintaining its supremacy. Staying cheap is not hard. Staying number 1 most certainly is.
I think that AQR is more properly compared to Fidelity in the 1980s. Fidelity, too, was dominant, but largely because of performance. Costs were pretty reasonable for actively managed funds, but Fidelity was Fidelity because of performance.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by nisiprius » Sat Nov 18, 2017 12:56 pm

Yep, Vanguard has very little to offer someone who wants "alternatives." If I wanted "alternatives" I'd be looking outside Vanguard. However, I don't want them.

I think the chief argument for "alternatives" is:
  • Unless something is different from traditional securities (stocks and bonds), it can't be better than traditional securities.
  • Alternatives are different from traditional securities.
  • Ergo, alternatives are better than traditional securities.
I think the most convincing "alternative" in recent years, commodities (or CCFs), has pretty much exploded in investors' faces, despite the apparent backing by impressive academic papers and once-widespread adoption (e.g. in Fidelity's Freedom Funds).

Something that Rekenthaler didn't talk about, and I think he should have, is that most of Vanguard's funds are long-only portfolios. They are just bundles of securities. I think the same is true of DFA.

But, for reasons I don't completely understand, all of AQR's funds that I've glanced at are long-short portfolios with leverage. Traditionally, mutual funds are supposed to be strictly limited as to how much leverage they can use, but apparently it is OK to get around that by using derivatives. I don't know if there is something about "alternatives" that makes this necessary, or if it's just AQR's way. It's not surprising that AQR does this, because Cliff Asness and AQR comes from the world of hedge funds, which have no such restrictions. Financial sophisticates almost always seem to use leverage, and always have very good arguments as to why leverage isn't dangerous if you know what you're doing, and why the particular way they are using leverage isn't a problem. But I don't like it.

Personally, I use a computer screen with three primary colors: red, green, and blue. There's a case to be made that you can get a wider gamut with four primaries; in fact, it's a valid case--it's just math. And one company, Sharp, has offered Aquos Quattron displays with red, green, blue, and yellow subpixels since about 2010. I don't have one. Do you?
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by whodidntante » Sat Nov 18, 2017 1:03 pm

I hold two AQR funds and I'm surprised at how well they are performing in this "melt-up" environment. As you pointed out, that's not really the environment where you expect to be glad you own them.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by whodidntante » Sat Nov 18, 2017 1:06 pm

jhfenton wrote:
Sat Nov 18, 2017 11:35 am
Theoretical wrote:
Sat Nov 18, 2017 10:01 am
At Fidelity, many of them are available for a $2500 minimum in an IRA.
Thanks. That is good to know.
AQR funds are also available in an HSA commission-free, though they are n-shares (0.25% 12b-1).
viewtopic.php?t=232381

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by randomguy » Sat Nov 18, 2017 1:19 pm

midareff wrote:
Sat Nov 18, 2017 11:58 am

Being first in category (QSPIX) is great except when that means you have considerably under performed the S&P500 Index.

That is like complaining total bond market has considerably underperformed the S&P 500. It is a true statement but it ignore the reasons why you by bonds and the like instead of the S&P 500.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by randomguy » Sat Nov 18, 2017 1:23 pm

nisiprius wrote:
Sat Nov 18, 2017 12:56 pm
Personally, I use a computer screen with three primary colors: red, green, and blue. There's a case to be made that you can get a wider gamut with four primaries; in fact, it's a valid case--it's just math. And one company, Sharp, has offered Aquos Quattron displays with red, green, blue, and yellow subpixels since about 2010. I don't have one. Do you?

Yes I do and I am pretty happy with its performance. But I will also admit it is a minor thing. I sort of expect my alternatives to be a minor thing also because I am only willing to sink 10% of my portfolio in them. To really change things up I would need to up that 25%+.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sat Nov 18, 2017 1:35 pm

nisiprius wrote:
Sat Nov 18, 2017 12:56 pm
I think the chief argument for "alternatives" is:
  • Unless something is different from traditional securities (stocks and bonds), it can't be better than traditional securities.
  • Alternatives are different from traditional securities.
  • Ergo, alternatives are better than traditional securities.
The point is not to get something better than traditional securities. The point is to get something different from traditional securities, even if it's worse on average*, so you don't have to bet as strongly on the best options. It's an MPT-style diversification argument.

*hopefully it's not worse, but getting a positive Sharpe ratio after fees and costs in a market neutral fashion is a real challenge already and in some models and understandings shouldn't even be sustainable at all, so you'd better not expect too much more

A lot of alts are not market neutral. Some are long non-stocks-and-bonds exposure, like for example CCFs. Some alt strategies have significant market betas because of underlying holdings, not shorting out market exposures, etc., and in this case what you need to evaluate is the performance of the non-market-related component.
nisiprius wrote:
Sat Nov 18, 2017 12:56 pm
Something that Rekenthaler didn't talk about, and I think he should have, is that most of Vanguard's funds are long-only portfolios. They are just bundles of securities. I think the same is true of DFA.

But, for reasons I don't completely understand, all of AQR's funds that I've glanced at are long-short portfolios with leverage. Traditionally, mutual funds are supposed to be strictly limited as to how much leverage they can use, but apparently it is OK to get around that by using derivatives. I don't know if there is something about "alternatives" that makes this necessary, or if it's just AQR's way. It's not surprising that AQR does this, because Cliff Asness and AQR comes from the world of hedge funds, which have no such restrictions. Financial sophisticates almost always seem to use leverage, and always have very good arguments as to why leverage isn't dangerous if you know what you're doing, and why the particular way they are using leverage isn't a problem. But I don't like it.
AQR runs a whole lot of long-only equity funds that are unleveraged, funds outside the alternatives category. The issue is that they're basically just boring factor funds, and AQR charges relatively high fees compared to what others do in this space. And performance hasn't been anything good in the relatively brief histories (single digits years), in part from some bad luck (certain factor definitions and construction methodologies doing worse than others over a given period) and also of course the underlying factor returns. But also because they're not really doing anything special there.

All the competitors pursuing similar alternatives strategies use derivatives, etc., many using leverage depending on the circumstance. As for the derivatives, these are the only ways to access certain investments, and they're a cheaper way of accessing other investments (for example, for trading the S&P 500 or other equity markets). A managed futures strategy is going to use derivatives because those derivatives are kind of in the name, right? More meaningfully, you can't trade a lot of those underlying products without derivatives, so that's why they are used. Worry more about strategies, not the tools to implement those strategies. Now, the implementation details also matter, how the trading is done, positions sized, trading signals, etc., but getting hung up on the tools is a bit shortsighted. There are a whole lot of arguments you could make against the underlying strategies. Would it bother you if a pension fund getting rid of a submanager for an equity sleeve moved the equity exposure into equity index futures temporarily before finding a new manager?

Outside of of the strawman field, everybody understands that leverage increases risk and can go wrong, but it's just a tool. You can use it to take too much risk, and you can use it in other ways too. It matters what you're leveraging. 2x leveraged short-term Treasuries is a lot less risky than stocks. A 30/70 portfolio leveraged 1.5x is less risky than stocks and is probably better diversified in a meaningful way (also likely to return less). A 2x leveraged stock portfolio is asking for a lot of trouble. So it really depends.

There are substantial risks in a lot of different alternatives strategies, especially the AQR funds highlighted. After all, if you can return 10%+ in a year in a market neutral way, you can easily lose that much and more just as quickly. They're clearly riding a lucky hot streak in some of these funds. The question is what to expect in the future.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by grok87 » Sat Nov 18, 2017 1:58 pm

Agree with others concern about the amount of leverage aqr is using in its alternative funds

Qspix for example is levered 6.9:1

https://funds.aqr.com/-/media/files/fun ... s/spaf.pdf

That means for every $1 you give them they make $6.90 worth of bets, $3.7 worth on the long side and $3.2 worth on the short side.

Yikes!

That means if the average bet the fund makes declines by just 15% the fund will be wiped out.
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by grok87 » Sat Nov 18, 2017 2:10 pm

whodidntante wrote:
Sat Nov 18, 2017 1:03 pm
I hold two AQR funds and I'm surprised at how well they are performing in this "melt-up" environment. As you pointed out, that's not really the environment where you expect to be glad you own them.
Agree

It's a subtle sign, i think, that the aqr funds actually do have more stock market beta exposure than they are letting on, driven i think by their use of leverage.

The article goes on to discuss some vanguard funds. It points out that the vanguard total bond market fund has had relatively average performance over the past 3 years. It has them ranked 40th worst out of 100 i think. Morningstar says 50th.

The unstated implication seems to be, poor vanguard, their stock funds are top notch but just look their flagship bond fund is underperforming. Better get back on the ball Vanguard!

Nonsense.

I don't own vanguard's total bond index but if i did i would be thrilled that it is underperforming its category. That's what good bond funds are SUPPOSED to do in equity bull markets. Those bond funds that are outperforming vanguard right now are most likely taking on equtiy-correlated risks that are probably going to blow up in their faces if and when the stock market crashes. It happened just that way in 2008.

I think the same thing may possibly be going on with AQR's alternatives that are leading the pack right now...
Last edited by grok87 on Sat Nov 18, 2017 2:19 pm, edited 3 times in total.
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by nisiprius » Sat Nov 18, 2017 2:12 pm

Thank you, lack_ey. I always learn from your posts (or I hope I do, sometimes I'm a slow learner).
lack_ey wrote:
Sat Nov 18, 2017 1:35 pm
nisiprius wrote:
Sat Nov 18, 2017 12:56 pm
...Something that Rekenthaler didn't talk about, and I think he should have, is that most of Vanguard's funds are long-only portfolios. They are just bundles of securities. I think the same is true of DFA. But, for reasons I don't completely understand, all of AQR's funds that I've glanced at are long-short portfolios with leverage...
AQR runs a whole lot of long-only equity funds that are unleveraged, funds outside the alternatives category. The issue is that they're basically just boring factor funds, and AQR charges relatively high fees compared to what others do in this space. And performance hasn't been anything good in the relatively brief histories (single digits years), in part from some bad luck (certain factor definitions and construction methodologies doing worse than others over a given period) and also of course the underlying factor returns. But also because they're not really doing anything special there.
And, just as a reality check... because I did say "the AQR funds I've glanced at"--Rekenthaler chooses to point out four. Going to the Morningstar "portfolio" tab,

AQR Long-Short Equity (QLEIX) -- and, yes, as its name implies it's long-short.
AQR Equity Market Neutral (QMNIX) -- long-short
AQR Style Premia Alternative (QSPIX) -- long-short
AQR Managed Futures Strategy (AQMRX) -- 107.53% long, 7.53% short... I guess that's pretty close to "long only."

Do you know a quick and easy way to find how much leverage a fund is using (effectively using, including use of derivatives?) I seem to recall this is stated in the QSPIX prospectus, but is there a faster way?
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sat Nov 18, 2017 2:29 pm

nisiprius wrote:
Sat Nov 18, 2017 2:12 pm
And, just as a reality check... because I did say "the AQR funds I've glanced at"--Rekenthaler chooses to point out four. Going to the Morningstar "portfolio" tab,

AQR Long-Short Equity (QLEIX) -- and, yes, as its name implies it's long-short.
AQR Equity Market Neutral (QMNIX) -- long-short
AQR Style Premia Alternative (QSPIX) -- long-short
AQR Managed Futures Strategy (AQMRX) -- 107.53% long, 7.53% short... I guess that's pretty close to "long only."

Do you know a quick and easy way to find how much leverage a fund is using (effectively using, including use of derivatives?) I seem to recall this is stated in the QSPIX prospectus, but is there a faster way?
Yeah, those four are pointed out because of AUM growth. These are kind of market neutral (managed futures may not be market neutral at any given point, but over a business cycle should average out around 0 betas), except the long-short equity fund, which pretty much does the exact same thing as their equity market neutral fund but adds a ~0.5 beta overlay using futures, with some mild market timing of that overlay that hasn't done much for them.

The long-only funds haven't had as much growth because they haven't had much success from a relative returns point of view. In fact many are trailing standard index funds. Also because it's kind of like going to an expensive sushi restaurant and somehow ordering steak because it's on the menu, which is probably overpriced there and not what they're known for, and you can get something similar in many other establishments. Disclaimer: with this bad analogy I mean to make no comment about foods, relative importance, whether or not such things should be considered.

With the AQR funds I would just check the fund website for leverage info. The fact sheets, I guess.

https://funds.aqr.com/fund-documents

Image
for AQR Style Premia, as of 2017-09-30

Remember that the long side is expected to be larger than the short side by notional dollar exposure because one of the underlying strategies is "defensive" (betting that lower-beta assets beat higher-beta assets, among other things, so to remain beta neutral you need more of the low-beta stuff than the high-beta).

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by randomguy » Sat Nov 18, 2017 2:55 pm

grok87 wrote:
Sat Nov 18, 2017 1:58 pm
Agree with others concern about the amount of leverage aqr is using in its alternative funds

Qspix for example is levered 6.9:1

https://funds.aqr.com/-/media/files/fun ... s/spaf.pdf

That means for every $1 you give them they make $6.90 worth of bets, $3.7 worth on the long side and $3.2 worth on the short side.

Yikes!

That means if the average bet the fund makes declines by just 15% the fund will be wiped out.
A 100% market decline will also wipeout a long only fund with no leverage. :) The difficulty is figuring out what the likelyhood of a 15% decline of their average bet is. We all know that 15% market declines are common. How often do you have a 15% decline when your hedged 3.7:3.2? And then instead of just having all the bets in one sector spread theym out among stocks, bonds, currency, and the rest.

You can read the papers and go those type of declines will not happen. The risk is they missed something and that unexpected risk wipes out the fund.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by whodidntante » Sat Nov 18, 2017 3:21 pm

grok87 wrote:
Sat Nov 18, 2017 2:10 pm
whodidntante wrote:
Sat Nov 18, 2017 1:03 pm
I hold two AQR funds and I'm surprised at how well they are performing in this "melt-up" environment. As you pointed out, that's not really the environment where you expect to be glad you own them.
It's a subtle sign, i think, that the aqr funds actually do have more stock market beta exposure than they are letting on, driven i think by their use of leverage.
Your hunch may prove correct. We'll know for sure after the next bear market.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sat Nov 18, 2017 3:45 pm

whodidntante wrote:
Sat Nov 18, 2017 3:21 pm
grok87 wrote:
Sat Nov 18, 2017 2:10 pm
whodidntante wrote:
Sat Nov 18, 2017 1:03 pm
I hold two AQR funds and I'm surprised at how well they are performing in this "melt-up" environment. As you pointed out, that's not really the environment where you expect to be glad you own them.
It's a subtle sign, i think, that the aqr funds actually do have more stock market beta exposure than they are letting on, driven i think by their use of leverage.
Your hunch may prove correct. We'll know for sure after the next bear market.
In which sense?

I don't really see it in the data so far:
https://www.portfoliovisualizer.com/fac ... sion=false
https://www.portfoliovisualizer.com/ass ... ingDays=60

By design Style Premia and Equity Market Neutral should be close to equity market neutral.

There are a lot of risks but I don't think it's about equity market beta. A market disruption combined blowing up even-more-leveraged funds doing similar things and then some resulting contagion, positions simultaneously going bad, etc. would be the real test.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by midareff » Sat Nov 18, 2017 4:55 pm

randomguy wrote:
Sat Nov 18, 2017 1:19 pm
midareff wrote:
Sat Nov 18, 2017 11:58 am

Being first in category (QSPIX) is great except when that means you have considerably under performed the S&P500 Index.

That is like complaining total bond market has considerably underperformed the S&P 500. It is a true statement but it ignore the reasons why you by bonds and the like instead of the S&P 500.
Seeing as it would be part of my equity allocation and NOT my bond allocation your comparison isn't valid for me.

So I have it right... you are recommending QSPIX as part of a bond allocation?

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by garlandwhizzer » Sat Nov 18, 2017 5:04 pm

matjen wrote:
What is interesting to me is that we haven't even entered an environment where these types of funds should really shine. When we do, if they perform as expected AQR will explode. If they falter and prove no/little better than beta then major trouble.
1+

I don't think there's any doubt that AQR is run by brilliant and knowledgeable students of the market, particularly with respect to factor investing and alternate investment strategies. The fund success they've had in some areas up to this point implies that in those arenas they either have had more skill or more luck in handling these rather complex strategies than competitors. This is, however, a growing and competitive arena of operation as money pours in. Time will answer a number of questions. Are they skillful or merely lucky? Will their success become capacity restrained? And finally, is it worth the extra cost relative to beta or less complex strategies?

At this point, I'm on the sidelines watching.

Garland Whizzer

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sat Nov 18, 2017 5:20 pm

midareff wrote:
Sat Nov 18, 2017 4:55 pm
Seeing as it would be part of my equity allocation and NOT my bond allocation your comparison isn't valid for me.

So I have it right... you are recommending QSPIX as part of a bond allocation?
Personally I would not recommend shoving square pegs into round holes and using this equity and bond allocation framework in the first place for strategies that fit in neither.

Though even if for some reason you compare to equities, why not world stock?

garlandwhizzer wrote:
Sat Nov 18, 2017 5:04 pm
Are they skillful or merely lucky?
Probably some of both? They have more experience in and attention to trade execution for these kinds of strategies than most. As for figuring out new trades, they don't really do that much. They don't as much come up with new ideas but repackage old ones, figure out the historically reproducible and effective parts to run those, and charge high fees for them (you know, high but lower than some others do).
garlandwhizzer wrote:
Sat Nov 18, 2017 5:04 pm
Will their success become capacity restrained?
Three of the four funds mentioned in the article have already closed to new investors, and they aren't the only ones.
garlandwhizzer wrote:
Sat Nov 18, 2017 5:04 pm
And finally, is it worth the extra cost relative to beta or less complex strategies?
Standalone, of course not. As part of a whole allocation that already includes cheaper exposures and less complex strategies, possibly, with a lot of maybes that have to go the right way.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by randomguy » Sat Nov 18, 2017 6:52 pm

midareff wrote:
Sat Nov 18, 2017 4:55 pm
randomguy wrote:
Sat Nov 18, 2017 1:19 pm
midareff wrote:
Sat Nov 18, 2017 11:58 am

Being first in category (QSPIX) is great except when that means you have considerably under performed the S&P500 Index.

That is like complaining total bond market has considerably underperformed the S&P 500. It is a true statement but it ignore the reasons why you by bonds and the like instead of the S&P 500.
Seeing as it would be part of my equity allocation and NOT my bond allocation your comparison isn't valid for me.

So I have it right... you are recommending QSPIX as part of a bond allocation?
Of course it comes out of bonds. And of course it also comes out of stocks. It all depends on what you are trying do to in terms of optimizing between return and volatility. And the big reason to buy is the hope that fund is that it is uncorrelated during down/flat markets. That benefit only shows up every now and then. A S&P 500 fund will never be uncorrelated with the S&P500 index:)

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Random Walker » Sat Nov 18, 2017 7:37 pm

Midareff,
I think it is incorrect to consider market neutral QSPIX part of an equity allocation. It invests in four styles across at least four asset classes. The styles are value, Momentum, carry, defensive. And the asset classes are equities, bonds, commodities, currencies I think. The styles within the fund are generally uncorrelated with each other, and the fund should be uncorrelated with both stocks and bonds.
Now you do bring up an important point. When one decides to create an alternative position, he needs to decide whether to take from stocks, bonds, or some of both to create the position. QSPIX, and most of the alternatives discussed here, are expected to have equity like returns with about half the volatility of equities. If one takes from the equity side of the portfolio, expected returns stays about the same, portfolio volatility should decrease, Sharpe ratio increase. If one takes from the bond side of the portfolio, Expected returns increases, volatility increases, Sharpe ratio should also increase. Of course one can also take a bit from both stocks and bonds to create the position as well. Rather than viewing the alternative as stock or bond, I think it is better to view the portfolio as a whole, and consider the potential effect of the new alternative position on the portfolio as a whole.

Dave

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by grok87 » Sat Nov 18, 2017 8:28 pm

randomguy wrote:
Sat Nov 18, 2017 2:55 pm
grok87 wrote:
Sat Nov 18, 2017 1:58 pm
Agree with others concern about the amount of leverage aqr is using in its alternative funds

Qspix for example is levered 6.9:1

https://funds.aqr.com/-/media/files/fun ... s/spaf.pdf

That means for every $1 you give them they make $6.90 worth of bets, $3.7 worth on the long side and $3.2 worth on the short side.

Yikes!

That means if the average bet the fund makes declines by just 15% the fund will be wiped out.
A 100% market decline will also wipeout a long only fund with no leverage. :) The difficulty is figuring out what the likelyhood of a 15% decline of their average bet is. We all know that 15% market declines are common. How often do you have a 15% decline when your hedged 3.7:3.2? And then instead of just having all the bets in one sector spread theym out among stocks, bonds, currency, and the rest.

You can read the papers and go those type of declines will not happen. The risk is they missed something and that unexpected risk wipes out the fund.
thanks
i've had a look at some of the papers. the current stable of funds has not been around very long. a lot of the analysis is back-tested
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by grok87 » Sat Nov 18, 2017 9:09 pm

lack_ey wrote:
Sat Nov 18, 2017 3:45 pm
whodidntante wrote:
Sat Nov 18, 2017 3:21 pm
grok87 wrote:
Sat Nov 18, 2017 2:10 pm
whodidntante wrote:
Sat Nov 18, 2017 1:03 pm
I hold two AQR funds and I'm surprised at how well they are performing in this "melt-up" environment. As you pointed out, that's not really the environment where you expect to be glad you own them.
It's a subtle sign, i think, that the aqr funds actually do have more stock market beta exposure than they are letting on, driven i think by their use of leverage.
Your hunch may prove correct. We'll know for sure after the next bear market.
In which sense?

I don't really see it in the data so far:
https://www.portfoliovisualizer.com/fac ... sion=false
https://www.portfoliovisualizer.com/ass ... ingDays=60

By design Style Premia and Equity Market Neutral should be close to equity market neutral.

There are a lot of risks but I don't think it's about equity market beta. A market disruption combined blowing up even-more-leveraged funds doing similar things and then some resulting contagion, positions simultaneously going bad, etc. would be the real test.
thanks. that portfolio visualizer is a pretty cool tool.

the trouble is that beta's are not stable. i agree with your point that right now QSPIX looks pretty uncorrelated to the stock market, i.e. low or zero beta. It does have a lot of leverage though. so one question is: if we get into a financial or other crisis, would its beta change?

One way to examine this is to look at how some of the more leveraged S&P industry sectors responded to the financial crisis. I ran the portfolio visualizer tool for some of the SPDR sector ETFS with the stock market = US for 3 periods:
1) 1999-2006
2) 2007-2010 (i.e. financial crisis)
3) 2010 - present

A) XLF (financials)
1) 1999-2006:............................beta=0.75, alpha =4.1%
2) 2007-2010 (i.e. financial crisis)...beta=1.56,, alpha = -13.7%
3) 2010 - present........................beta=1.19, alpha = -2.9%

B) XLK (tech)
1) 1999-2006:............................beta=1.81, alpha =6%
2) 2007-2010 (i.e. financial crisis)...beta=1.04, alpha = 4.7%
3) 2010 - present........................beta=0.98, alpha = 1.6%

Financials are the most leveraged sector and Tech one of the least leveraged. So during the financial crisis the beta of financials increased rather dramatically while the beta of tech dropped.

Now its tempting perhaps to attribute the financials increased beta to some sort of unique issue they had during the crisis. So let's look at utilities, another highly leveraged sector:

C) XLU (utilities)
1) 1999-2006:............................beta=0.31, alpha =3.2%
2) 2007-2010 (i.e. financial crisis)...beta=0.60, alpha = -0.36%
3) 2010 - present........................beta=0.24, alpha = 8.07%

So we see the same increase in beta during the financial crisis for a the highly leveraged utilities sector.

Leverage is all good fun in normal low-volatility times like the present. We'll see what happens i guess when markets sell off and volatility spikes.
"...people always live for ever when there is any annuity to be paid them"- Jane Austen

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sat Nov 18, 2017 9:50 pm

grok87 wrote:
Sat Nov 18, 2017 9:09 pm
thanks. that portfolio visualizer is a pretty cool tool.

the trouble is that beta's are not stable. i agree with your point that right now QSPIX looks pretty uncorrelated to the stock market, i.e. low or zero beta. It does have a lot of leverage though. so one question is: if we get into a financial or other crisis, would its beta change?

One way to examine this is to look at how some of the more leveraged S&P industry sectors responded to the financial crisis. I ran the portfolio visualizer tool for some of the SPDR sector ETFS with the stock market = US for 3 periods:
1) 1999-2006
2) 2007-2010 (i.e. financial crisis)
3) 2010 - present

A) XLF (financials)
1) 1999-2006:............................beta=0.75, alpha =4.1%
2) 2007-2010 (i.e. financial crisis)...beta=1.56,, alpha = -13.7%
3) 2010 - present........................beta=1.19, alpha = -2.9%

B) XLK (tech)
1) 1999-2006:............................beta=1.81, alpha =6%
2) 2007-2010 (i.e. financial crisis)...beta=1.04, alpha = 4.7%
3) 2010 - present........................beta=0.98, alpha = 1.6%

Financials are the most leveraged sector and Tech one of the least leveraged. So during the financial crisis the beta of financials increased rather dramatically while the beta of tech dropped.

Now its tempting perhaps to attribute the financials increased beta to some sort of unique issue they had during the crisis. So let's look at utilities, another highly leveraged sector:

C) XLU (utilities)
1) 1999-2006:............................beta=0.31, alpha =3.2%
2) 2007-2010 (i.e. financial crisis)...beta=0.60, alpha = -0.36%
3) 2010 - present........................beta=0.24, alpha = 8.07%

So we see the same increase in beta during the financial crisis for a the highly leveraged utilities sector.

Leverage is all good fun in normal low-volatility times like the present. We'll see what happens i guess when markets sell off and volatility spikes.
Leverage in a fund is not like leverage in stocks, though.

You've demonstrated that higher leverage for a stock can be riskier, with this being problematic in a financial crisis with a credit crunch. If there's more issued debt there's an increasing sensitivity to changes in market prospects, as companies are closer to the edge of some really bad trouble when things go wrong.

What you need to do is relate that to the components of a long/short equity portfolio and same for the other assets. A leveraged fund behaves as the underlying holdings do, just as an unleveraged fund. It just has larger notional exposures, so greater swings, and some path dependency based on shifting leverage ratios over time based on asset appreciation and depreciation, and depending on how quickly the manager makes trades to alter the exposures.

In fact your argument is backwards if anything—it's the more leveraged stocks that tend to be the opposite of defensive, so QSPIX is generally shorting those and those sectors.

The point you should be making is that the currency carry trade tends to do poorly in a crisis.

That said, you're right in pointing out that asset relationships and properties do change, particularly under market stress. It could be that the equity market beta changes, though the equity component at least is explicitly managed to calculate and adjust holdings over time to maintain around market neutral exposure (0 beta, not equal long and short in dollars). But I think you either have a reading here that doesn't follow or maybe I'm misunderstanding something.

I think it's more likely that some of these funds could lose substantial money during a crisis even without market beta markedly increasing. There are plenty of underlying exposures that could lose money.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by nedsaid » Sun Nov 19, 2017 1:52 am

garlandwhizzer wrote:
Sat Nov 18, 2017 5:04 pm
matjen wrote:
What is interesting to me is that we haven't even entered an environment where these types of funds should really shine. When we do, if they perform as expected AQR will explode. If they falter and prove no/little better than beta then major trouble.
1+

I don't think there's any doubt that AQR is run by brilliant and knowledgeable students of the market, particularly with respect to factor investing and alternate investment strategies. The fund success they've had in some areas up to this point implies that in those arenas they either have had more skill or more luck in handling these rather complex strategies than competitors. This is, however, a growing and competitive arena of operation as money pours in. Time will answer a number of questions. Are they skillful or merely lucky? Will their success become capacity restrained? And finally, is it worth the extra cost relative to beta or less complex strategies?

At this point, I'm on the sidelines watching.

Garland Whizzer
Garland, were I a client of Larry Swedroe's firm, I would probably dedicate 20% of my portfolio to such alternative funds. It is the old Nedsaid philosophy of trying to solve portfolio volatility by throwing asset classes at it. There is a part of me that likes to venture out and try new things.

But I am not a Swedroe client, and the Independent Broker (broker #4) who works with me on about 30% of my portfolio, is pretty much a plain vanilla type of investor. Plus I have a lot of clutter in my portfolio, which truthfully looks a lot like my work desk, and I don't really need any more. Heck, I have tried a lot of things and probably would like to try more.

No question Cliff Asness is a very bright guy. Probably what I would do is invest in 3-4 alternative strategies, with the hope that all four couldn't fail simultaneously. But I don't know, markets have a way of finding a chink in the armor. Maybe I am a bit fatalistic, but sooner or later you as an investor will get totally hosed in the market, best to wait out market insanity and allow time for prices to return to normal. We all want that magic diversifier that will do great when everything else does poorly. But even diversification doesn't seem to work 100% of the time. In really bad markets, the only thing that increases is correlation.

So I don't know. How I feel about this probably depends upon which side of the bed I woke up on and my mood for that day. I have been known to be wishy-washy. When faced with a choice, I have often said YES!!! and my portfolio and my waistline show the effects. Apple pie or pumpkin pie???YES!!! Vanilla Ice Cream or Chocolate Ice Cream??? Yes!!! London or Paris??? Yes!!! In some ways, I am just not too disciplined.

Individual stocks or mutual funds? Yes!!! Index funds or active funds? Yes!!! No-load or Loaded funds? Yes!!! Index funds or ETFs? Yes!!! I suppose I could be caught in a weak moment and buy such alternative funds as well. I think I need to find a support group. ;o)
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by grok87 » Sun Nov 19, 2017 8:09 am

lack_ey wrote:
Sat Nov 18, 2017 9:50 pm
Leverage in a fund is not like leverage in stocks, though.
Interesting point. I'll give it some thought...
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Robert T » Sun Nov 19, 2017 8:25 am

.
Stocks = Beta + non-beta factors + rf

Alternatives (AQR style premia) = Non-beta factors + rf

The greater your tilt to non-beta factors in stocks (such value, momentum, quality/defensive), the higher the correlation with alternatives that target a tilt to non-beta factors (such as value, momentum, quality/defensive). This implies some substitution.

If you have a specific target for non-beta factors at portfolio level you can achieve this through tilting your equity portfolio (at low cost), or using alternatives (at higher cost). Obviously its not a perfect substitution, but often examples are shown of adding non-beta factor tilted alternatives to a market portfolio. The benefits would be lower if added to an already factor tilted stock portfolio. A more apples to apples comparison would be to compare a market + factor tilted (zero beta) alternatives portfolio to a market + factor tilted equities portfolio – or at least to compare portfolios with more similar overall factor loads (whether achieved through equity tilts vs. alternatives).

Robert
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by midareff » Sun Nov 19, 2017 9:16 am

Random Walker wrote:
Sat Nov 18, 2017 7:37 pm
Midareff,
I think it is incorrect to consider market neutral QSPIX part of an equity allocation. It invests in four styles across at least four asset classes. The styles are value, Momentum, carry, defensive. And the asset classes are equities, bonds, commodities, currencies I think. The styles within the fund are generally uncorrelated with each other, and the fund should be uncorrelated with both stocks and bonds.
Now you do bring up an important point. When one decides to create an alternative position, he needs to decide whether to take from stocks, bonds, or some of both to create the position. QSPIX, and most of the alternatives discussed here, are expected to have equity like returns with about half the volatility of equities. If one takes from the equity side of the portfolio, expected returns stays about the same, portfolio volatility should decrease, Sharpe ratio increase. If one takes from the bond side of the portfolio, Expected returns increases, volatility increases, Sharpe ratio should also increase. Of course one can also take a bit from both stocks and bonds to create the position as well. Rather than viewing the alternative as stock or bond, I think it is better to view the portfolio as a whole, and consider the potential effect of the new alternative position on the portfolio as a whole.

Dave
I suspect you are right Dave... OTOH, these things work until the day they don't. I'll muddle through somehow with plain old vanilla equity and bond index funds.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by AlohaJoe » Sun Nov 19, 2017 10:21 am

jhfenton wrote:
Sat Nov 18, 2017 9:28 am
When AQR funds are widely available to retail investors at reasonable minimums, wake me up. Until then, they might as well be DFA or Stone Ridge. They don't exist in my non-advisor retail investor world.
While I empathise with the underlying sentiment...Since AQR is a sorta-passive-kinda place, their main selling point IMHO is a (relatively) transparent rules-based strategy. Which other people should, in theory, be able to offer as well. (Though the continued inability of others to provide cost-competitive offerings casts some doubt on that hypothesis....)

You can go buy WDTI (WisdomTree Managed Futures Strategy Fund) which
  • Has no minimums, unlike AQR
  • Has an ER of 0.65%
  • Doesn't use leverage
I suppose one could argue that WisdomTree's managed futures is "wrong" and AQR's is "right"? I don't actually know enough about managed futures to say one way or another. The WisdomTree fund is basically never discussed on Bogleheads so I'm not sure.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sun Nov 19, 2017 11:19 am

AlohaJoe wrote:
Sun Nov 19, 2017 10:21 am
jhfenton wrote:
Sat Nov 18, 2017 9:28 am
When AQR funds are widely available to retail investors at reasonable minimums, wake me up. Until then, they might as well be DFA or Stone Ridge. They don't exist in my non-advisor retail investor world.
While I empathise with the underlying sentiment...Since AQR is a sorta-passive-kinda place, their main selling point IMHO is a (relatively) transparent rules-based strategy. Which other people should, in theory, be able to offer as well. (Though the continued inability of others to provide cost-competitive offerings casts some doubt on that hypothesis....)

You can go buy WDTI (WisdomTree Managed Futures Strategy Fund) which
  • Has no minimums, unlike AQR
  • Has an ER of 0.65%
  • Doesn't use leverage
I suppose one could argue that WisdomTree's managed futures is "wrong" and AQR's is "right"? I don't actually know enough about managed futures to say one way or another. The WisdomTree fund is basically never discussed on Bogleheads so I'm not sure.
I would argue that WisdomTree's managed futures is wrong, sure, or at least worse.

Its weighting to fixed income is a bit low, only using US Treasury futures, and it doesn't use equities. The latest fact sheet shows 19 holdings either long or short or a currency pair contract, other than a few T-bills to manage the cash. AQR has 48 long holdings, 24 short holdings, and 47 currency pairs. That's not automatically better, but for a quant strategy I would rather take more bets. Wouldn't you?

The WisdomTree fund uses a very simple composite signal based on 3-month, 6-month, and 12-month trends (each coded as binary +/-1 based on up or down) to determine investment. It screens out the more volatile instruments. AQR on the other hand just uses volatility of components to adjust relative and absolute overall position sizes, allowing a larger investment universe, being able in theory to capitalize on more trends. They scale position sizes up and down to keep relatively steady volatility over time, which could sometimes mitigate against large crashes or gains during market turbulence.

An even bigger issue with the WisdomTree fund is that it does allocation based on nominal dollars rather than scaling by risk. Even though it uses commodities, currencies, and rates, it's currently got $90.6M notional in commodities positions relative to $55.3M for currencies and rates. And it uses about an equal amount in most commodities, irrespective of differing underlying volatility. Thus, performance is dragged around more by whichever components are more volatile, rather than taking a more balanced set of bets.

AQR on the other hand uses a number of related signals based on what the research suggests that go beyond just X-month price changes, and also attempts to identify potential reversals of trends. That said, some might prefer the simplest, by-the-books implementation and think of these adjustments as a net negative.

The WisdomTree fund is an index fund doing monthly updates to track the index. The non-index funds have greater flexibility in trading and could reduce costs there as well as pick up on changes within a month.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by long_gamma » Sun Nov 19, 2017 11:35 am

Add to the above reply, WDTI does have some weird rules like not shorting energy components (just long only).
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Random Walker » Sun Nov 19, 2017 12:02 pm

Hi Robert,
Not sure I completely understood your point. Are you saying one should compare a cheaper long only tilted equity portfolio with a portfolio of equal non market factor exposure that uses some of these more expensive market neutral alternatives? Wouldn’t the portfolio using alternatives have less exposure to market beta? Isn’t that the purpose of the alternatives, to diversify away from market beta? The way I see it, the cheapest way to get factor exposure is by tilting with long only funds. But with this approach, one only adds more tilt by also adding more market beta. Although the Market neutral funds are way more expensive, they are offering something unique. They offer pure exposure to factors without increasing market beta exposure. For almost all of us with basically long only equity portfolios where most all the risk is already wrapped up in market beta, the extra cost of pure factor exposure without the extra market beta exposure could potentially be worth it. Thanks,

Dave

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Random Walker » Sun Nov 19, 2017 12:11 pm

Midareff,
I agree there is absolutely nothing wrong with your approach, and lots that is right! The best and cheapest diversifier of equity risk is high quality bonds. As we add complexity to our portfolios with relatively small allocations to the esoteric stuff, marginal benefit decreases and marginal cost increases. Moreover, costs are certain and the potential benefits are just that, only potential. That being said, I’ve sort of taken the dive and turned into a factor junkie.

Dave

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Robert T » Sun Nov 19, 2017 2:44 pm

Random Walker wrote:
Sun Nov 19, 2017 12:02 pm
Not sure I completely understood your point.
Dave,

Let me try a simple illustration –

P1 = total market (beta load = 1, value load = 0)
P2 = long only value fund (beta load of 1, value load = 0.43)
P3 = long/short value fund (beta load = 0, value load = 1)
P4 = t-bills

Overall portfolio factor load targets:

Beta = 0.7
Value = 0.3

You can achieve this by:

70% P1 + 30% P3, or
70% P2 + 30% P4

The portfolio beta (and value) loads are the same. In this case achieving the overall portfolio factor tilt target with the long only value portfolio plus t-bills is likely cheaper than with the market portfolio + the long/short value fund.

Obviously we each need to decide, at portfolio level, how much exposure we want to each factor, then construct a portfolio to achieve this at lowest cost.

Even if you have a larger value load target than in the above example, it seems to make little sense to consider adding a long/short value fund (P3) unless you are unable to achieve your portfolio beta and value load targets with the most extreme long-only value tilt.

Robert
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Random Walker » Sun Nov 19, 2017 3:32 pm

Robert,
Thanks for that excellent explanation. Wouldn’t P2,4 be a superior choice to P1,3? I agree P2,4 would almost certainly be cheaper. Wouldn’t P2,4 also be more efficient? P1,3 and P2,4 have same exposures to market beta and value. But P2,4 does this with 30% risk free T-bills. P2,4 would have same expected return as P1,3, but I would expect over time we would see smaller big drawdowns and greater geometric return for P2,4. This seems especially true since not only are bonds generally uncorrelated with market beta, when equities tank, the correlation tends to go negative. To me P2,4 seems like a better portfolio at lower cost. Thanks for the explanations.

Dave

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sun Nov 19, 2017 3:57 pm

Clearly the long/short fund incurs more frictions and costs (don't forget borrowing costs on shorting stocks), and in practice also charges higher management fees, so in this scenario it is clear which way you should go.

If all you want is equity factors, use the long-only funds unless they're insufficient to meet the target loads. Actually, if not, it may even be worth selecting and maintaining a basket of stocks yourself to get more concentrated exposure.

But with the AQR funds and some other alts you're getting exposures to strategies outside of equities as well. That can't be replicated with equity factors. So the extra cost does get you something, whether or not it is actually worthwhile.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by stlutz » Sun Nov 19, 2017 5:16 pm

P2,4 would have same expected return as P1,3
I think that's only the case if the T-bill rate is zero. Otherwise the long-only portfolio has higher returns because it's getting the T-Bill interest.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sun Nov 19, 2017 5:19 pm

stlutz wrote:
Sun Nov 19, 2017 5:16 pm
P2,4 would have same expected return as P1,3
I think that's only the case if the T-bill rate is zero. Otherwise the long-only portfolio has higher returns because it's getting the T-Bill interest.
The long/short portfolio also gets T-bill interest. If it is net zero invested, that means it's sitting on cash.

It just also has shorting costs, greater trading costs, and so on.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Robert T » Sun Nov 19, 2017 7:11 pm

lack_ey wrote:
Sun Nov 19, 2017 3:57 pm
But with the AQR funds and some other alts you're getting exposures to strategies outside of equities as well.
This is true, and QSPIX has performed well since inception.

Would however also note the findings from the paper on Value and Momentum Everywhere by Asness et al. http://pages.stern.nyu.edu/~lpederse/pa ... ywhere.pdf

“The results indicate that value and momentum returns in one market are strongly related to value and momentum returns in other markets and asset classes.” Eight markets are included in the analysis leading to this conclusion - U.S. stocks, U.K. stocks, Europe stocks, Japan stocks, country index futures, currencies, government bonds, commodities.

In addition, the 40 percent drawdown in the simulated style premia series in the late 1990s seems consistent with the large negative value premium in equities at that time.

Chart from: http://www.sjcera.org/Pages/content/age ... 160325.pdf

Image

Robert
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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sun Nov 19, 2017 8:00 pm

Robert T wrote:
Sun Nov 19, 2017 7:11 pm
lack_ey wrote:
Sun Nov 19, 2017 3:57 pm
But with the AQR funds and some other alts you're getting exposures to strategies outside of equities as well.
This is true, and QSPIX has performed well since inception.

Would however also note the findings from the paper on Value and Momentum Everywhere by Asness et al. http://pages.stern.nyu.edu/~lpederse/pa ... ywhere.pdf

“The results indicate that value and momentum returns in one market are strongly related to value and momentum returns in other markets and asset classes.” Eight markets are included in the analysis leading to this conclusion - U.S. stocks, U.K. stocks, Europe stocks, Japan stocks, country index futures, currencies, government bonds, commodities.
They're strongly related in a statistical sense with high confidence (t values, whatever), but not so strongly related that there's little potential diversification benefit. Also, I don't think the defensive strategies are as related across asset classes, and something like AQR style premia has carry strategies as well, which are not really a distinct thing in equities, at least under the usual definitions.
Robert T wrote:
Sun Nov 19, 2017 7:11 pm
In addition, the 40 percent drawdown in the simulated style premia series in the late 1990s seems consistent with the large negative value premium in equities at that time.

Chart from: http://www.sjcera.org/Pages/content/age ... 160325.pdf

Image
Yes, and apparently with the defensive style not doing so well at the same time there.

Of course there's a notable relationship between value and momentum in equities and the fund relationship.

There's also a whole lot else driving returns, or else the fund can't return 37% cumulative in four years (and double digits the institutional version did with live trading the year before the mutual fund launched) over which the value factor and momentum factor in equities were hardly having their best days. If you run a global 4-factor regression on fund returns, which includes obviously market, value, and momentum, so far that's an unadjusted R^2 under 0.28.

Maybe the fund produces -5% p.a. alpha above equity factors for the next 10 years, or it goes along kind of like before. Either way, it's not really like equity tilts, for better or worse.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by AlohaJoe » Sun Nov 19, 2017 10:54 pm

lack_ey wrote:
Sun Nov 19, 2017 11:19 am
I suppose one could argue that WisdomTree's managed futures is "wrong" and AQR's is "right"? I don't actually know enough about managed futures to say one way or another. The WisdomTree fund is basically never discussed on Bogleheads so I'm not sure.
I would argue that WisdomTree's managed futures is wrong, sure, or at least worse.
This is very possibly true -- keep in mind my disclaimer that I don't know what I'm talking about when it comes to trend following! -- but my understanding is that the foundational academic research on trend following from AQR is based on a very simple index strategy:

"We create a time series momentum strategy that is simple, without many of the often arbitrary choices of more complex models. Specifically, we construct an equal weighted combination of 1-month, 3-month and 12-month time series momentum strategies for 67 markets across four major asset classes — 29 commodities, 11 equity indices, 15 bond markets and 12 currency pairs"

And a lot of the time someone makes a decision to include trend following it is based on things like "based on a backtest using AQR's data, a 60/30/10 portfolio outperformed/had a higher SWR/came with a pony".

It seems to me that if you believe the research and there is a cheap, widely available "good enough" fund then you should buy it instead of being sad that you don't have access to a (potentially) even better variation of the strategy.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Sun Nov 19, 2017 11:09 pm

AlohaJoe wrote:
Sun Nov 19, 2017 10:54 pm
This is very possibly true -- keep in mind my disclaimer that I don't know what I'm talking about when it comes to trend following! -- but my understanding is that the foundational academic research on trend following from AQR is based on a very simple index strategy:

"We create a time series momentum strategy that is simple, without many of the often arbitrary choices of more complex models. Specifically, we construct an equal weighted combination of 1-month, 3-month and 12-month time series momentum strategies for 67 markets across four major asset classes — 29 commodities, 11 equity indices, 15 bond markets and 12 currency pairs"

And a lot of the time someone makes a decision to include trend following it is based on things like "based on a backtest using AQR's data, a 60/30/10 portfolio outperformed/had a higher SWR/came with a pony".

It seems to me that if you believe the research and there is a cheap, widely available "good enough" fund then you should buy it instead of being sad that you don't have access to a (potentially) even better variation of the strategy.
The simpler strategy, just X-month trend, sure. It's like multiple value factor definitions or anything else—any given variant may or may not be better going forward, though some maybe make a little more sense (for example, using multiple price/fundamentals definitions rather than using the academic standard book/market from Fama and French).

The much bigger deal to me is the position sizing and investment universe on the WisdomTree index ETF. There are so many differences it's not in the ballpark and not that appealing.

And furthermore you get lower gross investment with the lower fee here. As one imperfect illustration, let's say you were comparing active bond managers, with manager A charging 0.4% and manager B charging 0.6%. Manager A invests 50% of assets in the Vanguard total bond market index fund and makes bets with the rest. Which is actually more expensive?

Then there's effectively a cost for using an index fund with monthly updates in this kind of space.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Robert T » Mon Nov 20, 2017 5:08 am

lack_ey wrote:
Sun Nov 19, 2017 8:00 pm
There's also a whole lot else driving returns, or else the fund can't return 37% cumulative in four years (and double digits the institutional version did with live trading the year before the mutual fund launched) over which the value factor and momentum factor in equities were hardly having their best days.
If you take 50% FF Global Equity Value premium and 50% FF Global Equity Momentum premium and leverage 3+ times you get the same cumulative increase as AQR style premia since start of 2013 to Oct. 2017. There have been large monthly and annual return differences but similar cumulative returns over the full period.

Obviously no guarantees.

Robert
.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Mon Nov 20, 2017 11:44 am

Robert T wrote:
Mon Nov 20, 2017 5:08 am
lack_ey wrote:
Sun Nov 19, 2017 8:00 pm
There's also a whole lot else driving returns, or else the fund can't return 37% cumulative in four years (and double digits the institutional version did with live trading the year before the mutual fund launched) over which the value factor and momentum factor in equities were hardly having their best days.
If you take 50% FF Global Equity Value premium and 50% FF Global Equity Momentum premium and leverage 3+ times you get the same cumulative increase as AQR style premia since start of 2013 to Oct. 2017. There have been large monthly and annual return differences but similar cumulative returns over the full period.

Obviously no guarantees.

Robert
.
This result heavily driven by ex-US stock momentum in raw factor data in 2013. How much of equity factor momentum are you actually able to capture in these markets after trading, especially given that more of the momentum is in small caps? Which funds are cheaply accessing equity momentum to a significant degree?

Some years I do think you see a large relationship between the value+momentum returns and the fund, like in 2016 when global value was significantly positive, global momentum negative but not quite as much, and the fund gained slightly, with carry and defensive being net close to 0 on the year.

Anyway, it seems like if you regress the fund on the value and momentum equity factors, you end up with loadings likely well below 1, not something like 1.5. That also seems to make sense based on the gross exposures in the fund.

Getting both value and momentum loadings simultaneously that high, or even significant across a whole equity allocation (at least 0.25 and 0.25, let's say), seems difficult, especially without generating some negative alpha along the way.

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Robert T » Tue Nov 21, 2017 8:00 am

.
Another point not really touched on in this thread is taxes.

According to M*, since inception of QSPIX:

Pre-tax return = 8.21%
After-tax return = 5.71%
Tax cost = 2.50%

So adding expense ratio (1.50%) + tax cost (2.50%) = 4.00%

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by Theoretical » Tue Nov 21, 2017 8:50 am

As a point of contrast, here's Vanguard's Market Neutral fund:

Code: Select all

Since Inception
(10/31/2017)
Pretax Return	 	 	 	 	 	 	 	 	 	 
VMNFX	0.68	-0.59	-1.66	-4.11	1.06	1.43	3.28	0.78	1.39	2.73
Tax-adjusted Return *	 	 	 	 	 	 	 	 	 	 
VMNFX	0.68	-0.59	-1.66	-4.11	0.90	1.37	3.23	0.41	1.02	2.15
% Rank in Category	22	73	74	84	69	36	13	57	64	—
Tax Cost Ratio	 	 	 	 	 	 	 	 	 	 
VMNFX	—	—	—	—

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Re: Morningstar - AQR: The Vanguard of Alternative Investing?

Post by lack_ey » Tue Nov 21, 2017 11:13 am

Robert T wrote:
Tue Nov 21, 2017 8:00 am
.
Another point not really touched on in this thread is taxes.

According to M*, since inception of QSPIX:

Pre-tax return = 8.21%
After-tax return = 5.71%
Tax cost = 2.50%

So adding expense ratio (1.50%) + tax cost (2.50%) = 4.00%

Robert
.
For sure, this is tax-advantaged space only. Though given the usual fund minimums, without advisor access you're likely only able to invest in an IRA anyway...

Some would have a lower tax cost than Morningstar calculates, though if you have enough assets to make an advisor worthwhile or be able to actually meet $1 million minimums yourself, you're probably in a high tax bracket.

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