AQR Capital Management Review

If you are reading my blog you probably already know that I am heavily biased against active management because as a group they add zero value but cost a whole lot in expenses. This is indisputable. A few of them occasionally even muster the courage and intellectual honesty to admit as much, such as in this quote from Jeremy Grantham:

Let’s start with the Investment Industry component. It is so obvious in this business that it’s a zero sum game. We collectively add nothing but costs. We produce no widgets; we merely shuffle the existing value of all stocks and all bonds in a cosmic poker game. At the end of each year, the investment community is behind the markets in total by about 1% costs and individuals by 2%. And the costs have steadily grown. As our industry’s assets grew tenfold from 1989 to 2007, despite huge economics of scale, the fees per dollar also grew. There was no fee competition, contrary to theory.

Obviously such admissions are exceedingly rare. This is more or less equivalent of admitting that the active manager's and his colleagues' life's work is to transfer money from clients to themselves. Which is exactly the truth, of course, but not the sort of thing you say if you wish to continue your racket.

The only hope for an active manager to deny the above to to show that he or she is one of the few who actually delivers good value to his or her customers, unlike the rest of the investment industry. So I am kicking off what may or may not become a regular feature of my blog where I look in detail at performance of one active management shop to see whether its marketing hype lines up with reality.

Today's lucky contestant is AQR Capital Management. AQR funds focus on several strategies, including risk parity, momentum, and several takes on market-neutral, in addition to the usual stock-picking based on fundamentals. AQR is also a prolific publisher of research papers that (surprise!) support these strategies. In my opinion, AQR tries to go much further than an average fund shop to make itself look academically reputable.

So, let's see how AQR funds have actually performed relative to their closest logical passive benchmarks represented by boring Vanguard index funds. The business of benchmark selection for an active portfolio is anything but simple. There simply is no good passive benchmark for, say, merger arbitrage or managed futures strategies. I will do my best to translate all of AQR various strategies to a fair mix of bonds and stocks. Market-neutral and commodity funds will be compared to the total bond market fund. All-equity funds will be compared to 100% stock funds, of the appropriate geographical distribution and/or size. Mixed stock/bond funds, such as "risk parity" ones will be compared to balanced Vanguard funds, namely VBINX, that conveniently matches AQR's own choice of benchmark.

Some benchmarks may end up seeming unfair anyway, I suppose. But when you start with the premise, as I do and think you should too, that only stocks and bonds are worthwhile passive investments (real estate or farmland are not really passive investments) and try to reduce the bewildering multitude of instruments and strategies conjured up by Wall Street to just those two simple groups some "unfair" choices will be made.

To make things simpler and to save myself some time, I did not bother calculating annual returns. I simply compared total returns since inception for all of AQR's funds to total returns of corresponding Vanguard-based benchmarks over the exact same time period. This was possible by the fact that all benchmarks are much older than AQR's funds. AQR may also have already shuttered some older funds that bombed -- a common practice; I don't know if that actually happened and in any case I ignore it. Many of AQR's funds are very new, started in 2012, while a few are from 2009-2010, so the magnitudes of actual and benchmark returns will be all over the place. But all that really matters for us is how each AQR fund fared against its specific benchmark since its inception. Let's look at that in detail:

The table above shows all of AQR's existing funds, their Vanguard-based benchmark as chosen by me and returns for the AQR fund and the benchmark since the AQR's fund's inception and through today, January 13, 2013 as reported by Morningstar.com. The "winner" is highlighted in green color and the "loser" in red for all pairs of AQR funds and their benchmarks. Of course, you should do your own due diligence and come up with more appropriate passive benchmarks if you believe my choices were unfair.

Passive benchmarks beat AQR's funds in 11 out of 18 cases, including 3 out of 3 for AQR's oldest funds based on momentum strategies. This is despite the fact that those old momentum funds' entire existence took place in a very strong bull market, which you would think would be highly beneficial for momentum strategies. I won't try tally up the magnitude by which each benchmark beat its AQR adversary or vice versa. From just glancing at it, it appears that benchmarks that beat AQR funds on average did so by quite a bit more than AQR funds that beat their benchmarks.

The conclusion is that in case of AQR the hype of active management's ability to come up with clever market-beating strategies badly fails to live up to reality. Passive benchmarks easily beat the majority of AQR funds. Only 3 of 18 AQR funds -- ATIMX, AQGIX, and AQIIX beat their benchmarks by what can be confidently called more than a rounding error. If you invest in AQR funds you may want to ponder what exactly you are getting for your money.