Asness and other AQR partners also observed that many of the strategies being by hedge funds were not unique. Sure, they require skill to execute profitably, but were not entirely distinctive among managers. They could be implemented systematically. At the same time, hedge fund replication strategies were gaining traction among institutions. The rise of this “really dumb idea” – to seek correlated returns with hedge funds in aggregate but not the underlying strategies – was unsettling. The firm leveraged off the trailblazing research by Chicago and Northwestern University professors, Todd Mitchell and Mark Pulvino, who were hired by AQR in 2001, to find ways of running hedge fund strategies systematically and not just replicate returns. Asness, meanwhile, sought to undermine his new adversary. He delivered a presentation entitled: ‘Hedge fund replication: Not everything that can be done should be done’.
The release of hedge fund beta can be seen as AQR’s contribution to the “demystification of hedge fund returns” – a necessary evolution of the hedge fund industry, Asness says. So far, the firm runs $1 billion in its hedge fund beta portfolios, indicating it has also been a smart business move. But Asness still believes in alpha. “I’m not such a cynic that I don’t think there are hedge fund managers with no skill out there. Where I think people like us will have an effect is that over the next five, 10, 20 years, the ability of managers to get paid hedge fund prices for hedge fund beta will change. “There will always be a role for true skill. People like us cannot build a bottom-up portfolio of replicable strategies that approximate someone’s true skill at ferreting out value. I don’t think we’ll eliminate this skill, but I think that over time we’ll eliminate the easy overcharged money.” Hedge fund beta is not Asness and AQR’s attempt to undermine an alternative future. It’s a way of disciplining the industry. “What I would not like to see is a devastated industry that people give up on,” he says.
“No matter what share of it AQR gets, I’d like it to lead to a more realistic industry that divides skill from market beta hedge fund beta, has an idea of where we make money and what we should charge for, and an industry where expectations and fees are more aligned. And that will be a much healthier industry than one that is insanely lucrative for managers but is actually not offering a good deal.” The ‘A’ in AQR is not for ‘Asness’ During our interview, an AQR salesmen accompanying Asness jokes that the founder’s inability to let a good argument go is the biggest threat to the business. But a more realistic threat is one that challenges every successful venture: outliving its founders. Asness has generated research ideas and models for AQR since its inception, and spearheads its ideas in academia and the financial media. He is often attributed much responsibility for its success. “I’m just the biggest ham with the biggest mouth. And I was instrumental in starting it. But that doesn’t mean that losing me would be a disaster,” he says, pausing. “I hate this! It should be a disaster!” At age 43, only five clients have asked him about AQR’s succession plan.