HEDGE FUNDS

‘The next Bridgewater’

AQR is taking the institutional world by storm; goes from $1 billion to $25 billion in eight years

GREENWICH, Conn. — In just eight years, AQR Capital Management LLC has become a darling of the institutional world, with $25 billion under management to prove it.

AQR's assets under management grew 65% last year, to $20 billion. Last year, AQR won mandates of $200 million or more each from the likes of the $210 billion California Public Employees' Retirement System, the $52.2 billion Minnesota State Board of Investment and the $54.8 billion Public School Employees' Retirement System of Pennsylvania.

The firm has snared another $5 billion so far this year, including a subadvisory mandate of A$3.95 billion (US$3 billion) in core global equities from BT Financial Group Pty. Ltd., Sydney. And the new business pipeline is bursting for the rest of the year.

AQR's meteoric rise prompted one consultant who requested anonymity to call the firm "the next Bridgewater." Bridgewater, like AQR, has benefited hugely from portable alpha strategies. Bridgewater closed its alternative investment funds except to portable alpha clients last year (Pensions & Investments, Dec. 12) and managed $160 billion as of May 1.

But unlike Bridgewater, which took 20 years to reach its current size, AQR seemed destined from the outset to succeed. Clifford S. Asness, Robert J. Krail and John M.S. Liew got their doctorates together at the University of Chicago and went on to join Goldman Sachs Asset Management in New York, where they worked in the quantitative research group. Mr. Asness was managing director and director of research; Mr. Krail was vice president, portfolio manager, and developed global stock selection models; Mr. Liew was a vice president and developed global asset allocation models.

The trio managed $7 billion in hedge fund and other strategies when they left to form AQR. They brought with them David G. Kabiller, vice president, pension services group at parent Goldman Sachs & Co., New York.

The roles of the founders, who all carry the title of founding principal (except for Mr. Asness, who also is managing principal), haven't changed since their Goldman days, Mr. Kabiller said. Mr. Asness also serves as chief executive/chief investment officer. Mr. Kabiller heads business development.

Opened with $1 billion

AQR opened March 31, 1998, with $1 billion. It could have started with $2 billion, but Mr. Kabiller said the firm's principals were cautious about accepting too much too soon. Although AQR is often considered primarily a hedge fund shop, the firm actually manages $17 billion in long-only strategies — mainly in international equities — compared with $8 billion in hedge funds. Mr. Kabiller expects growth in long-only strategies to continue to outpace that of hedge funds.

The key to success has been AQR's business model.

Mr. Kabiller said AQR is totally committed to employee ownership, with a deliberate program of new partner creation, he said. The approach seems to be working: The firm has lost none of its senior investment staff.

"The goal was to bring together a world-class group of thinkers and let them figure out how to outsmart the collective wisdom of the market. It's money management in a research think tank that delivers alpha however the client needs it," he said.

AQR's research emphasis borders on the obsessive: With so many Ph.D. holders on staff, there is a huge amount of interest in the academic side of finance, Mr. Kabiller said.

It's that marriage of business savvy from their days at Goldman Sachs and technical understanding of academic finance that has made AQR "such a terrific business. I am a big fan," said Andrew Lo, Harris & Harris group professor and director of the MIT Laboratory for Financial Engineering in the Sloan School of Management at Massachusetts Institute of Technology, Cambridge, Mass.

"I think Cliff (Asness) is a very unusual combination. He has the technical skills to manage money, but can communicate complex financial ideas intuitively and effectively to an institutional investor audience. With Cliff, it's not about black boxes … he has the technical skill to build them, but instead, he provides an open picture of AQR's investment process, of where alpha is generated and how the assets are being managed," Mr. Lo said.

Best of both worlds

The same investment engines are used for hedge fund, long-only, portable alpha and any other solution a client might need, Mr. Kabiller said. "We're trying to take the best of the hedge fund world and combine it with the stability of a long-only manager. Most hedge funds are like revolving doors. They offer appealing economics, but can't hang onto their people. By offering an ownership stake, we provide employees with a very strong incentive to stay," he said.

The basic investment approach uses quantitative processes to integrate value and momentum investment: in other words, going long on value stocks and shorting growth stocks.

That process is yielding results. Performance data supplied by AQR showed its long-only international equity composite returned an annualized 34.6% for the three years ended March 31, and 13.7% for the five years, vastly outperforming the 24.9% and 2.7% respective returns of the Morgan Stanley (MS) Capital International Europe Australasia Far East index.

As assets have grown, AQR has become pickier about the clients it accepts. "We love innovation and tend to gravitate toward clients that are smart, interesting and have problems we can help them find solutions for. We tend to say ‘no' these days to clients that are smaller or more mundane in what they are seeking from us," Mr. Kabiller said.

That choosiness and a constant drive to improve, impresses consultants at Jeffrey Slocum & Associates Inc., Minneapolis, who have known the AQR team since their Goldman Sachs days, said Texas S. Hemmaplardh, director of hedge fund strategies.

"They've done a great job of diversifying their models and finding new ways to put them to work. They do careful research … have added to their business operations strength and adapted to changing markets," Mr. Hemmaplardh said.