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Thursday, November 15, 2012

AQR's Asness Sings a Song About Risk

Reported by Tommy Fernandez

Investors and portfolio managers need to think more explicitly about the investment risks they take and be sure that they are getting paid appropriately for it, according to Clifford Asness, managing and founding principal of AQR Capital Management.

Asness delivered a lecture on the evolution of asset management, particularly as it relates to evolving ideas about risk, during an educational session at the Schwab Impact 2012 Conference in Chicago.

The presentation was lightheaded and snarky, as Asness poked fun on himself and the industry, and investors changing views on alpha, asset allocation and numerous other subjects.

Examples of his humor: Television interviews are the only time when men can, And should, comfortably wear pancake makeup.

Another zinger was aimed at the high fallutin declarations of some global macro asset managers. "To argue that they are doing something simple and systematic would be a stretch."

Much of the presentation was focused at shaking audience members from the more established so- called commonsensical attitudes about risk. for example, the idea that a portfolio invested 60 percent in equities and 40 percent in bonds is balanced.

Using a variety of pie chart diagrams, Asness showed that a 60/40 portfolio actually translated into something like a 90/10 portfolio with 90 percent of the portfolios risks allocated in stocks.

The first simple tune to Asness' song: don't allocate your portfolio based on dollars, but by risk profiles.

Further, investors need to think about sources of return in a cost effective way, and they need to think about risk more explicitly.

For example, if one asset is three times riskier than another asset, allocating half of a portfolio to each asset is not balanced.

He argued for aiming for equal risk allocations for the categories a manager vests within.

Asness noted that "every mutual fund family in the world often presents a series of recommended portfolios to investors -- but they don't look like this."

Much of the presentation was wonky, and moderately math-heavy, for which Asness frequently apologized.

But at the heart of the wonky presentations were a handful of simple messages, like understand exactly where you get your returns, and how, and be sure they are appropriate for the risk you are taking.

Asness also took potshots at a number of risk neuroses and jargon. For example, he said leverage is not necessarily evil, and it actually less scary than concentration risk, and "you don't get paid for being concentrated."

He also wand against the idea of risk control. That term, he said, carries the unhealthy assumption of always being right. The better way for looking at risk management is preparing for when you'll be wrong.

The discussion also turned to the wide variety of alpha seeking investments popular now, including managed futures and various forms of arbitrage-- which he said is another dirty financial word, a la George Carlin.

He also told investors that you don't need to be heros anymore and stick to a strategy when you're being hammered in the markets. He noted that perhaps the only die hard hero investor is Warren Buffet, who is famous for sticking to an investment like "grim death."

Among Buffet's strong points, which Asness' firm mimicked in an investment model, was finding good quality, cheap and most importantly, stable companies.

"He has stuck through some grim times," Asness said of Buffet 

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