Know Your Audience

AQR is arguably one of the top fund firms in the world right now. They manage over $170 billion in a wide variety of quantitative investment strategies. They are able to marry financial research with real-world investible strategies as good as anyone in the marketplace.

While they began as a hedge fund firm that catered to mostly institutional and high net worth investors, they have diversified their business model over the past decade by rolling out a number of liquid alt and factor-based mutual funds.

One of their more impressive offerings is the AQR Style Premia Alternative Fund (ticker: QSPIX). This strategy seemingly has it all. It invests across four different academically-researched factors — value, momentum, yield and low volatility — in a variety of different markets — stocks, bonds, currencies and commodities.

The fund has little-to-no exposure to market beta because this is a market neutral approach (so it goes both long and short and thus hedges out market exposure) which utilizes some leverage and a sophisticated volatility-based weighting system. They also target certain risk-adjusted return parameters and offer two fund classes in terms of how much volatility the fund targets.

The goal, as it is with all alternative investments, is to create a return stream that is uncorrelated with more conventional stock and bond performance.

In terms of finance theory, academic research and portfolio construction, this fund would seem to have just about everything an investment nerd could ask for (although it is currently closed to new investors).

When looking at a fund offering like this the first question that comes to mind is this: who would this fund be suitable for?

At our conference a couple weeks ago we had Larry Swedroe speak on a panel about the death (or lack thereof) of the 60/40 portfolio. Swedroe brought up this fund in particular when discussing the need for balancing out complexity and simplicity in a portfolio:

There is no one right portfolio for everybody. The right portfolio is the one you are most likely to to stick to or adhere to, rebalance and sleep well.

A good advisor tailors the portfolio not just to all of the academic research, but tailors to what the client is going to be able to stick with.

We approve, for example, and use AQR’s Multi-Style Premia Fund and Managed Futures Fund. But I tell people I think 80% of our clients maybe shouldn’t have it, because they won’t understand it and it will go through say three, four, five year periods of underperforming and then they’ll bail out.

You do your client a great disservice if you put them in something they don’t understand.

This is something many practitioners in the finance industry fail to grasp. Having the right investor can be more important than having the right investment. Even the best investment strategy isn’t always the correct one.

I get questions on a regular basis from investors who ask about unconventional investments beyond the more traditional strategies most are accustomed to. My advice is that the strategy itself doesn’t matter nearly as much as your ability to understand exactly what you’re getting yourself into.

Even then you must have more than a cursory knowledge about how certain strategies intereact with other investments in terms of an overall portfolio structure. The final piece of the puzzle is, of course, staying invested in whatever alternative structure you choose.

And if you’re an advisor, it goes far beyond understanding a fund or process yourself; you also have to be able to explain it to your clients, set reasonable expectations for what it can or cannot do and, most importantly, know your clients well enough to gauge whether they have the ability to stick with it or not.

Rule number one is to know thyself as an investor. If you’re doling out investment advice, it’s just as important to know thy client.

Further Reading:
Managing Someone Else’s Emotions