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3 Qualities of an Easy-to-Stick-With Investment

AQR's Cliff Asness digs into why some multifactor quantitative strategies have been struggling.


This article is part of our coverage of the 2019 Morningstar Investment Conference. 

It hasn't been easy to be an investor in some multifactor long-short equity funds lately. These funds attempt to deliver smoother returns than long-only funds and protect against market volatility. For many funds, however, performance hasn't been what many would expect of late.

Take, for instance,  AQR Long-Short Equity (QLENX). The fund shed more than 16% last year and is up less than 1% so far in 2019.

Cliff Asness, managing director and founding principal at AQR, addressed the underperformance during his keynote at the 2019 Morningstar Investment Conference. What could have been a dry, geeky exploration of various factors was instead a timeless lesson about why it's important for investors to fully understand what they own if they want to succeed with a given investment.

Asness began by addressing the obvious: Performance has been, using his word, "crappy." Making money by investing in some uncorrelated factors hasn't been easy the past year or so. Making matters worse, he said, is that when quant strategies lose, there's no simple explanation owing to the complexities and nuances of the multifactor approach.

"People want to understand why," he noted.

Discretionary strategies are easier for investors to understand, Asness argued. When such strategies don't work, they at least have good stories. For instance, when a concentrated stock-picking strategy hits a pothole, the explanation is usually simple and satisfying: A few holdings torpedoed overall returns. Investors may still not be happy with the underperformance, but they at least understand why the investment performed as it did.

Similarly, the performance of single-factor quant strategies--such as value--is easy to grasp: Investors can often see a single factor at play in the market, by following the financial media, or by talking with other investors. They understand why the investment is lagging.

"Sticking with a strategy is easier if you think you get it," Asness observed. And sticking with a strategy is a prerequisite for succeeding with a strategy, he added.

Asness outlined three properties that make particular investment strategies easier to stick with than others.

1) Strategies where the intuition (or at least a good story) about why the strategy wins or loses is easy to understand, such as discretionary strategies, or pure value and other single-factor strategies.

2) Strategies with very high Sharpe ratios--those strategies that never seem to lose money and when they do, it's only for a very brief period. Few strategies fit here, Asness admitted.

3) Strategies that aren't too "maverick." In other words, approaches that are similar to others being practiced and widely held. It's harder to stick with a strategy when it doesn't look like everything else.

According to Asness, multifactor quant investing goes zero for three for the above.

He thinks there's a better way to express what multifactor investing is really about. In reality, those investing in these strategies own a set of characteristics of a diversified portfolio, both long and short. Asness suggests that investors think of it as owning two conglomerates--one with all the long stocks and one with all the short stocks. What you're betting on is the difference in returns between the two diversified conglomerates. And what the characteristics are of those conglomerates impacts the return differential.

Over time, Asness said, combining factors--value, momentum, carry, defensive, volatility--across multiple markets can yield strong long-term results. But investors need to stick with those investments.

"To survive in the long term, brace yourself for the short term," he concluded.

Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.