CalPERS made big news today announcing it will end its investments in hedge funds. AQR has long researched and commented on the hedge fund industry and here we reference that body of work to put CalPERS's decision into context.
Many of the current articles that are critical of hedge funds may be giving good advice, but for the wrong reasons.
Cliff argues that certain well-known classic strategies that have worked over the long term will continue to work going forward, though perhaps not at the same level and with different risks than in the past. He focuses on classic “factor”-type strategies, things like value, momentum, carry and quality/defensive.
For me, a good book is one that speaks to something important and that causes me to think differently and more clearly about the chosen topic. My AQR colleague Lasse Pedersen has written just such a book, Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined. (Full disclosure: he extols me as one of many, along with our competitors.) From now on, there are two kinds of investors: the efficiently inefficient ones and the merely inefficient ones who didn’t read this book.
Critics seeking to attack risk parity don't have to go all tin-foil-hat crazy — blaming the strategy for the exceptional market volatility last summer. Instead, they could just do what people usually do, attack recent performance, because risk parity has undeniably been through a tough relative performance period of late. But we still believe in it as an alternative long-term strategic asset allocation that’s typically used to diversify a more traditional equity-dominated allocation.
First, I must issue a disclaimer. This is for wonks already immersed in the factor literature. There's lots of inside baseball, assumed terminology, etc., in this one. I explain what I’m doing along the way, but rarely from scratch. If this stuff is brand new to you and you still understand it all you are way smarter than me (you are allowed to find that to be faint praise). There’s nothing more mathematical here than a regression model but there is lots of shop talk. So, if "factor wonk" doesn't describe you, you probably have friends and a social life, so that’s nice, but this piece won't make much sense (consider it even).