The cover of Barron's February 29, 2016 issue features a picture of three founders of AQR, which manages about $141 billion of assets. We are told that AQR "gets impressive returns in good markets and bad." When we turn to the article we are greeted with the headline "Market Brainiacs." Once we start reading we are reminded that big losses were suffered by some of the notable hedge funds since the US stock market peaked in July 2015. The Barron's article goes on to state that "Yet, against his tough backdrop, a bunch of academics are delivering." We are then presented with bar graphs showing that from July 21, 2015 through February 12, 2016 five of the AQR funds outperformed three stock market indexes - the S&P 500, the MSCI World, and the MSCI Emerging.
All well and good, but do seven months really prove anything? Of the five AQR funds featured in the bar graphs, only three had been in existence long enough to have even a three-year track record, and only two had been around long enough to post a five-year record. Sure enough, all five of them beat the S&P 500 over the last year, but the three funds with a three-year record all trailed the S&P 500 over those three years, and all rather significantly. While the S&P 500 gained an average of approximately 10.7% for the three years, one of the featured AQR funds lost approximately 3.5% per year, for an annual difference of about 14.2%, or cumulative difference of approximate 48% in just over three years. And remember this included the superior performance of the last one year. Seems to this observer that the performance in the two prior years must have been quite bad indeed. Does this qualify as an impressive return? And over the prior five years it's even worse. The AQR fund delivered average losses of 1.5% per year, while the S&P 500 return 10.1% per year, for it aggregate difference of about 69%. To me, that's huge.
The only other AQR fund listed in the article which had been around long enough to generate a five-year record returned about 4.2% per year. But the S&P 500 earned 10.1% per year during those years. This annual difference of 5.9% translates into about 38% over the five-year period.
These AQR funds may have performed better than other hedge funds, and maybe those were the "impressive returns" to which Barron's was referring. But is that the appropriate measure? Is it fair to extol a fund return based on its last one year and essentially ignore its three-year or five-year history? Since the hedge funds as a whole are consistently beaten by the S&P 500 Index, do we just eliminate a good benchmark? Is the appropriate comparison just what the hedge funds do relative to each other rather than against the S&P 500 or some other appropriate market index? If you're playing against really weak competition, even poor results are going to look good. Should we celebrate the record of a minor league sports team because it beat competition much inferior to that in the majors?
So I'm not so sure what these AQR funds are "delivering." Based on the five-year records, I'd rather they delivered pizza to me and let the S&P 500 deliver investment returns. Even if they have better returns during some market downturns, they're getting swamped in the upturns. And I guess I have another question. Why is Barron's extolling their acumen when simply investing in index funds would leave investors far ahead?
Leland Faust is an honors graduate from UC Berkeley (economics) and Harvard Law School. He was the founder of CSI Capital Management where he served as chief investment officer from 1978 through 2011 and managed over $1.5 billion. Since 1978 he has represented over one hundred NFL, NBA and MLB all stars.
Barron's has named him four times to its annual list of top 100 independent investment advisors in the country. He has also been named to the Sporting News' list of the 100 most powerful people in sports, one of only two investment advisors ever to be included in that roster. He is a tri-athlete, public speaker and author. His first book is scheduled for release in the Fall, 2016.
Follow Leland on Twitter and Facebook @LelandFaust.