Key Takeaways
- • Cliff Asness, co-founder of AQR Capital Management, defends liquid alternatives despite recent underperformance, arguing that disciplined investors who remain committed through difficult periods should ultimately benefit from long-term gains and portfolio diversification.
- • AQR's quantitative factor-based liquid alts have experienced "tough times" recently, but Asness positions the difficulty of maintaining conviction as evidence that the strategies are sustainable—investors profit precisely because staying the course is psychologically challenging.
- • Liquid alternatives should be constructed using long/short positioning in correlated assets, designed to deliver low correlation to traditional stocks and bonds, which are trading at expensive valuations; they function as portfolio diversifiers, not market hedges.
- • Asness explicitly cautions against using liquid alts as a bearish bet on equities or traditional assets; investors seeking directional downside exposure should take explicit short positions rather than misapplying liquid alts as market hedges.
- • The sustainability of liquid alt strategies depends on investor discipline during underperformance cycles—the psychological difficulty of adhering to the strategy is, paradoxically, a key reason these approaches generate alpha over time.
Summary
Cliff Asness, co-founder of Greenwich, Connecticut-based hedge fund AQR Capital Management, published a defense of liquid alternatives in September 2018, acknowledging recent disappointing performance while making the case for investor persistence. In a blog post and accompanying longer paper, Asness argued that despite quantitative factor-based liquid alts—strategies AQR favors—experiencing difficult performance, disciplined investors should maintain their allocation and expect eventual worthwhile returns.
Asness framed the psychological challenge of remaining committed to liquid alts as a fundamental feature, not a flaw, of the strategy. "We acknowledge and, speaking even for myself, suffer from many of the difficulties that come with sticking with such strategies through tough times," he wrote. "Of course, this difficulty is a big part of why we think the strategies work to begin with and are sustainable going forward." This framing positions the pain of short-term underperformance as compensation for long-term alpha—the very hardship that deters most investors from staying the course is what creates opportunity for those who do.
The primary construction method for uncorrelated liquid alternatives, according to Asness, involves simultaneously taking long positions in certain assets while shorting related assets where there is analytical reason to expect the long positions to outperform. This long/short approach is designed to generate returns independent of broad market movements, providing genuine portfolio diversification. The timing is particularly relevant given Asness's assessment that stocks and bonds are trading at expensive levels, making traditional diversification less effective.
Asness made a critical distinction regarding investor intent: liquid alts are not appropriate vehicles for bearish market timing or directional bets against equities. "You do not want a liquid alt because you're bearish on stocks or, more generally, traditional assets," he wrote. "That kind of timing is difficult to do well." Investors convinced of an imminent market downturn should establish explicit short positions rather than repurposing liquid alts as hedges. The strategy's value proposition rests on its role as a low-correlation diversifier within a portfolio, not as market protection during anticipated crashes.
Asness framed the psychological challenge of remaining committed to liquid alts as a fundamental feature, not a flaw, of the strategy. "We acknowledge and, speaking even for myself, suffer from many of the difficulties that come with sticking with such strategies through tough times," he wrote. "Of course, this difficulty is a big part of why we think the strategies work to begin with and are sustainable going forward." This framing positions the pain of short-term underperformance as compensation for long-term alpha—the very hardship that deters most investors from staying the course is what creates opportunity for those who do.
The primary construction method for uncorrelated liquid alternatives, according to Asness, involves simultaneously taking long positions in certain assets while shorting related assets where there is analytical reason to expect the long positions to outperform. This long/short approach is designed to generate returns independent of broad market movements, providing genuine portfolio diversification. The timing is particularly relevant given Asness's assessment that stocks and bonds are trading at expensive levels, making traditional diversification less effective.
Asness made a critical distinction regarding investor intent: liquid alts are not appropriate vehicles for bearish market timing or directional bets against equities. "You do not want a liquid alt because you're bearish on stocks or, more generally, traditional assets," he wrote. "That kind of timing is difficult to do well." Investors convinced of an imminent market downturn should establish explicit short positions rather than repurposing liquid alts as hedges. The strategy's value proposition rests on its role as a low-correlation diversifier within a portfolio, not as market protection during anticipated crashes.
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