would have cut investors out after each of those false signals.
The strategy has not worked as well as you might think, so
that’s one aspect of why I’ve become more cautious about these
If I may, I want to say something here about today’s low expected
returns, an important topic we touched on earlier. I think everybody knows we are in a world of low expected returns, and this is
true not just for bonds but for many other assets. Everyone here
also knows that U.S. pension plans often make optimistic assumptions about expected returns. I recently realized that when the literature on defined contribution pensions discusses the savings rates
individual savers need to achieve adequate retirement income, all
of the studies seem to be based on expected returns that were
anchored to recent decades’ experience when we got a tailwind
from capital gains in both stocks and bonds.
Today, I think it’s realistic to expect something more modest.
When we calculated, for example, what a 2-percentage-point lower
expected return means for required savings rates under typical
assumptions, we saw that savings rates would have to almost double from 8 percent to 15 percent. This is not something that’s generally recognized yet.
My response certainly isn’t that because everything is expensive,
investors should go to cash. Market timing won’t work because you
may be wrong for the next five years, and investors won’t have the
patience to wait. Maybe holding your nose and buying lots of these
expensive assets, diversifying widely—I especially recommend
applying some market-neutral long/short strategies that won’t be as
expensive because the richness due to low discount rates washes
out between the long and the short leg—that’s essentially as good
as it gets. Not great, but as good as it gets.
Margaret Towle: Hedge fund managers have received a fair
amount of negative publicity of late. Some funds are very secretive,
and others are relatively open. Would you comment on the state of
hedge funds today and their outlook for the future, particularly
with regard to your comments about expected returns?
Antti Ilmanen: Sure. I think the fair criticisms against hedge funds
are related to fees and market directionality, besides the transparency issue you raise. If you look at major hedge fund indexes, you’ll
see an embarrassing 80-percent correlation with equity markets
over the past ten years. So whatever you think about fees, they are
harder to justify when a meaningful part of hedge fund returns is
beta-related rather than truly uncorrelated alpha. Fortunately,
there’s been a push for investors to better understand what they are
getting from active managers, including hedge funds; investors
should not pay alpha fees for beta performance. I expected more of
such demystifying effort and fee pressure after the global financial
crisis, but that was a period when hedge funds became popular
because they hadn’t done as badly as equities during that time, and
they promised more for the future.
It took a while, but now these funds are under pressure. Looking
ahead, I think hedge funds will be subject to more of these investor
pressures, related to both fees and market directionality and also to
transparency. Investors no longer easily accept admonitions like,
“Trust me; I’ve got a great track record.” The pressure to demystify
the investment process is good for end-investors, and, actually,
I think it’s good for the providers because it will result in a more
At AQR, we chose to push this demystifying path both for ethical
reasons, because we want to do right for the end-investor, and
also for selfish business reasons. Most investors are fiduciaries
who need to understand the investment processes they’re involved
in. When we share information with them, they become more
comfortable, can communicate better with their boards, and
become more committed to the processes long term. If you simply
tell them, “Trust me,” you live and die with short-term performance. We think the demystification approach gives us a more
stable asset base.
Margaret Towle: Most recognize that hedge funds are not a homogeneous group and that directionality is an issue that investors
seem to be focusing on. Given what you just said, would it make
sense for investors to focus on hedge fund strategies that are negatively correlated, such as some global macro funds, in other words,
a willingness to pay for diversification in addition to performance?
Antti Ilmanen: You always want good performance, and you want
some diversification. I’d say that investors are rightly thinking more
about diversification, which guides you toward trend-followers
(managed futures), macro managers, or other strategies that
involve long–short positions; that is, strategies that don’t involve a
0.5 or higher correlation with equities. Of course there are exceptions (skillful market-directional managers worth pursuing), but
because there’s so much luck versus skill involved in ex-post investment results, it’s a good idea to favor managers who are effective
Margaret Towle: Is there anything else you’d like to comment on
that we haven’t discussed?
Antti Ilmanen: Maybe the theme of better risk diversification. I’ll
reemphasize that most investor portfolios have a big concentration
in equity risk, which is understandable because there is a clear
long-term equity premium and equities constitute a conventional,
easy way of adding value. Many so-called diversifiers have such
high correlations with equities that adding them to your portfolio
doesn’t change things much. So ideas that help investors diversify
and make the equities concentration less dominant are especially
important. That’s why I like some market-neutral strategies—value,
momentum, carry, defensive strategies—as well as trend-following.
All of these strategies are useful, especially today when long-only
investments are as expensive as they are. That’s a pitch for my
strongest strategic view.