AQR Saves Face, Rescues Fund

By Emma Trincal, Senior Financial Correspondent

Tuesday, August 14, 2007

GREENWICH, Conn. (HedgeWorld.com)�AQR Capital Management LLC has been hit with losses, but the $37 billion investment manager is fighting back on several fronts, mounting a public relations campaign and apparently securing financing for itself.

AQR's founder, Cliff Asness, sent a letter to his investors on Friday [Aug. 10] in an attempt to stop rumors of a blowup. And according to the Wall Street Journal, citing an unnamed source, last week the Greenwich-based quantitative hedge fund received a $1 billion capital infusion from investors. AQR did not respond to phone calls and emails from HedgeWorld.

AQR is one among many quantitative funds that have been hammered with severe losses over the past two weeks Previous HedgeWorld Story.

In his letter, Mr. Asness said AQR�s Global Stock Selection High Volatility Fund had come under �severe pressure� this month. According to information obtained by HedgeWorld and published in a Premium story Monday [Aug. 13], the losses for the year through early August were significant Previous HedgeWorld Story.

"I don't know about it but it wouldn't surprise me if they got a capital infusion," said Daniel Strachman, managing member of consulting firm A&C Advisors in Fanwood, N.J. "I think, though, that the real issue here is why the models are not working."

"I've talked to a couple of quant managers," said Ed Easterling, president of Dallas-based Crestmont Research, a hedge fund advisory firm. "Because their models have gotten out of whack, they've had significant losses over the past two weeks. The spreads in their models have widened and they want to get additional capital because they don't think that those spreads will stay."

That is what transpired at Goldman Sachs Group, Inc. on Tuesday [Aug. 13]. During a conference call, Goldman officials said that the bank had partnered with several investors to inject $3 billion in one of Goldman's troubled quantitative equity long/short funds, with Goldman putting in $2 billion of its own money Previous HedgeWorld Story. The bank said that the cash injection was "an interesting investment opportunity" because prices had gone in unexpected directions and eventually would revert to normal. Meanwhile, assets with good fundamentals were available at discounted prices which, the bank said, was the rationale for the cash infusion. Goldman even went so far as to say that it would consider buying into other outside funds providing that "it makes sense."

"All the quant funds have recently had cash infusions. All of them," said the founder of a New York-based fund of funds and family office, who declined to be named as a matter of policy.

With Goldman's recapitalizing of one of its funds, some market participants said they would not be surprised if other quantitative funds followed suit. After all, it was only recently that some hedge fund managers sought capital via the public markets. Fortress Investment Group LLC and The Blackstone Group LP completed their initial public offerings in February and June, respectively, just before the market problems started.

AQR was reportedly lining up its own IPO filing earlier this summer. But the credit crunch and recent market turmoil led the firm to postpone its filing, according to press reports.

Mr. Easterling said that if AQR did indeed receive a fund infusion, there would be two possible reasons behind such an investment. "The first possibility is opportunity," he said. "The disparity between overvalued and undervalued securities, which quant funds exploit, has widened significantly. It has therefore created buying opportunities. This, of course, is what founders of a fund getting a cash infusion would want you believe."

That's the point Goldman wanted to get across in yesterday's conference call when it denied that the $3 billion cash injection was an attempt to rescue the fund after it had lost 30% so far for the year.

Mr. Easterling said he had no information about AQR's reported capital injection. But talking in general terms he said that, "poor performance coupled with leverage leads to an urgent need for capital. The money coming in could be to shore up the fund so that it can sustain its credit line."

Francis Gaskins, IPO analyst at IPODesktop.com, an IPO research firm, said, "When there is a capital investment like that, it often means that they're in real trouble. They're probably trying to save their fund by injecting liquidity."

This injecting of cash into distressed funds has come at a time when two interesting factors are converging. On the one hand, there is a liquidity crunch for some structured credit assets, which progressively has affected other sectors of the market such as loans and stocks. On the other hand, the hedge fund IPO trend is slowing down. With the recent subprime mortgage crisis and credit woes, several funds that had planned to go public have had to put their IPO filings on hold. But the need for liquidity is still there. And the need to get sources of funding independent from investors to guard against massive redemptions is never greater than in times of stress such as today.

One of the main reasons for going public was to get permanent capital from the market. If this route is now abandoned by many due to the current market environment, the need for liquidity will have to be met in other ways.

"AQR was talking about filing," Mr. Gaskins said. "It's over for them. They can't go public. The music is over for hedge fund IPOs in general because a lot of hedge funds wanted to go public based on good track records. But if the track records show disaster, the public will walk away from the IPO table."

In the current liquidity crisis, some funds have resorted to other means to keep their funds afloat. In France that country's largest bank, BNP Paribas, simply froze redemptions in three of its funds because it was not in a position to assess the net asset value of the funds Previous HedgeWorld Story.

Saving the fund financially is one step. Saving face and giving investors the answers they need is the other side of managing crisis. That's the public relations side. Mr. Asness, in his letter to his investors, aimed to calm nerves and dispel negative buzz without giving away too many details.

"If the rumors are that we are in some pain over the recent widespread quant stock selection woes, then they are accurate. If the rumors are more severe than that, then they are simply false."

Mr. Asness went on to say that the firm's business was "quite diversified," with an estimated $27 billion in traditional products and $10 billion in absolute return hedge funds.

"Our business is stable and healthy and we have top-notch clients, who, like us, focus on the long-term," he wrote.

Mr. Asness noted that the stock selection strategy this month had come under "severe pressure" but wrote that the global macro portfolio was posting a "meaningful positive month." He didn't quantify that. A former investor in AQR who is familiar with the fund said that indeed, the bulk of AQR's assets�in global macro strategies�is positive not just for the month but also for the year.

Commenting on how poorly quantitative models are working right now, Mr. Asness wrote in his letter, ". . . This is not about models. This is about a strategy getting too crowded, as other successful strategies both quantitative and non quantitative have gotten many times in the past, and then suffering when too many try to get out the same door."

Mr. Asness has a point. Quantitative strategies have produced good returns for several years in a row with relatively low volatility. With the increase in Sharpe ratio, more investors joined in, bringing more and more money into the strategy. But when big, multi-strategy funds began to allocate chunks of money to this investment style, leverage had to increase drastically in order to keep returns at the levels where they were before.

The rest is known. A number of those large multi-strategy funds lost money in their credit strategies due to the stress in the subprime mortgage market. Those losses triggered a de-leveraging process in an attempt to raise cash. And where else can cash be quickly found than in the U.S. equity market?

Mr. Asness described the intensity of the de-leveraging in those terms: "This is decidedly not a regular drawdown. It's a de-leveraging of historical proportions. . . . We have temporarily been managing a reduction of our notional exposure to [some] strategies."

Translation: AQR has been selling some of its positions, and AQR is not alone.