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AQR's Momentum Funds (A) XXXXXXXXXX R E V : M A R C H 2 9 , XXXXXXXXXX ________________________________________________________________________________________________________________ Professors...

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AQR's Momentum Funds (A)

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R E V : M A R C H 2 9 , XXXXXXXXXX
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Professors Daniel Bergstresser (HBS), Lauren Cohen (HBS), Randolph Cohen (MIT Sloan School of Management) and Christopher Malloy (HBS)
prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of
primary data, or illustrations of effective or ineffective management.

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D A N I E L B E R G S T R E S S E R
L A U R E N C O H E N
R A N D O L P H C O H E N
C H R I S T O P H E R M A L L O Y
AQR's Momentum Funds (A)

In early 2009, after significant research and reflection, Cliff Asness, founder and principal at AQR,
was considering the launch of three new retail mutual funds that would offer investors exposure to
‘Momentum,’ a new investment style. While momentum strategies were commonplace among hedge
funds, the new AQR funds would become the first retail funds to focus on this strategy.
The Momentum Strategy
AQR defined stock momentum as ‘the phenomenon that stocks which have performed well in the
past relative to other stocks (winners) continued to perform well in the future, and stocks that have
performed relatively poorly (losers) continue to perform poorly.’ This relative performance was a key
component of momentum, as it implied existence and ability to implement the strategy i
espective of
up or down markets.
The first academic paper demonstrating the high returns associated with the momentum strategy
was a 1993 publication by Narasimhan Jegadeesh and Sheridan Titman. Among the most important
extensions of this work were Clifford Asness’s 1994 paper showing the robust profitability of
momentum investing strategies, and a paper by Mark Grinblatt and Tobias Moskowitz in 1999
demonstrating the role that industry affiliation played in momentum’s performance.1 Asness was a
founding partner at AQR, and Moskowitz, a professor at the University of Chicago, served as a
consultant at AQR. Since the original academic work, hundreds of papers had been published on
momentum. While explanations for the phenomenon differed, there was widespread agreement
about its existence and pervasiveness. In particular, the momentum phenomenon had also been
found to exist in international equity markets and across various asset classes.

1 See Jegadeesh, Narasimhan, and Sheridan Titman, “Returns to buying winners and selling losers: implications for stock
market efficiency,” Journal of Finance, 48, 1993; Asness, Clifford S., "The power of past stock returns to explain future stock
eturns," Goldman Sachs Asset Management, 1994; Grinblatt, Mark, and Tobias Moskowitz, "Do industries explain
momentum?" Journal of Finance, 54, 1999.
For the exclusive use of D. Ghosh, 2020.
This document is authorized for use only by Devleena Ghosh in Behavioral Corporate Finance (Summer 2020) taught by DUCCIO MARTELLI, Universit?? degli Studi di Perugia from Jun 2020
to Aug 2020.
XXXXXXXXXXAQR's Momentum Funds (A)
2
Some argued that momentum investors experienced outsized average returns as compensation for
earing undiversifiable risk. Evidence in support of this explanation was the fact that high-
momentum stocks had a strong tendency to move together, making it difficult to obtain momentum
profits without exposing oneself to the possibility of substantial loss.
Others argued that momentum profits were caused by cognitive e
ors and i
ationalities in the
market. One set of theories saw momentum as a result of ove
eaction to news – e.g., a company
made a positive announcement, leading to a price increase, which then caused additional buying in
the form of an i
ational bandwagon effect. This effect was driven by investors who mistakenly
expected that good news should be followed by more good news. This follow-on buying would
create a momentum effect.
A second set of behavioral theories took the opposite approach, explaining momentum as a
consequence of unde
eaction, or slow reaction to news. For example, consider an announcement of
news that, in a rational world, would merit a 10% increase in the stock price. Holders of the
unde
eaction view would argue that it is common for the stock to increase, say, 6% immediately,
and then have the remaining 4% price growth over the subsequent year. The momentum effect
would be driven by this “drift” resulting from the information slowly leaking into prices.
While the debate raged on in the halls of academia as to momentum’s cause, investment vehicles
were designed by a variety of firms in an attempt to profit from the strategy. In general this
opportunity was only available to deep-pocketed institutional investors. Hedge funds frequently
included momentum among their strategies, and institutional equity funds often had a momentum
tilt to their portfolios. AQR wondered whether momentum would also be an attractive strategy if
offered to retail investors.
Empirical evidence on momentum
There was ample empirical evidence on price momentum in equities. The most common such
strategies followed Jegadeesh and Titman in using a prior or “backtest” period to define good
performing (winner) stocks and poorly performing (loser) stocks, and then formed a portfolio that
ought winner stocks and sold loser stocks, and held this portfolio into the future. Although there
were many variations of this strategy, including changing the past time window over which to define
winners and losers, or altering the horizon of the holding period after portfolios were defined, a very
common formulation was based on a pre-ranking period of roughly past year returns, and then a
future holding period of 1 month. Specifically, at the beginning of each month all firms were assigned
to one of ten portfolios ranked according to past year returns (skipping the prior month).2 Stocks in
the lowest decile of past returns (decile 1) were assigned to the loser portfolio of stocks, while stocks
in the highest decile of past returns (decile 10) were assigned to the winner portfolio. Momentum
eturns were then computed as the returns to the long-short portfolio that went long (decile 10)
winner stocks and short (decile 1) loser stocks over the following month. At the end of every month,
stocks were re-ranked, and a new portfolio of (winner stocks - loser stocks) was formed and held
during the next month.
2 It was common to skip the prior month (t-1) when computing past year returns (i.e., to use t-12 to t-2 returns rather than t-12
to t-1 returns), because of evidence in Jegadeesh XXXXXXXXXXthat stocks with high returns last month tend to reverse in the following
month. See Jegadeesh, Narasimhan, “Evidence of predictable behavior in security markets," Journal of Finance, 45, 1990 and
Asness, Clifford S., "The power of past stock returns to explain future stock returns," Goldman Sachs Asset Management, 1994.
For the exclusive use of D. Ghosh, 2020.
This document is authorized for use only by Devleena Ghosh in Behavioral Corporate Finance (Summer 2020) taught by DUCCIO MARTELLI, Universit?? degli Studi di Perugia from Jun 2020
to Aug 2020.
AQR's Momentum Funds (A XXXXXXXXXX
3
Jegadeesh and Titman (JT) published their findings in XXXXXXXXXXMany investors believed that an
easily explained strategy like momentum would lose its efficacy once it became well known. Thus
the performance of momentum both before and after the publication of the JT paper was particularly
elevant. Kenneth French of Dartmouth’s Tuck School of Business maintained a data li
ary online3
which showed the historical performance of many quantitative strategies. Included was data on a
momentum-based factor that its creators, French and University of Chicago economist Eugene Fama,
called UMD (for Up minus Down) or MOM; in this formulation, momentum was computed from the
highest 30th percentile of past return stocks (UP) minus the lowest 30th percentile of past returns
stocks (DOWN). According to the average returns from the annual UMD data on French’s site,
UMD’s returns were actually slightly larger in the post-1992 period XXXXXXXXXX):
 Pre- Jegadeesh and Titman paper, XXXXXXXXXX: 10.79%
 Post- Jegadeesh and Titman paper, XXXXXXXXXX: 11.48%
 Full sample period, XXXXXXXXXX: 10.92%
Exhibit 1 shows the annual returns to the Fama-French UMD momentum strategy over the entire
XXXXXXXXXXperiod, while Exhibit 2 shows the cumulative performance of a dollar invested in UMD in
1927 versus a dollar invested in the overall market (CRSP NYSE/Nasdaq value-weight portfolio) in
1927. Exhibit 3 provides summary statistics over the entire sample period for the momentum "10
minus 1" portfolio, as well as the individual long and short component portfolios (i.e., deciles 1 and
10). Exhibit 4 presents the average monthly returns from 1927 to 2008 for all ten portfolios formed on
past returns, as well as the long-short "10 minus 1" momentum portfolio.
AQR
AQR was established in 1998 and headquartered in Greenwich, CT. The founding principals of
the firm included Clifford Asness, David Kabiller, Robert Krail, and John Liew, who had all worked
together at Goldman Sachs before leaving to start AQR.
Asness, Krail, and Liew had all met in the Finance PhD program at the University of Chicago,
where Asness’ dissertation had focused on momentum investing. AQR had grown substantially
from its start in 1998, and by early 2009 AQR had over 200 employees and managed over $19 billion
in assets. A large portion of these assets were invested in hedge fund strategies.
Answered Same Day Jun 27, 2021

Solution

Tanmoy answered on Jun 28 2021
130 Votes
AQR Momentum Fund
Introduction
AQR is a capital investment management company founded by Clifford Asness, David Kabiller, Robert Krail and John Liew in Greenwich, Connecticut, USA. It was founded with an intention to focus on momentum investment in the year 1998. By 2009, AQR had a workforce of over 200 employees and managed assets worth over $19 billion. The company used to deal with high net worth clients who invested mostly in hedge funds. Hence, a large portion of these assets were invested in hedge funds. The strategies used to invest hedge funds were based on pure absolute return alpha and used financial derivatives to hedge the long and short positions of the underlying assets. AQR also partnered with CNH Partners LLC to help them in convertible and merger a
itrage. The hedge fund investment business of AQR was extremely profitable. Therefore, they were trying to pool the savings of the retail investors and try their luck in mutual funds that was in demand.
Momentum Fund investment
The chairman and founder of AQR, after research and analysis decided to launch three new mutual funds for retail investors with momentum style of investment. The same strategy was used in investment of hedge funds in AQR. The momentum strategy was based on a principle that stocks which performed well previously will also continue to perform prudent in the future while the stocks which underperformed in the past will perform poorly in the future. AQR has been using this strategy in dealing their hedge fund and now wanted to apply the same strategy in their mutual funds.
Momentum Strategy
Momentum strategy was written by Narasimhan Jegadeesh and Sheridan Titman in an academic publication of 1993. In this publication it was discovered that using momentum strategy many hedge funds earned high returns. Clifford Asness the founder of AQR and Tobias Maskowitz a professor and a former consultant of AQR later extended the research and founded robust profitability and the role the industry played in momentum investing strategies respectively. But, there have been many positive as well as negative views on the momentum strategy. While some investors earned mammoth average returns as a price for investing in undiversifiable risk while others stated that momentum profits was a result of cognitive e
ors and...
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