NEW YORK, March 9 (Reuters) - Portfolio managers who frown on leverage to boost returns risk becoming too concentrated in aggressive asset classes such as equities, Clifford Asness, co-founder of quantitative money manager AQR Capital Management, said on Wednesday.
Aversion to using leverage, or borrowed money, to enhance trading strategies has lingered since the global financial crisis, said Asness, who addressed the Global Association of Risk Professionals conference in New York.
The use of borrowed money to boost returns on stocks and bonds triggered steep losses for managers as the financial crisis worsened. But those now shunning leverage are risking the diversification of their portfolios, he said.
“If you are unwilling to (use leverage) and want to get more return, the only way to do it is to move to more aggressive asset classes and to take more concentrated positions,” he said.
This is more acceptable in the industry today, than “some geeky, dangerous method that you heard was evil,” he said.
Last year, Asness — whose firm manages $29 billion using algorithm-based strategies — said the failures of 2008 were not because diversification failed, but that most funds were not as diversified as they had believed.
Greenwich, Connecticut-based AQR in October launched a “risk parity” fund that aims to improve diversification by considering allocation of risk versus capital. A traditional model of 60 percent stocks and 40 percent bonds could equate to 90 percent stocks, based on risk, he said.
Asness laid out numerous arguments for using reasonable leverage to a diversified portfolio, though was quick to note that it too can be taken too far. Using leverage also means a counterparty can pull the plug on the fund’s strategy, adding another layer of risk, he noted.
Asked about stress testing for portfolios, Asness said that AQR’s tests include both made-up scenarios and those based on historical data. He was skeptical of results, however.
“I am close to coming up with a rule ... to figure out what you can do, and then halve it,” he said.