Billionaire Investor Cliff Asness on Managing Risk, 'Buffer' ETFs and More
By Cliff Asness, Co-founder and Chief Investment Officer of AQR Capital Management, as told to WSJ's Telis Demos and Gunjan Banerji.
In a financial landscape increasingly defined by rapid technological change, behavioral finance, and a bewildering array of complex investment products, investors are seeking clarity and safety more than ever. Who better to offer a clear-eyed, data-driven perspective than Cliff Asness, the influential quant investor, co-founder, and Chief Investment Officer of AQR Capital Management? Known for his rigorous academic approach and his willingness to challenge market fads, Asness recently sat down for a frank and wide-ranging discussion on the WSJ’s Take On the Week podcast, delving into everything from the dangers of the options trading boom to the fundamental nature of market efficiency.
This article dissects Asness’s core arguments, providing a deep dive into the skeptical analysis of newly popular financial products, the timeless importance of diversification, and a provocative assessment of how social media is reshaping financial markets. At its heart, the conversation serves as a powerful reminder that in investing, simplicity often triumphs over manufactured complexity, and that the emotional compulsion to do something is often the greatest risk of all. As Asness summarized, with wisdom applicable to novices and professionals alike: “I would say even for professional investors, doing nothing is surprisingly often the right strategy.”
The Options Boom and the Buffer Trap
The interview began by addressing one of the most significant and fastest-growing trends in retail and institutional investing: the massive surge in options trading and options-based investment vehicles. What was once a relatively obscure corner of the market, primarily dominated by specialists and high-net-worth investors, has exploded into a mainstream phenomenon, largely fueled by ease of access and the allure of downside protection.
Asness notes the remarkable growth: "There are $60 billion in hedged equity funds tracked by Morningstar today. It was half that just a few years ago." This figure has since been revised, with the broader category of options trading related funds now exceeding $230 billion.
The products in question—primarily "buffer" ETFs and "hedged equity" funds—promise a tempting, yet often illusory, outcome: most of the stock market’s upside with a significant cut-off, or "buffer," on the downside risk. The core mechanism involves purchasing options, particularly puts (the right to sell an asset at a specific price by a stated date), which function as stock insurance.
The Mechanics and the Appeal
Asness explains the theoretical simplicity and the subsequent practical complexity of these funds. Broadly, they combine a basic stock market exposure (like the S&P 500) with various options strategies designed to "shape the distribution" of returns.
The most common design involves a combination of buying and selling puts and calls, both in-the-money and out-of-the-money, to create a specific payoff profile. The simplest theoretical example is buying the S&P 500 and simultaneously buying a protective put. “You just cut off the downside,” Asness says. The price paid for this insurance is the put’s premium, which acts as a drag on any potential upside. The investor loses a little on the premium if markets rise, but if markets fall sharply, the put "kicks in" and limits the loss.
This promise of a free lunch—or at least, a greatly subsidized one—is what makes these products so alluring. They target the investor’s deeply human desire to profit from market gains without suffering the corresponding pain of market crashes.
The Equity Risk Premium: The Price of Admission
Asness is deeply cynical about the long-term viability and rationale of these complex hedging strategies, and his skepticism is rooted in one of the most fundamental concepts in finance: the Equity Risk Premium (ERP).
The ERP is the excess return that investors demand and receive, on average, for holding stocks, which are inherently volatile and risky, over lower-risk assets like bonds or cash. It is the core reason why stocks, over decades, deliver greater returns.
Asness argues that buffer funds violate the intuitive logic of this risk/reward trade-off: “You get paid an equity risk premium to be in stocks because they have some downside.”
If an investor could systematically eliminate the "scary part"—the significant downside risk—without giving up a proportionally huge amount of the upside, the ERP would evaporate, and everyone would adopt these strategies. But in a rational, functioning market, there is a price for every benefit.
“You have to always be a little immediately cynical when someone says you could have most of that without the scary part. Because the scary part is probably why you get paid,” Asness asserts. The volatility and the risk of a sharp drawdown are not bugs; they are features that generate the long-term premium. Seeking to insure against this risk with complex options strategies effectively costs the investor that premium, potentially leaving them with lower returns and similar or even greater complexity.
The Data Speaks: Simple vs. Synthetic Hedging
The quantitative investor is not content with theoretical arguments alone; the performance data must validate the strategy. And according to AQR’s research, the data on buffer and hedged equity funds is overwhelmingly unfavorable.
Asness draws a stark comparison, suggesting that the complexity of options-based hedging is unnecessary when a vastly simpler and more transparent alternative exists: combining stocks with cash.
The Superiority of Simplicity
If an investor is worried about a market slide, the most trivial and most effective method of downside mitigation is to reduce equity exposure and increase cash holdings. As Asness points out, if an investor holds 80% in the stock market and 20% in cash, they receive 80% of the market’s upside potential but also reduce their downside exposure by 20%.
“And by the way, that’s how like grandma and grandpa told you to invest, right? Like put a little in stocks and a little in bonds and government,” Demos commented, underscoring the simplicity of the classic approach.
AQR’s empirical review of the complex, options-based products shows that they generally fail to deliver on their central promise. “The vast majority of buffered funds, when compared to a very simple straight up mix of an index fund and cash, didn’t outperform it. They underperformed it and didn’t have smaller drawdowns. They had larger drawdowns.”
The sheer disappointment extends to the broader category of hedged equity funds. Looking at those with at least five years of performance, Asness states that the majority "failed to deliver either better returns or less severe drawdowns than a portfolio of cash and stocks."
The conclusion is unambiguous: for the average investor nervous about market risk, the best advice is to "sell some stocks. Real simple. Don't get... This is too cute by half is another way to put it." The complexity of a buffer fund merely hides a transaction cost and a strategic underperformance that the investor would have been better off avoiding through simplicity.
The Threat of the Grinding Bear Market
Beyond historical underperformance, Asness highlights a specific market environment where options-based strategies are uniquely ill-suited: the "grinding bear market."
The worst-case scenario for an equity investor is not a short, sharp crash that quickly reverses, but a slow, continuous decline, such as the one experienced during the Global Financial Crisis (GFC) of 2008-2009 or the inflation-driven slide of 2022.
Options-based strategies, particularly protective puts, are most effective and yield their highest payoff during massive, extreme, sudden market movements.
However, in a grinding bear market:
Extreme moves are absent: The options never realize their maximum theoretical payoff.
Premiums rise: As the market becomes nervous and the decline drags on, insurance (the cost of puts) becomes increasingly expensive.
Consequently, the strategy is consistently paying high premiums for protection that never fully kicks in, leading to significant relative underperformance. “A grinding bear market, you never get that extreme move. And options premiums tend to go up and up and up because in bear markets, insurance becomes more expensive.”
Asness’s final recommendation against these products is therefore unequivocal: “I won't mince words, we recommend against buffered funds.”
The Quest for Uncorrelated Returns
While Asness strongly advises against manufactured complexity and expensive hedging, he is a fervent proponent of a different kind of risk management: true diversification through uncorrelated returns. The goal here is not to eliminate risk (which is impossible without eliminating return) but to introduce investment streams that move independently of the traditional stock market.
Defining Correlation
For clarity, Asness distinguishes between correlation types:
Negatively Correlated (A Hedge): One asset moves opposite to the other (e.g., as stocks go down, this asset goes up).
Uncorrelated (True Diversification): One asset's movement provides "no information about this other one."
The core of AQR’s business is providing these uncorrelated alternatives, often through strategies like "long-short" funds, where a manager goes long (buys) 1,500 stocks they believe will outperform and simultaneously shorts (bets against) 1,500 stocks they believe will underperform, in a balanced, market-neutral way. If done well, the strategy should have near-zero correlation to the broader market and deliver positive returns regardless of the S&P 500’s direction.
The Math of Equitization: Adding Gravy
The classic criticism of any successful uncorrelated alternative is that by allocating capital away from the stock market (especially in a long bull run), an investor may improve their risk-adjusted return but potentially lower their total return. The problem: “You can't eat risk adjusted returns.”
Asness proposes a solution that turns the uncorrelated return into pure "gravy": equitizing the alternative.
The strategy is simple yet powerful:
Take money out of stocks and place it in the uncorrelated long-short fund.
Simultaneously, add a simple, cheap S&P 500 future on top of the long-short fund.
This combination replaces the original stock market exposure that was removed, while the active uncorrelated returns generated by the long-short fund are added on top. “Then you are simply adding. And then if the uncorrelated alternative goes up, it’s just gravy.” This approach ensures the investor maintains full market exposure while benefiting from an entirely separate stream of return that reduces overall portfolio volatility.
Why Diversification "Failed" for U.S. Investors
Asness addresses a common sentiment heard in the U.S. over the last 15 years: "Diversification didn't work." This feeling stems from the unprecedented, multi-year outperformance of U.S. large cap equities, which "crushed bonds" and "crushed equities around the world."
From a U.S. investor’s perspective, having money allocated to foreign stocks or other asset classes proved to be a performance drag. However, Asness offers a critical rebuttal: "Diversification always works. It just doesn't always work for everyone at the same time."
For an investor outside the U.S., diversification was highly effective. The U.S. performance advantage was driven not solely by organic growth, but significantly by "multiple expansion"—the U.S. market becoming vastly more expensive relative to the rest of the world.
Expecting that revaluation to repeat itself from an already expensive starting point is “very naive.” The U.S. stock market now trades at a substantial premium to the rest of the world. Asness argues that even if the U.S. doesn't regress to the mean, if valuations simply stop expanding, the diversification trade will reassert its value. “I think diversification is, frankly, always something I'd recommend, but I feel better about it now for a U.S. investor than normal.”
Market Efficiency in the Digital Age
A quantitative investor's livelihood is based on the idea that markets contain inefficiencies that can be exploited for profit. As a product of the Chicago School, Asness is a theoretical student of the Efficient Market Hypothesis (EMH), the idea famously championed by his former professor and mentor, Nobel laureate Gene Fama.
However, Asness offers a "heretical" view: markets have gotten less efficient in recent years, primarily due to behavioral and structural changes driven by technology.
The Paradox of Technology
Asness acknowledges the advancements in trading technology. In the realm of short-term information assimilation, markets are likely more efficient. Algorithms can parse satellite imagery, earnings reports, and news flashes at lightning speed, ensuring that information is quickly reflected in the stock price.
But the types of inefficiencies AQR targets—like valuation biases that persist over the long term—are a different matter. These are driven by behavioral errors, not trading latency. "Technology has very little to do with that... This is about behavioral biases. This is about market structure changes."
The Role of Passive Investing
One hypothesis for the drop in long-term efficiency is the massive rise of passive investing. While not a fanatic who believes passive investing is "destroying the world," Asness accepts the basic arithmetic: “We can’t all be passive investors.”
The fundamental mechanism that keeps markets honest is active investors performing fundamental analysis—evaluating a company’s prospects and properly pricing its stock. As more capital flows into passive funds that simply track an index, fewer individuals are performing this critical price-discovery function. This "could loosen the bounds of rationality and make us deviate bigger and more" from fundamental values.
Social Media and the Mob Mentality
The primary driver of inefficiency, in Asness’s view, is the digital ecosystem surrounding trading—specifically, social media, 24/7 online access, and gamified trading.
He makes a dark comparison to the political sphere, noting that social media has polarized political discourse and encouraged a "mob mentality." The stock market, he argues, is equally vulnerable because its pricing mechanism is fundamentally a "voting mechanism."
“If this environment has poisoned our voting mechanisms in politics, why would it not affect our markets?”
The pricing of a stock is not an arbitrage—it’s a bet. Shorting an overpriced stock or buying a cheap one carries the risk of the crowd voting against you for longer than you can sustain the bet. When social media platforms consolidate and amplify a collective, uncritical "vote," the result is extreme, persistent inefficiency.
The most obvious example is the meme stock phenomenon, which Asness calls a “completely online mob phenomenon.” But this irrationality is not confined to obscure, unprofitable companies. Asness agrees that companies like Tesla and Palantir exist on a "spectrum" of inefficiency. They may be profitable, but they possess a "very meme-like component where they're a little cultish and driven by a mob of people who feel so strongly and will shout you down and call you terrible names if you disagree."
This environment has made markets "more susceptible to bouts of extreme inefficiency where the world just goes somewhat mad."
The Gamification of Finance
The merger of entertainment, gambling, and traditional finance is perhaps the most alarming trend for Asness. The ability to trade stocks, crypto, and sports bets all within the same platform represents a fundamental change in investor psychology, effectively turning investing into a form of high-stakes entertainment.
Single-Day Options: The FanDuel of Finance
The hottest product in this new, gamified ecosystem is the single-day option (often referred to by the zero-day expiration acronym, 0DTE). These are trades that expire within hours or even minutes.
Asness is blunt about their purpose and value: "Nobody's ever needed that in history." He directly compares the activity to gambling.
“FanDuels is very popular too. And the average, I promise you the average player on FanDuels loses because FanDuels makes money. It’s pretty easy to figure out. And I don’t think single day options are really any different.”
In his analysis, when an investor backs out the cost of the option premium relative to the implied volatility and likely outcome, the contracts are "going to be very bad deals." They are designed to make the brokerages rich.
The appeal, like any form of gambling, lies in the exceptional success story—the one person who posts their massive win on social media. But for the average participant, the outcome is negative: “You’re paying too much. You’re making some version of Wall Street rich and yourself poorer.”
The Voting Machine vs. The Weighing Machine
The question then becomes: how does this extreme market behavior end? Asness invokes the famous wisdom of Warren Buffett: “In the short run, the market’s a voting machine, in the long run, it’s a weighing machine.”
This quote perfectly captures Asness’s entire argument. The voting machine process—the mob psychology, the gamification, the short-term frenzy—can drive prices to irrational extremes. But "ultimately truth wins." Eventually, the market becomes a weighing machine, and the fundamental value of a company’s assets, cash flow, and long-term prospects will dictate its price.
The problem, which even Asness cannot solve, is predicting the timing of this return to rationality. The market can remain irrational for longer than one might imagine. He is convinced, however, that the shift will not come from Wall Street exercising moral restraint.
“There’s never going to be the case where Wall Street’s going to go, you know, we’ve been really successful selling these for the last five years… but frankly the investors are having subpar performance, so we’re going to pull back.”
The end of the froth will only come from disappointed investors slowly realizing that these products do not work as advertised.
The Volatility Imperative
If the advice is to avoid complex hedges and options, what should the long-term investor do about market risk? Asness is not advocating that people should "run away from risk or volatility." In fact, he suggests the opposite: learn to embrace it.
Volatility as the Price of Admission
Volatility, or the natural fluctuation of market prices, is a necessary component of the equity risk premium. “Volatility, it’s the price of admission. It’s what you accept to get the upside.”
As long as an asset class—like stocks—is still expected to deliver a positive premium over time, the more volatility an investor can tolerate without panicking and selling at a low, the more they will make in the long term. The error is taking on too much volatility—more than an investor can psychologically endure—forcing them to liquidate their holdings during a downturn.
Fighting the 'Volatility Laundering' of Alts
Asness has been critical of vehicles that artificially mask volatility, a practice sometimes referred to as "volatility laundering." This occurs when alternative investments (alts) report lower, smoother volatility figures, leading investors to believe they are receiving stable, high returns without risk. In many cases, the lower reported volatility is simply due to infrequent pricing of illiquid assets, not true risk mitigation.
He advocates for leaning into risk when appropriate, for instance, by being more aggressive with uncorrelated funds—"Lean into volatility is the motto of that particular piece." By consciously understanding and increasing the volatility of a truly diversifying alternative (through higher leverage or more aggressive positioning), an investor can potentially boost their total returns without drastically increasing the overall portfolio risk, provided they can tolerate the necessary swings.
Structural Debates and Current Risks
The discussion broadened to cover more structural issues in corporate finance and the current macroeconomic environment.
The Quarterly Earnings Debate: More Information or Short-Termism?
President Trump has advocated for changing the requirement for quarterly earnings reports, suggesting a move to a six-month model to align more with private markets and, arguably, dampen market volatility.
Asness admits the question is difficult. His instinctive preference is for more information, not less, as reporting less frequently can simply raise the stakes when new information is eventually released. “The stakes are raised if it’s every six months. Suddenly that number that on a quarter can drive things. You’re going to learn a lot of new information.”
However, he concedes there is "no magic to a quarter." The rhythm of quarterly reporting is a historical convention, not a divine rule. He also dismisses the general argument of "short-termism," noting that the most expensive stocks in the world today are priced not on next quarter's results, but on expectations for the next 10 to 30 years of growth. The market, even in its volatile state, remains largely a discounting mechanism for long-term cash flows. While he probably wouldn't make the change himself, it is not "the hill I’ll die on."
The Twin Worries: Froth and the Fed's Bind
Finally, Asness was asked to identify the biggest risk to markets right now. He cited a combination of macroeconomic constraint and the very behavioral froth they had been discussing.
1. The Federal Reserve's Mild Bind: As a non-monetary economist, Asness views the Federal Reserve as facing a "mild bind." While the economy shows signs of slowing, inflation remains stubbornly at the high end of the Fed’s preferred range. This constrains the Fed’s ability to aggressively cut rates, creating an uncertain path forward for economic recovery without reigniting price pressures.
2. Market Froth and Mob Psychology: His biggest personal worry, however, returns to the core theme of the conversation: the level of froth and the effects of mob psychology in the market.
How the current era of speculative excess ends is the unpredictable factor. Asness quotes Robert Frost: “Some things end in fire and some things end in ice.”
Ice (Slow Air Out): A long, slow period of lower-than-expected returns as valuations gradually normalize.
Fire (Conflagration): A sudden, sharp crash driven by the amplified "mob psychology" that the digital age has fostered.
“When we have the world that we’ve been talking about this whole time of mob psychology and bigger moves, maybe you have a slow air out of the balloon, but maybe not. And I’m not making big bets on this myself, but I do find it a little frightening.”
Conclusion: Stick to the Process
Cliff Asness’s conversation offers a powerful diagnosis of the current financial moment. It is a time of manufactured complexity, gamified speculation, and unprecedented accessibility to high-risk tools. Yet, the remedies remain rooted in timeless financial wisdom.
The key takeaways for any investor are:
Reject Synthetic Complexity: Avoid "buffer" funds and complex hedged strategies that promise "free insurance." They are almost universally shown to underperform the simple alternative of a blended portfolio of stocks and cash.
Embrace True Diversification: Seek genuinely uncorrelated returns (the "gravy") to improve risk-adjusted outcomes, especially now that U.S. markets are so richly valued relative to the rest of the world.
Stick to the Process: Do not attempt to time the market based on short-term fear or greed. The greatest success often comes from "doing nothing" during times of panic and sticking with a rational, long-term, and academically sound investment process.
Accept Volatility: Understand that market swings are the inherent price paid for the long-term Equity Risk Premium. An investor’s greatest enemy is often their own emotional reaction to those swings.
In an era of relentless distraction and algorithmic noise, Asness’s advice serves as a necessary anchor: The market may be a voting machine in the short run, driven by the madness of the crowd, but only the long-run weighing machine—the reality of fundamental value—is worth betting on.
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