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AQR Capital Management, LLC | Two Greenwich Plaza, Third Floor | Greenwich, CT 06830 | T: 203.742.3600 | F: 203.742.3100 | www.aqr.com

AQR C A P I T A LM A N A G E M E N T

The information set forth herein has been obtained or derived from sources believed by AQR Capital Management, LLC (“AQR”) to be reliable. However, AQR does not make any representation or warranty, express or implied, as to the information’s accuracy or completeness, nor does AQR recommend that the attached information serve as the basis of any investment decision. This document has been provided to you in response to an unsolicited specific request and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. This document is intended exclusively for the use of the person to whom it has been delivered by AQR Capital Management, LLC, and it is not to be reproduced or redistributed to any other person. This document is subject to further review and revision. Please refer to the Fund’s PPM for more information on general terms, risks and fees. For one-on-one presentation use only.

Third Quarter 2009

HEDGE FUND BETA AND PORTFOLIO CONSTRUCTION

Clifford S. Asness, Ph.D.Managing & Founding PrincipalAQR Capital Management, LLC

1AQR C A P I T A LM A N A G E M E N TAQR C A P I T A LM A N A G E M E N T

The Evolution of Portfolio Construction

Traditional Approach• Start with a limited set of assets

• Allocate capital to them

• Find managers for each asset class and allocate capital to them

• Investment objective: allocating capital to assets with high expected return, try to add some alpha

Beyond the Traditional Approach• Seek out as many market exposures as possible

• Allocate risk to them

• Use active management only where managers have unique skill

• Investment objective: building the most efficient portfolio

Today’s Agenda• Look at ways of moving beyond the traditional approach, including a focus on “hedge fund beta”


Beyond the Traditional Approach

DynamicExposures

Market Exposures

Skill

• S&P 500 Index• Lehman Aggregate• Emerging Equities• Commodities

Examples

• Skill-Based Active Strategies (“Alpha”)• Exposure Timing Strategies• Market-Independent

• Carry Trades• Pure Value• Pure Momentum• Systematic Arbitrage Strategies• Hedge Fund Beta


Risk BudgetingRisk budgeting is often the most crucial decision investors make

We illustrate a model risk budget, but investors must make the final call based on their own beliefs

Once the risk budget is set, investors can choose asset classes and managers for each portfolio component

Contrarian / Liquidity Event Alpha Strategies, 3%

Convertible Arbitrage, 3%

Event Driven, 4%

Fixed Income Relative Value, 2%

Dedicated Short Bias, 4%

Equity Market Neutral, 3%

Equity Long/Short, 3%

Global Macro, 5%

Managed Futures, 4%

Emerging Markets, 2%

Credit Market Exposure, 15%

Inflation Market Exposure, 15%

Bond Market Exposure, 15%

Equity Market Exposure, 15%

Asset Allocation Asset Strategies, 3%

Stock Selection Alpha Strategies, 3%

Source: AQR. The above exposures are for illustrative purposes only and are subject to change. Please read important risk disclosures in the Appendix.


Portfolio Construction: Market Exposures

Objectives of Market ExposuresInclude a broad range of different asset classes around the globe; goal should be to maximize diversification – the only free lunch in finance

Provide long-term positive expected returns as compensation for holding risky assets; expected returns for each asset are commensurate with their expected risk

Portfolio Theory Implementation

Set a broad investable universe including as many asset classes as possible1. Diversify Broadly

Find the most efficient portfolio and scale it to include the desired level of risk3. Maximize Efficiency

Use risk budgeting to target how much portfolio risk should come from each investment2. Diversify Risk


Developed• Australia • Netherlands• Spain • Hong Kong• Japan • Switzerland• France • United Kingdom• Germany • United States• Italy

Mid Cap• United States

Small Cap• United States

Emerging• China • South Africa• India • Singapore• Taiwan

Inflation Linked Bonds• France• United Kingdom• United States

Commodities• Corn • Soybeans• Wheat • Aluminum• Copper • Crude Oil• Lead • Brent Oil• Nickel • Gas Oil• Zinc • Heating Oil• Gold • Natural Gas• Silver • Live Cattle• Cocoa • Feeder Cattle• Coffee • Lean Hogs• Cotton • Sugar

Developed• Australia• Europe• United Kingdom• Japan• United States

Emerging• Czech Republic• Hong Kong• Hungary• South Korea• Poland• Singapore• South Africa

Credit Spreads – Inv Grade• United States

Credit Spreads – High Yield• United States

Emerging Currency Forwards• Brazil • South Korea• Israel • South Africa• Mexico • Singapore• Turkey • Taiwan

Comm Mort-backed Spreads• United States

Equity Exposure Interest Rate Exposure Inflation Exposure Credit/Default Exposure

1. Diversify Broadly

The above exposures are for illustrative purposes only. Please read important risk disclosures in the Appendix.


2. Diversify RiskInvestors tend to view portfolio diversification in terms of asset allocation

• A portfolio with a balanced asset distribution is perceived as diversified

Below we illustrate the significant equity risk in a traditional capital allocation portfolio

In risk terms, this portfolio is actually very concentrated as equity risk dominates the portfolio due to the greater volatility of stocks versus other asset classes

Equities

Private Equity

Bonds

Real Estate

Hedge Fund of Funds

Capital Allocation (Traditional Approach) Risk Allocation (New Approach)

60% Equity Capital 89% Equity RiskThe above risk exposures are based on AQR volatility and correlation estimates and are for illustrative purposes only. Please read important risk disclosures in the Appendix.


Maximize EfficiencyFind most efficient portfolio (greatest return per unit of risk)

Lever (or de-lever) that portfolio to desired risk level

3. Maximize Efficiency

For illustrative purposes only. Please read important risk disclosures in the Appendix. Volatility

Expe

cted

Ret

urn

Risk-FreeRate

Most Efficient Portfolio

(2)

Leverage

100%Bonds

100% Stocks

60%/40% Stocks/Bonds 100%

Commodities

100%TIPS

Benefit of Risk Diversification and Efficient Portfolio Construction

Benefit of Broad and Global Diversification100%

Emerging Equities

Most Efficient Portfolio Leveraged to 60/40 Risk Level

(3)

(1)


Remain Diversified with Modest Leverage

Source: Datastream. For 100% Equities we use the S&P500 Index. For 60/40, we use 60% S&P 500 and 40% Barclays Aggregate Bond Index. Data through 9/30/09. Leverage is 158.51%. Please see important disclosures relating to hypothetical performance and risks in the Appendix.

Modest leverage can give investors more opportunity to stay diversified and not load up on equities

“Levered 60/40” has beaten 100% equities over the long-term, just as theory would suggest and has outperformed over the recent crisis

While leverage involves certain risks, they should be viewed in the overall portfolio context

(Hypothetical) Growth of $1

$0

$2

$4

$6

$8

$10

$12

$14

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

100% EquitiesLevered 60/4060/40


What Should a Diversified Portfolio Look Like?

Overly concentrated in equity risk Diversifies risk allocations while considering correlations across asset classes

Source: AQR. Charts are for illustration purposes only. Please see important risk disclosures in the Appendix.

Typical Portfolio Sample Risk Parity Portfolio

Risk Allocation

Equity Risk

Nominal Interest Rate Risk

Inflation Risk

Credit/Default Risk


Portfolio Construction: Dynamic ExposuresObjectives of Dynamic Exposures (“Hedge Fund Betas”)

Capture the fundamental insights of a range of active management strategies – along with a meaningful portion of the risk premium those strategies earn – using a dynamic but clearly-defined investment process

Avoid the drawbacks of high fees, long lock-ups, low transparency and high leverage associated with hedge funds, which have historically been the predominant source of dynamic exposures for institutional investors

Well-known strategies based on sound economic principles and years of empirical studyEconomically intuitive

Bottom-up construction of dynamic trading strategiesDynamic

Well-defined investment process shared openly with investorsTransparent

Designed to be uncorrelated with traditional market exposuresAlternative

Emphasis on liquid securities that can be traded at low cost and strategies that require only limited leverageLiquid


How Alpha Becomes Beta

ALPHA

ALPHA

HEDGE FUND BETA

NON-TRADITIONAL BETA

TRADITIONAL BETA

ALPHA

TRADITIONAL BETA

ALPHA

NON-TRADITIONAL BETA

TRADITIONAL BETA

No reason to prefer alpha over a new beta an exposure you don’t have is “alpha to you”!

Many strategies earn a premium by providing liquidity value: make a market in un-loved assets

AQR Global Risk Premium

Fund

AQR DELTA Fund

Prior to EquityIndices

– Returns viewed as alpha

Traditional Beta introduced

Examples:– S&P 500 Index– Lehman Aggregate

Non-Traditional Beta introduced

Examples:– Commodity Indices– Real Estate

Hedge Fund Beta introduced

Examples:– Merger Arbitrage– Convertible Arbitrage

Time


Case Study: Merger Arbitrage

Basic Merger Arbitrage Strategy• Go long the target and short the acquirer

• Allows managers to offer insurance and provide liquidity to those who held target’s stock prior to deal announcement

AQR/CNH Proprietary Dataset• ~15,000 mergers (going back to 1963)

• We have actively managed merger arb strategy (since 2001)

• Control for survivorship and timing biases

Can create portfolio by holding some exposure to each announced merger deal (or try to do a little better ☺)


Hedge Fund Betas:The common risk exposures shared by hedge fund managers pursuing similar strategies.

What’s inside Hedge Funds?

Something Else(Systematic Exposures)

αUnique Alpha

βMarket Beta

A Closer Look


Hedge Fund Beta is Different

Market Beta Hedge Fund Beta

InvestmentProcess

Single asset class,generally cap-weighted

Buy-and-hold strategy,long-only

Infrequent trading,holdings change slowly

Multiple strategies, each with a unique weighting system; cap-

weighting does not apply

ImplementationDynamic strategies trading a range of

asset classes and instruments, long and short; infrastructure is critical

RebalancingFrequent adjustment to positions as

market conditions change; must manage t-costs


Hedge Fund Beta Everywhere

EventDriven

Fixed IncomeRelative Value

EquityMarketNeutral

DedicatedShort Bias

GlobalMacro

Emerging Markets

ConvertibleArbitrage

Long/ShortEquity

ManagedFutures

For illustrative purposes only. Please read important risk disclosures in the Appendix.


Source: AQR proprietary data. Data updated through March 2009. Correlations are annualized net figures based on hypothetical quarterly data from the following page and use a 1.00% management fee and no performance fee. The hypothetical hedge fund beta portfolio performance is for illustration purposes only and not the returns to an actual fund or account. Importantly, the HFRI Composite and the CS Tremont Index are non-investable indices. Please see important disclosures relating to the hypothetical portfolio details, performance and risks in the Appendix.

Restoring Diversification Attributes

Quarterly Correlations of a Hypothetical Hedge Fund Beta Portfolio

1.01.00.2S&P 500 Index

1.00.90.2MSCI World Index

0.80.80.3HFRI Hedge Fund Composite Index

0.80.60.5HFRI Funds of Funds Composite Index

0.80.70.6CS Tremont Hedge Fund Index

0.20.21.0Hypothetical Hedge Fund Beta Portfolio

TheS&P 500

Index(Last 5 Years)

TheS&P 500

Index(1990 - Present)

HypotheticalHedge FundBeta Portfolio

(1990 - Present)

1.01.00.2S&P 500 Index

1.00.90.2MSCI World Index

0.80.80.3HFRI Hedge Fund Composite Index

0.80.60.5HFRI Funds of Funds Composite Index

0.80.70.6CS Tremont Hedge Fund Index

0.20.21.0Hypothetical Hedge Fund Beta Portfolio

TheS&P 500

Index(Last 5 Years)

TheS&P 500

Index(1990 - Present)

HypotheticalHedge FundBeta Portfolio

(1990 - Present)


Source: AQR proprietary data. Data updated through 9/30/09. Returns, volatility and correlations are annualized net figures based on quarterly data. The hypothetical hedge fund beta portfolio performance is for illustration purposes only and not the returns to an actual fund or account. We use a 1.00% annualized fixed fee and no performance fee for the hypothetical hedge fund beta portfolio. (We believe this is a reasonable assumption.) Importantly, the HFRI Fund of Funds Composite Index and the CS Tremont Hedge Fund Index are non-investable indices. Please see important disclosures relating to the hypothetical portfolio details, performance and risks in the Appendix.

Hypothetical Net Returns of a Hedge Fund Beta Portfolio and Hedge Fund Indexes

… And It Seems To Work

$0

$100

$200

$300

$400

$500

$600

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Tota

l Wea

lth

Hypothetical HF Beta Portfolio

CS Tremont Hedge Fund Index

HFRI Fund of Funds Composite Index

Annualized Annualized Sharpe Max DrawdownNet Return Volatility Ratio (Peak-Trough)

Hypothetical HF Beta Portfolio 11.9% 5.7% 1.4 -9%CS Tremont Hedge Fund Index 9.3% 7.9% 0.7 -20%HFRI Funds of Funds Composite Index 6.0% 6.3% 0.4 -22%


Portfolio Construction: Skill ExposuresObjectives of Skill Exposures

Deliver exposure to investment managers’ ability to either time different markets or select specific securities.

Provide unique, diversifying return streams; may require longer lock-up periods and use of leverage

Focus on large-scale sources of manager skillCapacity

Active strategies should have low correlation to traditional marketsCorrelation

Find managers with different expertise and strategies that are differentiatedDiversification

Acting against trends and conventional wisdom is a form of skillContrarian

Get paid for your long-term horizon by providing liquidity when it is in short supplyLiquidity


Returns From Being a Contrarian

Taking a long-term contrarian view is a form of “value” investing – available in large capacity

Basic mean-reversion concept – something beat-up is candidate for addition• Large absolute drawdown

• Large drawdown relative to other investments

• Active strategies that have meaningfully trailed their benchmarks

• Direct measures of valuation or attractiveness

Applies at the asset class, strategy and even manager level• Even strategies that do well long-term often have multi-year periods of underperformance

• Investors rarely give managers enough time (okay, that’s self-serving)

• Evaluation periods for managers correspond to periods over which value strategies work


Opportunities to Provide Liquidity

IDIOSYNCRATIC EVENT EXAMPLES

Risk Arbitrage

• Merger spread blowouts

• Trade opportunities around merger elections

Capital Structure

• Dual-class shares

• Cross holding “stub” trades

• Distribution of shares via spin-offs

Corporate Financings

• Technical dislocations due to concentrated hedging

• Debtor-in-possession and bankruptcy exit financing

• New issues and exchange offers

SYSTEMATIC EVENT EXAMPLES

Market dislocations

• 1998 LTCM affect on convertible and merger arbitrage

• 2005 convertible arbitrage blow-up

• 2008 arbitrage strategies general de-leveraging:

• Convertible bonds

• Closed-end funds

• SPACs

• PIPES


Convert Arbitrage attractiveness is measured by median deviations of bond prices from theoretical values

In December 2008 attractiveness was at 99th percentile cheap, which was over three times as high as any period prior to 2008 in our data set (which goes back to 1985)

Contrarian Opportunity: Convertible Arbitrage

Source: AQR Proprietary Models. Theoretical value is hypothetical in nature. Please see important disclosures in the Appendix. Data updated through 9/30/09.

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

`

Cheap Convertible Bonds

Expensive Convertible Bonds

Median Discount of Convertibles to Theoretical Values*


Conclusion: Portfolio Construction and HF Beta1. Portfolio construction focuses on allocating risk to three return sources:

• Skill

• Dynamic return

• Market Return

2. Hedge fund beta provides a new approach to dynamic strategies that had been offered only through active managers / hedge funds• Investors seek non-market return sources in their portfolios

• Using hedge funds to access these returns had drawbacks – fees, liquidity, lack of transparency

• Hedge fund beta may be a better, more efficient, more transparent approach to accessing these return sources

3. Risk Parity products offer an alternative to over-reliance on equities for market return


Appendix – Performance DisclosuresThe information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Please obtain the advice of your fiduciary prior to any investment. This document is intended exclusively for the use of the person to whom it has been delivered and it is not to be reproduced or redistributed to any other person. AQR Capital Management, LLC ("AQR") does not make any representation or warranty, express or implied, as to the information’s accuracy or completeness. This document is subject to further review and revision. You should be aware that there are certain conflicts of interest that may exist in the provision of this information such that you should not rely principally on such information as the basis of any investment decision. AQR has sponsored and manages a number of other private investment funds, proprietary accounts and various separate institutional accounts, each of which uses quantitative return forecasting models and systematic risk control methods to pursue a variety of strategies and which may differ from the investments discussed herein. While AQR acts in a manner that it considers fair, reasonable and equitable in allocating investment opportunities to each of its private investment funds, proprietary accounts and various separate institutional accounts, there are no specific obligations or requirements concerning the allocation of time, effort or investment opportunities to each fund or account nor are there any restrictions on the nature or timing of investments for the various funds or accounts which AQR or its affiliates may manage. Please refer to item 9 of AQR’s ADV Part II for additional information on potential conflicts of interest. The recipient should conduct his or her own analysis and consult with professional advisors prior to making any investment decisions. Any investment made will be in the sole discretion of the reader.

Past performance is not an indication of future performance.

Hypothetical results (e.g., quantitative backtests) have many inherent limitations, some of which, but not all, are described herein. No representation is being made that any fund or account will or is likely to achieve profits or losses similar to those shown herein. In fact, there are frequently sharp differences between hypothetical results and the actual results subsequently realized by any particular trading program. One of the limitations of hypothetical results is that they are generally prepared with the benefit of hindsight. In addition, hypothetical trading does not involve financial risk, and no hypothetical trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or adhere to a particular trading program in spite of trading losses are material points which can adversely affect actual trading results. The hypothetical results contained herein represent the application of the quantitative models as currently in effect on the date first written above and there can be no assurance that the models will remain the same in the future or that an application of the current models in the future will produce similar results because the relevant market and economic conditions that prevailed during the hypothetical performance period will not necessarily recur. There are numerous other factors related to the markets in general or to the implementation of any specific trading program which cannot be fully accounted for in the preparation of hypothetical results, all of which can adversely affect actual trading results. Hypothetical results are presented for illustrative purposes only.

There is a risk of substantial loss associated with trading commodities, futures, options and leverage. Before investing carefully consider your financial position and risk tolerance to determine if the proposed trading style is appropriate. Investors should realize that when engaging in leverage, trading futures, commodities and/or granting/writing options one could lose the full balance of their account. It is also possible to lose more than the initial deposit when engaging in leverage, trading futures and/or granting/writing options. All funds committed should be purely risk capital.

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AQR MANAGEMENT CAPITAL - Granicus