AQR’s Aaron Brown on Red-Blooded Risk

Aaron Brown learned how to drive behind the wheel of a 1962 Volkswagen microbus decades before he became risk manager at hedge fund AQR Capital Management. The best thing about the vehicle, he recalls, was its road feel — the immediate sense that every action he took as a driver had a direct connection to the engine and wheels. Automotive technology has come a long way in the past 50 years, but despite a host of LED and digital displays, the dashboard of a modern car is not unlike that of a ’62 VW microbus. Most drivers today have no clue that software mimics old-style road feel even though there are few mechanical connections to the drivetrain. Today a driver could steer a car with a joystick.

The capital markets remind Brown of cars: Investors no longer have any direct contact with people on the floor of an exchange. To be sure, computer-based trading systems and intermediate processing systems make markets far more efficient. But investors lack the road feel they used to enjoy when they knew who was buying and selling. “Our financial system has become so complex that it has no meaning anymore,” says Brown, 55. “It’s a system that doesn’t work.” His observations prompted him to write Red-Blooded Risk, a recently published book that shows how advancements in the mathematical analyses behind game theory radically changed how the most successful investors operate. For example, he says, market participants make the mistake of designing complex risk mitigation mechanisms to cope with high-speed markets. “When a system fails, the urge is to add a system that addresses the failure. But chances are the added system will cause the next problem,” says Brown. “What makes a VW bus so fun is that it doesn’t require a 5,000-page operator’s manual.”