In Conversation with Martin Lueck – Aspect Capital

The Aspect and AHL co-founder tells his story, Part 2

Originally published in the October 2014 issue

Niels Kaastrup-Larsen in his podcast, Top Traders Unplugged, interviews some of the most successful hedge fund managers in the world. In episodes 37 and 38, Niels speaks with Martin Lueck, co-founder and Research Director at Aspect Capital. Lueck is well known in the alternative investment industry as one of the co-founders of AHL in the mid-1980s. The second part of the interview begins with Lueck explaining the Aspect Diversified Programme. The first part of the interview can be found here.

Martin Lueck: By 2004, in particular, a couple of trends converged, or effects converged. Number one, actually Aspect was doing reasonably well. We had had a run of good performance. We had managed to raise assets, so I think we were a fairly sizeable account for many of our brokers and market makers and when we’d hit one of those discrete trading points, I’m sure it was a very attractive piece of flow. So first of all we were noticeable. Secondly, I want to highlight in the FX markets that this was the era of disintermediation of the interbank market, do you remember that? As it became more democratized and everyone had access to the same price feeds, well the bank trading desks had to make a living and spent time understanding our models. So back to the early point about being picked off. What that told us was that we just had too much of a market impact. We were too visible to the markets, so around that period these were the same effects we were capturing, Niels, but in a different way that meant that our entry and exit to the markets were much, much smoother and effectively invisible. So since then huge development and huge focus on execution, to really obfuscate what we are doing, to dribble our trades into the markets in random pieces at random delays, and really trying to exploit the market volatility rather than forcing our business to get done as quickly as possible.

Niels Kaastrup-Larsen: Sure, interesting.

ML: So that was a sort of starting place to describe what the Aspect Diversified Programme looks like today. In talking about the grand sweep of how the programme has evolved, it has remained predominantly medium-term trend following. That is what we are committed to delivering to our clients, so when you go through a challenging period for trend following, the temptation is to introduce other models or to change the weights either to reflect what would have worked, or to reflect what you think will work. We don’t think that’s our place. It is for some other firms because they’ve sold themselves as multi-strat or whatever it is, but our place is to deliver high-quality medium-term trend-following returns to our institutional and now broader client base. 80% of the portfolio is focused on those trend-following models. We trade over 150 markets and multiple contracts in many of them, so it’s probably around 180 or 200 instruments. 20% of the risk, Niels, is in a range of modulating factors, or complementary models that are designed to, if you will, take some of the rough edges off of trend following, or take advantage of orthogonal or diversifying effects that we believe have a similar level of persistence or attraction as the momentum component.

NKL: Right, so not really mean reversion or counter-trend, or is it more on the exit side that helps you get out a bit quicker or get in a bit earlier?

ML: Actually I’d sort of think about it slightly differently. I may have misled you by using a term like modulating: what that doesn’t mean is that they are all focused on what the trend models are doing and are therefore speeding them up or slowing them down or making them more sensitive or not. Actually, they’re effectively capturing other factors. It may be that some of those factors are related to the trend following. So it may, for example, be relative momentum between instruments in your trend-following portion which clearly is a diversifying effect, but they will have the effect of capturing diversifying factors. You’ve got different information sources: whether it’s a carry effect in FX, or in fixed income, or in equities. You can look at features and different dynamics of the term structure. You can look at mean reverting or other market dynamics – typically faster strategies, but we don’t choose to look at them as, “Is this getting us out of our trend-following position?” I should also stress that we continue to evolve and improve and hammer away at the trend-following piece, and I’m often asked that in due diligence questionnaires. You know, you’ve been doing this for 30 years – I would have thought you would have figured it out by now. There’s always more that you can do, and it’s fascinating.

NKL: Yes, absolutely. How do you weight the portfolio in broad terms between financial markets and commodity markets, because that’s always being brought up when you compare smaller managers to larger managers?

ML: Well, not surprisingly, our starting point is a very agnostic outlook. So we absolutely defy or eschew the world view that says you can look at what’s happened historically and predict what’s going to happen in the near future. Obviously, that is essentially what the behavioural aspect of trend following is based on – your ability to infer that because I had a good run in bonds means that they’re going to continue to perform so I’m going to go overweight in bonds. That’s not something that we ascribe to. We are seeking the most agnostic portfolio construction we can, and, therefore, if I had no liquidity or correlation constraints I would trade an even spread of sectors, Niels.

So my starting place is broad diversification across, we talk about seven sectors internally, and then I will modulate – I’ve used that word too often – I will flex that agnostic diversification with appropriate consideration for the long-term structural correlation between markets, and also cognizant of the liquidity characteristics of the markets. That’s something that we review on a regular basis, and the portfolio allocation structure slightly flexes very gently around different liquidity characteristics. Obviously there are hard limits that the exchange will impose on you in many markets that you can’t be bigger than position X, but we also impose our own much more conservative constraints about how much of the average daily volume or the open interest we’re prepared to be, and how much we’re prepared to be in tail events. All of that feeds into a process that regularly and systematically determines what the allocation will look like.

NKL: Do you have a lot of scope for growth when you look at the markets you trade, the balance of the portfolio as it is today, and the constraints that you just mentioned? Does it still allow you to grow substantially from here without having to change that side of things, so to speak?

ML: Absolutely. There is considerable capacity in the programme, and we’re very careful about it. I don’t say that willy-nilly, because as those flexes happen in the programme, we look to understand different features, how that’s changing the correlation structure, and any potential impact it has on the markets. That gives us a great deal of comfort, there’s significant capacity, but it also, Niels, gives us a clear point at which we know we need to be careful. So it’s not like, “Yeah, just keep going until something goes wrong.” It’s, well, given these conservative constraints, when we hit this particular point then we need to be very careful. What comes out of that is, number one, you need to be cognizant of not just your own size, but also what’s going on in the markets. You could stand still, and the markets could dry up. So you also need to be aware of that risk.
NKL: Let me ask you a slightly different question, and that’s about, as you say, you need to be aware of what the markets can handle. I assume that you trade foreign exchange and not just foreign exchange via futures?

ML: Yep, we trade them both, but predominantly interbank.

NKL: Sure. Given what happened in 2008, 2009, where certainly liquidity in those markets seemed to change dramatically (let’s put it that way) and what’s going on in the financial industry as a whole today, the concerns that we have perhaps with some of the things happening in the banking sector and what the central banks are doing, and the fact that it’s really opaque in terms of what is inside a bank, are you concerned about liquidity drying up again should we enter into a new phase of the crisis? Have you learned something to deal with that sudden change in liquidity in a market?

ML: OK, well, there are two parts to that. One is the sort of ambient liquidity of the markets and our ability to respond to changes in those. If we see the spread expanding, or we see a period of unfavourable behaviour in our execution algorithms, how we respond to that, I’ll come back to in a second. The other – I don’t know whether you were alluding to this – was in the crisis of 2008 there were literally bank lines being frozen. So again, at least we were cognizant before 2008 that a prudent managed account holder will have back-up relationships, and certainly we had back-up prime brokerage relationships. So for everything that we do – and again that’s sort of I think a truism now for most of the institutional money management firms – you’ve got multiple clearing houses; you’ve got multiple prime brokers. If you can persuade your clients to go through the pain of setting up those multiple relationships and you can go through the additional burden of keeping them alive, it just means you have that degree of flexibility that if, heaven forbid – but it did happen – heaven forbid your lines dry up with prime broker A, you can move those positions and carry on trading at prime broker B. So absolutely, I think we were well placed to survive that cleanly in 2008, but we’ve continued to strengthen that feature of the business, that operational robustness. I think that the regulators and the due diligence folks that have come in have seen that that was probably a model of how to do it.

In terms of the market dynamics, well you’ve sort of highlighted one of the most challenging markets to get true numbers on what liquidity dynamics are. I make two observations. First is the point I wanted to make earlier: in addition to being clear about what our capacity is with a given set of markets, we can continue to monitor and include new markets. So over the past few years we’ve introduced a range of non-deliverable currencies which expands the universe of opportunity. It also expands the complexity of monitoring their liquidity profiles. But I think that the most important feature in what we do is that approximately 95% of our strategy trading is handled box-to-box. It’s electronic execution, but it’s monitored 24 hours a day by the very experienced trading team, and they have certain circuit breakers or thresholds or canaries in coal mines, if you will, that indicate where we see sporadic changes in liquidity profiles, shall we say. If we see those, the portfolio construction will adapt.

NKL: So on one part I think many people think of trend following as, OK, you get your signal to buy or to sell, and then you follow along for the ride, and you have some kind of position size algorithm, but when I listen to what you’re explaining, I think what you are actually saying is that since you have smoothed out this process, the position size is more a reflection of the strength of the signal. Because the more confirmation you get, the bigger you will build your position and so on and so forth. In my mind, I think a lot of the secret to success of trend following is not so much where we buy and where we sell, are we a day late, or a day early? A lot of it is really the risk management and thereby the position sizing itself. That’s a big part of the secret sauce to the success or the robustness of trend following. How doyou view that?

ML: I think you’re absolutely right, it’s what we do as a holistic challenge. You can get overly focused on an individual trend-following model at an individual time scale, but it’s the combination of all of the pieces put together, and the combination of all of the markets put together, and how you risk manage the whole that determines, obviously, your end performance. So I make two observations. The first is that the positions that we hold are, yes, a function of signal strength and conviction, but that, as you would expect, would be modulated by what you perceive as the risk of the market. So for a given signal strength, if I see the volatility of a market – which is a cipher for risk, if you will – if you see that, say, double, I will effectively halve my position to maintain the same risk for that given signal strength. Point two is that it’s not an inexorable line. The stronger the trend, the bigger the position I’ll put on, but as you can imagine, Niels, to do this without limit would be madness. So there’s knowing effectively when to back off and perhaps when to be a provider of liquidity to the markets rather than a consumer of liquidity. That’s another delicate feature of what we do.

NKL: Yeah. So in effect, just to be clear, you’re not actually using a stop loss per se, because it comes automatically as the strength of the signal changes – your position changes along with it.

ML: That’s exactly right. So it’s a gradually modulating signal. Obviously we spent time researching super-fast intra-day models, and there’s utility in there, and some people do them very well, but one of the things that I like to stress, for an institutional investor, is the intuitive quality of medium-term trend following. What I mean by that, Niels, is that if you read the Financial Times or the Wall Street Journal or your local financial newspaper, and you follow roughly what’s going on in global markets, then you will have a good intuitive sense of the positions that we hold. Obviously the detail and the complexity of exactly the position size that we hold, as you’ve said, is a function of signal strength, volatility, where you are in the development of that trend, portfolio construction, risk management – are you up against any exposure constraints, all of those pieces? But by and large if you stand back just a short way and look at the ebb and flow, at the dynamics of how that portfolio is moving from day to day, it’s very intuitive. You can broadly, as an institutional investor, understand why a trend-following portfolio makes and loses money when it does.

NKL: Which has always, actually, puzzled me, because people often criticize what we do from saying that it’s complex, it’s difficult to understand. I’m just puzzled about this because it’s really not that difficult to understand that when something goes up you buy, because you think it’s going higher, and if it goes down, you sell, because you think it’s going lower. Compared to a fixed income arbitrage or whatever they call these strategies… yet people seem to love those strategies more. I wanted to ask you just a final point about the programme itself. Going back to research a little bit here, how much research do you actually need to do to overcome, or to improve efficient execution? Is that a big part of research when you get to your size, to make sure you can continue to grow and have efficient execution?

ML: Yes, as a research team we look at the problem of continuing to evolve and develop the programme. We break it down into the core trend-following components: the diversifying modulating strategies; the portfolio construction and risk management piece; and execution. By and large there is always someone working on something in each of those areas, and over the sweep of time we will have periods of more concentration in one area than in others, so it’s a bit of an ebb and flow. About four years ago we embarked on the transition to a wholly box-to-box. If you look at the history of our execution process back in the good old days of where we would trade binary in big clips, and we had to get it down to an open outcry market, our execution research, in those days, Niels, was to go to Chicago and meet the biggest and “baddest” floor brokers, and you’d hire them, because they got to the front of the pack. So over time markets have become more electronic, and that’s played into the technology-led firms. Then actually taking the leap to a predominantly box-to-box world, albeit monitored carefully, that has been an enormous commitment of research effort and investment. It requires ongoing monitoring. I would stress that we don’t do high-frequency trading (HFT), so we’re not going head to head with sort of an HFT firm, where you’re swapping out algorithms every few minutes or every few hours. We have a suite of execution algorithms which are generally fit for purpose. We ensure that they are correctly parameterized for the liquidity. Markets change their characteristics. What is the sort of resting bid-offer spread? What are the typical clip sizes that people are making available? Those are the characteristics of markets that we need to review and re-parameterize on a regular basis, and obviously monitor if they’re changing more rapidly than we expect. It’s an ongoing monitoring effort. I think because we’re not slamming the markets with very fast models, our execution algorithms are predominately looking to make us (I’d love to say) invisible, but certainly to obfuscate what we do and to capture, if you will, a patience premium. We’re not in a hurry to get our business done, but it’s an ongoing effort.

NKL: I have a general question regarding risk management and that is, how do you define risk? Meaning, there are so many different risk measures: people talk about value at risk, margin to equity, position size, risk to stop, whatever it might be, but is there something that you’ve come across which you feel very comfortable with looking at when you look at risk, what that means to you and to your portfolio?

ML: Well, I’ll go slightly at a tangent. I think that I’ve banged on earlier about how important we think the risk management challenge is in terms of how you put the component pieces together and then ensuring that you don’t get transfixed by VaR measures – making sure that you have other measures of risk. I think that’s been an important piece of the puzzle for us, and stood us in good stead in this period of extremely low volatility, where you run the risk that if you are just looking at VaR you can blow up, and up, and up a position and then if volatility returns to the market, you can get a very unpleasant surprise. Yes, we look at that suite of issues, and yes we’re obviously very focused on operational risk; having had the institutional piece very much is fundamental DNA of Aspect.

The other thing that I think is interesting about how we’ve approached risk is if I talk about model risk for a moment. I think this is great, and again it’s part of the journey that this was never written in a textbook anywhere. As I say, I couldn’t spell risk in the early days of AHL, and for a while the consultants would come in and they’d say, “Who’s the director of research?” Michael Adam or I would stick up our hands, and then they’d say, “and who’s the director of risk?” And we’d also stick up our hands, and they’d sort of say, “Well that doesn’t work.” The point here is that we talked earlier about encouraging a collegiate and collaborative and innovative research effort, and that’s what we’ve done, and I think we do it quite well, but it’s having the right checks and balances. We try to create an atmosphere that’s sort of like an academic peer review group. So we have just a super risk team. Every one of them is just as smart and just as experienced as any of the researchers, and it’s their job to shred, if they can, the best research that comes out of the research team.

So there’s a very formal risk review process. Every component that comes out, every new component idea that comes out of the research team – whether it’s an evolution or an improvement to the trend-following piece, or a new modulating strategy, or an amendment to the execution algorithms or the portfolio construction methodology – each one of those will get looked at in isolation and taken apart with some out of sample data and some synthetic data, and then we also conduct an examination of the underlying hypothesis and the failure cases. They absolutely stress their components and then, Niels, we typically aim for three releases a year. They look at the holistic release. I may have a couple of tweaks, evolutionary improvements to the trend following. I may have something new going on in the modulation piece. I may have another, but they get aggregated into a new programme release and the risk team will have reviewed every component, but then they also review the dynamics of it overall, how all of the pieces work together, and I think that is a crucially important piece of the problem, which again may get under-recognized.

NKL: Yeah, definitely. Do you think correlations today are a meaningful thing to look at, or are we just living in a world where markets get more and more correlated, certainly within sectors, but maybe even across sectors?

ML: I absolutely think it’s a crucial thing that we look at both for the opportunity set, in what we do, and also for the risk management challenge. I think that it ebbs and flows, and we’ve been through a period of, as you say, what has felt like a secular increase in correlation. In the risk-on, risk-off world of 2012 you began to think if somebody had singled you out to be taken apart. I think right now we’re seeing correlations begin to fall, signs that the opportunity set is broadening. So I don’t give up on the prospect of having diversification. I think absolutely the world is now a much more diverse set of opportunities than it was 18 months or two years ago, Niels.

NKL: Now we’ve talked about the risk management side, and of course part of what we have to accept in running these strategies is drawdowns. One of the things that investors seem to struggle with, if I can put it like that, is the emotions that drawdowns bring with them. You’ve been around. As you’ve mentioned, you’ve seen it before. How do we best help investors understand that a drawdown in a strategy like yours is not necessarily the same as some kind of open-ended risk where it’s just going to continue to go down, and down, and down, again? Of course, we are dealing with issues that are related to how the human mind is working and we have these biases inside us, but how do we best give them confidence in times of drawdown and help them take some of the emotional stress out? I ask this, Marty, because we see so often that investors leave the CTA strategy at the worst possible time.

ML: I don’t know whether you are familiar with Peter Lynch, who was just sort of a legendary fund manager at Fidelity? I once saw a piece of analysis that looked at how much money individual investors had actually made with Peter and it was a tragedy, because as his performance would leap forward, that’s when the money sloshed in, and then he would have a drawdown and that’s when the money sloshed out, so if you aggregated those chunks of money that typically bought at the high and sold at the lows, it was nowhere like the performance that the chap had generated. When you’ve got an upset client you probably don’t start the conversation with that observation, butit’s one observation.

The next observation I make is that, again, provided the client has bought into managed futures for the right reason (you know what I’m saying here); if it’s just popped out the top of the only thing that made you money in 2008 and you just say, well, I’ll have some of that, without understanding its role as a diversifying constituent that will move risk to capture the prevalent opportunities, be that rising or falling markets on a well-diversified basis. If they have understood that, it is in their portfolio to provide diversification from the equities piece and the bond piece and whatever other assets they have in the portfolio, then what goes with that is by definition you’ve put this thing in your portfolio because it’s uncorrelated, then when you have periods that equities are plummeting, and your managed futures are making money, then we’re OK aren’t we, Niels? We’re heroes, but if you turn that around and equity markets are booming and managed futures are losing money, well you’re an idiot, but that goes with the turf. Obviously I’m not trying to present it as anti-correlated with equities, because we know it isn’t, but that low level of correlation does mean that it will behave differently from the stuff that is certainly on the front page of the FT or the Wall Street Journal. So there is a level of idiosyncratic risk. First of all you have to make sure that your clients are comfortable with that idiosyncratic risk, and they look at it in the context of their portfolio rather than just transfixing on the line item.

Second thing is, everything goes through a drawdown, whether it’s managed futures or the equity markets, and boy, when equity markets hit a drawdown, they really do it well. They make our drawdowns look small, and any other strategy. No one factor, Niels, is going to work all the time, but a well-constructed portfolio that exposes you to equity risk premium, to carry from time to time, to value investing… I mean, gosh, those value investors around the time of the tech bubble, they were getting it in the neck, but if you saw a value investor suddenly change their spots and become persuaded that they’ve given up on my value investing approach and are going to become a momentum trader, you’d probably run for the hills. All of those are good reasons to support sticking with the strategy that you have invested in and the utility that it provides to your portfolio. In my view, that’s also a little bit of a reminder to the manager community that investors have bought us because we provide a utility to them. You don’t want to go surprising them and suddenly looking like a carry trade.

NKL: Sure, I completely agree, Marty. I think again, as you rightly say, it’s not just about investors necessarily not understanding the concepts in full, it’s also about how we, as managers, have tried to explain it over the years, and maybe we haven’t done a good job in doing that. I personally find that maybe we’ve spent too much time focusing on explaining how we do things and what we do rather than actually focusing on why we do it, and I think again, if you can get people to buy into why you do what you do, and your beliefs, so to speak, it becomes a different and a much easier conversation – so I think that’s true. I wanted to ask you just one more question on the drawdown side, and maybe it’s a very short answer for you (but I don’t know): we try to eliminate risk as much as we can; we try to manage risk as much as we can, but is there anything that’s left in the back of your mind when you go to sleep at night and where you say, “Hmm, I don’t really want to wake up tomorrow and this has happened”; meaning, is there anything where you simply just accept that this kind of risk I can’t eliminate? So is there anything that could keep you up at night?

ML: That’s one of those questions where the more you think about it, the less sleep you’ll get. Risk management, I think, is about finding the right balance. On the one hand, we are paid to take risk, Niels, but on the other hand you don’t want to take foolish risks that could be avoided. So starting at the really extreme end, the world we live in is a febrile place at the moment. We’ve all lived through various things, whether they’re terrorist attacks or hurricanes or tsunamis, which can knock out your ability to trade. When you put it like that, well, it’s only money, as compared with the loss of life and the significance of these effects, but we do need to think about it. It’s something to be aware of: what would you do in the event that a certain exchange is incapacitated? In an electronic world that is somewhat less of an issue than on the open outcry floors, but still, one’s inability to trade a market just has to be one of the most uncontrollable events that you can deal with. Then you sort of work your way in from there. We’ve talked about having multiple prime brokerage and clearing lines. We obviously have a fiduciary responsibility to our clients to make sure that their money is as safe as we can possibly ensure that it is, and that it doesn’t get stuck, if there’s some kind of financial or, again, geopolitical event. I think then, really, the risk management challenge is just to never be complacent. You’ve talked about the psychological challenge. Clearly there are psychological challenges for the investors. It’s our job, as you say, to help them understand and to work our way through in the spirit of partnership, but there are also psychological challenges as a manager. You should just expect always to see something new.

NKL: Yeah, true. I wanted to ask you also, it’s a little bit about risk, but it’s a completely different question. I want to tap into your mindset, if I can put it that way, because you started off many, many years ago with $25,000 and then later on $100,000 and so, as an entrepreneur, your mindset is of course, “OK, let’s do it, we’re going to take certain levels of risk”, and as you said you over-optimized. You did all sorts of things, but you didn’t have any fear that, “OK, if it doesn’t work it doesn’t work,” and the consequences, if I can put it that way, were not so grand at that time. Then suddenly, years later, you’re super-successful. You’ve got billions of dollars under management. You’ve got 120 people to feed every month. How does that impact the mindset and the risk willingness, so to speak, of you? Does that automatically lead to becoming more risk-averse in a sense?

ML: It probably does, Niels. I think it’s part of the journey and also part of growing up. In the early Brockham/AHL there was no roadmap for what we were doing, and we just took one day at a time and if it had all blown up, well, it wasn’t a good idea in the first place, and we all would have gone off and done something else. Then you find yourself in the position where you are managing billions of dollars of other people’s… it is important – it is pension fund money, it is people’s savings, it’s people’s hopes and dreams and, as you say, 120 fantastic people. I put it down, actually, to teamwork. I’ve sort of alluded to the fact that my business career is not predicated on my genius, because there isn’t much of that. It’s on being fortunate enough to work with some really talented people.

In many ways, I think what I’ve tried to do is almost keep a child-like enthusiasm and energy and outlook. So it’s somewhere between child-like and scientific. There’s always new information. There are always new opportunities. There are always reasons to be cheerful, and that’s my mindset. I think the maturation process that has happened to us as a business is that I trust and surround myself with people that really nail thisdown way better than I can. I think what I’m saying is that I haven’t taken it upon myself to be all things to all men, to all investors. I think that it’s a combination of, sort of, that you need the yin and the yang; you need the people that are still entrepreneurial and coming up with wacky ideas, and then you need that thorough, diligent, process-driven risk management, constant review, constant “Could we do this better?”, and that’s in our DNA, but I like to think that we still have some of the youthful enthusiasm that hasn’t gone away.

NKL: I’ve got a couple of more questions before we go to the last section which is the more general and fun stuff, but you talk about the vision. What’s the biggest challenge that you see in that future evolution, or where we are right now? What do you think is the biggest challenge that you face?

ML: Challenge and opportunity. Growth and evolution is not a linear process, is it Niels? You sort of think you’re on a ledge, you think you’re in equilibrium condition, and then something comes along, and the world shifts. I think it’s being able to adapt to those shifts and seeing the opportunities rather than just the threats. I think what’s going on is that this extended period of challenging performance has rattled many investors, and it speaks to the continuing evolution of the fund management industry in general.

We’re seeing an evolution in our space and in other hedge fund, or alternative strategies. There’s fee pressure, there’s pressure to deliver purer factors, if you will, and we can all say, oh dear, it’s not what it used to be, fee yields are not what they used to be, it’s a terrible thing, and hope this performance returns so we can all crank our fees back up. I view it as a natural evolution and opportunity. Also, combined with that is that once-upon-a-time if you wanted to – as everyone should have wanted to – get into managed futures and have them in their portfolio, goodness me, we make it hard as an industry. So when I talk about democratization, when I talk about a place in the model portfolios of pension funds and of Mom and Pops, that’s where I want it to be. So yeah, there are challenges, fees, performance, drawdowns, all of the things that we dwell on, but it’s also a fantastic set of opportunities.

NKL: Absolutely. It’s no secret that a small percentage of the hedge funds and managed futures industry manages a very, very large portion of the assets. I don’t know the exact numbers, but if I say that 10% of the managers manage 90% of the assets, it’s probably not that far away. Is there a risk in that – that so many of the smaller firms struggle and essentially are being forced out?

ML: It is a Darwinian process, so I think, if I look into my crystal ball, I think what’s going to happen is performance will return. I don’t know when. Don’t take that as a guarantee, but as performance returns for what we do, and people’s appetite for it improves, then some of the smaller folks who have just not had a chance recently in a very difficult environment are going to have a chance. I think some of these seeding funds and some of the fund of funds managers that make a point of investing in the smaller folks are going to have a run, and then – I won’t say a change of the guard, because I’m not going anywhere, and I’m sure David isn’t going anywhere – but you will see some other people develop substantial businesses, and I think that’s fine, again, so this isn’t about me trying to raise the barrier to entry and make sure that nobody else can get in here.

NKL: I try to remember to ask my guests what they would like to ask the next guest that I speak to, to get kind of a trader’s insight to what would be really interesting to hear, but with you I’d like todo something slightly different, and that is to say, what would you like to ask my next guest, and what if that guest was David Harding?

ML: Ohh… well… David… we, usually, run through a random set of topics whenever we meet and speak, and he’s highly entertaining. I think, given what we see from the outside of Winton, I would love to get his perspective on does he see the managed futures industry continuing as a self-standing entity, or is it going to be subsumed into some kind of mainstream mega asset management business? Is Winton, AQR, Bridgewater, are these the mega firms of the future – the Googles and the Facebooks of our industry – or is there still space? And does he still think of himself as a managed futures manager?

NKL: Final question on this section, and that is, you mentioned before that you were obviously part of many, many due diligence meetings, phone calls, questionnaires and so on and so forth, but I wanted to ask, what do you think is the question that investors forget to ask (or fail to ask) when they do their due diligence today? What should they be asking you?

ML: I don’t have a sound bite of the one question that they’re always missing, but I think it’s a lot of the area that we’ve covered. It’s making sure that both they appreciate and that the manager that they are speaking with appreciates that it’s a holistic endeavour. So when I speak to fledgling managers, or people that we’re talking to – and as you allude to, it’s a difficult environment out there, so we do speak to a lot of folks that have run some money – if the person is just banging on about their entry points and exit points and the stochastic model, that’s important, but it’s by no means the whole story. It’s making sure that the manager can articulate how they… many of the questions you’ve asked me: how do you put the pieces together? How do you think about the risk management? How do you think about evolving this? What do you like least about your programme at the moment, and what are you doing about it? I think it’s the ability to evolve the programme that is crucial, and that’s what separates the long-standing firms from the untested.

NKL: I wanted to ask you about what you feel it takes to become a great trader, a great fund manager, but in more of the context as to those who have hope and aspirations to one day be the next Aspect, is there any advice that you can give to new, or smaller, managers, for that matter, that they can learn from, lessons that you’ve learned over the years that have helped you get through different times and evolve?

ML: I think my starting place is it’s obviously just a very broad church, and my particular style is different from say David’s, is different from a discretionary macro manager, or discretionary CTA, so I guess the sort of first nugget is be true to yourself. If you are just a passionate discretionary trader, then hone those skills rather than constraining yourself unnecessarily by the belief that it has to be systematic. I don’t know. Or actually conversely, the other way around, because I look at someone like me and I am way more of a scientist, Niels, than I am a trader, and therefore we have tried to capture in the model how we would rationally respond to events, to how the portfolio evolves. Which isn’t to mean that we don’t supervise it and watch it all the time, but my point here is that if you build a model and say, well, that’s good enough for normal running, and when the VaR explodes, or the correlation explodes in the portfolio, I’ll have to step in and make a discretionary call on down-gearing or cutting out a position or sector or something like that… So if somebody says to you, I’m 95% of the time systematic, and I’ve got discretionary leg: “No, Niels, you are 100% discretionary, and you will beunable to get the confidence about the integrity of the models that you developed and the usefulness of any back tests that you do.”

Last point – sorry I keep banging on – when I talk about that risk review process being both at a component level and then also aggregated across the whole release, that’s really crucial, because what we’re doing in that exercise is basically going back through time and challenging ourselves to say, could we have run that programme? You can say, “Oh, this is a brilliant and fantastic model, and I’ll just bang them all together.” If, in 1994 or 2005, or 2009, it would have concentrated the portfolio into a place where you just couldn’t have hung on to that size position, and you would have intervened as a manager, or your client would have called you up and said, “What the heck are you doing?” then you can’t launch that programme. You’ve got to build in an appropriate constraint, or you’ve got to modify the admixture so that it doesn’t do that under those circumstances. Does that make sense?

NKL: Yes, it makes a lot of sense, and I think you actually said something very early on in this answer that I think is really, really crucial because, no doubt, there are so many firms that aspire to be like an Aspect, or aspire to be like a Winton, because we believe that this is what investors want us to be, and therefore we should be like them. At the same time nobody is going to buy a firm that is essentially just trying to be a lookalike of something else, because then they can just buy the real thing, so to speak, so we also try to be different and differentiate ourselves. I think what people sometimes forget is that the only thing that really differentiates one manager from another is the manager themselves. So be true to yourself is such great advice, because that’s really what it comes down to.

ML: I would say so too.

NKL: Is there any book that you would recommend that people should read, and I’m not referring to your physics books back at Oxford, but maybe just something that during your career has made a big impact on you and something that you would recommend?

ML: I hark back to the days of Michael Adam’s father, Cyril, handing us a book on technical trading models. That was very formative. I have always credited Jack Schwager with it, but I’m not sure that it was Schwager’s book, so I would refer to that as a good primer, and also, more recently, I’ve had the pleasure of meeting Antti Ilmanen, and I think that he’s just done a super job of surveying the space. In the spirit of learn everything you can, and then focus on where your passion is, I sort of read… I like the short history of Britain, or I think there’s one book called Brideshead Abbreviated, so it’s just sort of precis versions of the great novels, because life is way too short and there isn’t time to read everything that I would love to read. Similarly with some of these, like Antti’s book, it’s an absolute classic to give you an overview of many quantitative investing techniques.

NKL: Sure. If you, Marty, could go back and meet your younger self is there anything that you would tell yourself to do differently based on all of your experience that you have now?

ML: Lots, Niels [laughs]. No big thing, because you can’t have that wisdom until you have the scars that go with it. I think probably recognizing the value of teamship, collegiate reliance on one another, if I could have done that a few years earlier that probably would have been good. If I could have recognized the importance of chemistry and how important it is that you just are comfortable with the people that you are working with, that would be another thing to learn. Would I have done something completely different? I doubt it; this has been a heck of a journey.

NKL: Yeah, absolutely. Almost final question, Marty, is there a fun fact that you can share about yourself that people who might even know you don’t know about you?

ML: Very little fun [laughs].

NKL: It could be a talent, a hidden talent. It could be anything. I don’t know; I’ve heard many different answers to this question, and there is no wrong or right.

ML: My friends would all roll their eyebrows, particularly my kids, so the little anecdote I’ll end on is: I talked about my eager days as a skier and mountain climber; so in fact the romance with my wife began on a climbing expedition up Mount Kenya. So to celebrate that on our 10th wedding anniversary I surprised the family and took everyone, so we had four little kids by then, and took them all down to Kenya for a surprise vacation. On the plane down there – so this is pre 9/11 – a nutter got in the cockpit and took control of the jumbo jet, and we basically went free-fall, fell out of the sky, and it was all quite dramatic and very traumatic, and we landed and got on with our lives, but it was sort of a singular watershed. My children always go, “Oh, don’t tell the airplane story Dad.” So I’ve been tried and tested by British Airways, and I understand that it’s part of the training programme now for cabin staff, the film of that flight is part of their training.
NKL: Wow. Now I asked you earlier today about what investors are not asking you about important questions. I also need to be testing my own efforts, so I want to ask you if there’s anything you feel that I have missed, something that you want to add, to ensure that I’ve done justice to you, the AHL story, the Aspect story, anything? Obviously, at the same time, thanking you for helping democratize things by sharing all of this.

ML: I think you are doing a great job. I’m doing my part, and you’re doing yours through these podcasts, so thank you. I’ve become convinced over the years that the role of systematic trading is key, is core to a well-balanced portfolio. I don’t actually think that there’s magic to it. So this could just be shooting myself in the foot, but I think this is less about the genius of the trader than about the repeatability, robustness, thoroughness, and extensibility of the approach. So I think that, whereas managed futures, like so many other hedge fund or alternative industries, has grown out of the flamboyance and the uniqueness, and the flare of individuals, I think that the future is – you’ve got to have those, but it does play more to a model portfolio view of the world – that you need this, and you need other strategies, and whether you get them all from one shop, that doesn’t seem like a sustainable outlook, does it? Whether you get all the pieces of your portfolio from one shop, or whether you get them from numerous different shops, which I espouse, because I think people should concentrate. I think that’s the way it’s going, and that’s what I’ve tried to do, and that’s where Aspect has positioned itself. So less about the cult of personality and more about the cult of robustness, and reliability, and evolutionary improvement.

Niels, it’s been my pleasure, and we can wake up that lady at the dinner table now that we’re done, and I look forward to seeing you soon.

Part 1 was published in the last issue. Listen to the full interview at