TTU130: Marty Lueck, Co-Founder of Aspect Capital

[00:00:07] Marty

Certainly going into 2023 (with this level of uncertainty), we are going to see misestimation, we’re going to see capital flows, we’re going to see trends in a number of sectors that make me much more positive about the potential returns and the potential utility of an allocation to a liquid alternative, and directionally agnostic unbiased diversifier than there may have been over the previous 10 years.

[00:00:34] Intro

Imagine spending an hour with the world’s greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.

Before we begin today’s conversation, remember to keep two things in mind. All the discussion we will have about investment performance is about the past, and past performance does not guarantee or even infer anything about future performance. Also understand that there’s a significant risk of financial loss with all investment strategies, and you need to request and understand the specific risks from the investment manager about their product before you make investment decisions.

Here’s your host, veteran hedge fund manager, Niels Kaastrup-Larsen.

[00:01:24] Niels

Hey, everyone. Welcome to another edition of Top Traders Unplugged where today, Alan Dunne and I are joined by Marty Lueck, Research Director and President of Aspect Capital, as part of our mini-series focusing on the one investment strategy that beat everything else in 2022, namely, trend following and managed futures more broadly.

First off, Marty, it is great to have you back on the podcast. Thanks so much for joining us today. We have really been looking forward to our conversation, and I hope you’re doing well – had maybe some time off over the holidays after what I imagined was a busy year, which also happens to be the 25th anniversary of Aspect Capital, if I’m not remembering incorrectly.

[00:01:30] Marty

Absolutely right. Niels and Alan, it is a pleasure to be with you both again. I hope you’re well and Happy( almost still) New Year.

Yes, 2022 was an exciting year for many reasons and I think we as a family, like many other people, indulged in a little bit of revenge travel towards the end of the year. So I rounded up my family and we made our first ever trip to New Zealand and had the pleasure of seeing my brother, who lives in Australia, for the first time in five years. So it was really good all around. I’m very happy to be back at my desk for what I’m sure is going to be an equally exciting 2023.

[00:02:57] Niels

Yeah, it definitely will be. We’ll dive into quite a few topics as well that we found, that we thought would be interesting for the audience to listen to. Now, before we do that, I thought maybe we could provide a little bit of highlights, a background to Aspect. So perhaps you could share that. As I mentioned, 25 years in the business. That’s a great achievement milestone. Of course, you’ve been in the business for a lot longer than that. But maybe, talk a little bit about the strategies you run but also how the business looks as we enter into this new and exciting year.

[00:03:38] Marty

Yeah. Well, the origins of Aspect were on the back of AHL, which was the first company I started with David Harding and Michael Adam, and that business was acquired by Man Group, who did, and have done, a super job of exploiting it. We left to start Aspect because at the time, back in the late ’90s, the strategy wasn’t being exploited in institutional investors’ portfolios adequately. That was really our objective was to make trend as a liquid, directionally agnostic diversifier, broadly available and understandable to institutional investors because we felt it was an important addition to their portfolios.

Scroll forward 25 years and I think one more time, that has been demonstrated as being the case; liquid, directionally agnostic, extremely valuable diversifier in investors’ portfolios. Along the way, Niels, we’ve had that consistent focus on research, on enhancing every component of our systematic investment process so that we do our best to think ahead about risk concerns and about managing our investors’ money in a consistent, thoughtful, risk-managed way, and we’ve diversified the business.

So we run a range of programs that are complementary to the original trend focus with a number of relative value and absolute return programs. That’s broadened our research effort and the set of capabilities that we can offer to our investors. So now, the business is 130 people, almost all of us based in London. We manage $10 billion at the start of 2023. I have, I think, a very exciting outlook for the strategy, well, for the range of strategies, in what I think we will probably agree is a new paradigm that we entered into, that we transitioned to over the course of last year.

[00:05:56] Niels

Yeah. Absolutely. Of course, I love your origin story with your co-founders of AHL. I still remember when we huddled together when you had your 30th anniversary of that founding at Abbey Road Studios a few years ago. The chemistry between the three of you was very beautiful to watch after all those years and we had a great conversation that people of course can find in the library of these podcast episodes.

[00:06:25] Marty

That was great, Niels, and I’m very grateful that you were able to round us up and do it. It was a pleasure to be with Michael and David again and, as you say, the chemistry is very similar.

[00:06:43] Niels

All right. Well, we have, as I mentioned, a few different topics that we’re going to go through and we’ll interchange a little bit. So as usual, Alan, why don’t you kick it off with where we want to start.

[00:06:54] Alan

Sure. Good to see you, Marty. You touched on a few important aspects of Aspect, I guess: the research process, systematic trading, liquid markets, directionally agnostic, they kind of all paint a picture of the investment philosophy. When you go back to your early days at AHL and starting up the firm, would you say the investment philosophy has evolved over time? Your beliefs and the opportunities that are available in markets, has that evolved or has that been fairly consistent (would you say) over time?

[00:07:34] Marty

Well, I think the way in, the real origin story of AHL was more three physicists just pottering around with financial data and distilling some essential features of markets that could be captured and systematized. I think it’s only through the passage of time where that has coalesced into a clearer (what you described as) investment philosophy. As three 20-somethings, I don’t think any of us claimed to have an investment philosophy. But what that has evolved into is something really clear and I hope, really useful, once again, to our investors. That is the power of broadly diversified trend, to be able to capture (I don’t want to keep saying it but), the directional agnosticism.

We’re indifferent to rising and falling markets through the use of futures, through the very broad exposure to asset classes that are diversified one from the other. Very much in our case, what became a foundation, a cornerstone of our now investment philosophy, is to remain unbiased. Because the tendency is to have, if not a recency bias, you look at the data and you conclude, up bonds and they go up. So I’m going to dial that into the models. That, as we’ve seen, can be a big mistake.

So the disciplined and consistent application of trend with as broad an application as possible, thoughtful risk management and portfolio construction, and an unbiased approach to capturing those trends, that’s a consistent investment philosophy that I think distilled out of that early origin story and has remained consistent throughout. On top of that, Alan, the research process has looked at every component of that and continued to enhance and expand it over the arc of 25 years at Aspect and many years at AHL before that.

[00:09:56] Alan

We always ask, kicking off, about the perspective on why these strategies work. You’re obviously exploiting opportunities from a trend perspective and combining that with other strategies, with greater computing power or with greater information. Why do you think these opportunities continue to exist in markets?

[00:10:19] Marty

The essence of trend (which we’ll come back to the utility of trend as a building block in investors’ portfolio), I think it essentially boils down to behavioral and the ability of investors to digest new information. Personally, I think a good analogy to this is how we all responded to the COVID pandemic. I think you’d agree with me, gentleman, that February of 2020, there’s some problem off in China but not my problem, and then it sort of gets closer to home and you think, “Crikey! This is not good.” And then the mandate comes down and everyone back home (if you remember), we were all saying we’ll be back at work in a couple of weeks.

Our ability to digest information is sort of constrained by the speed of human cognition, and all the technology in the world isn’t really going to change that. So I’ve never been a believer in the singularity. You don’t immediately snap to full fair value around the world. Trends develop for a number of reasons (I don’t want to just single it out), but a lot of this that I think we saw very much in 2022, and speaks to my expectations for 2023, is persistent uncertainty.

So look, last year, at the global response, and in particular, the Fed’s response to inflation prints, it was always transitory and it kept coming, and it kept coming and then transitory became, maybe, not so transitory. But we were always behind the curve. So, it’s your inability to predict and always be surprised that creates trading decisions, that creates flows, and those are the effects that trend capitalizes on. It’s a very particular strategy, it’s a very useful strategy.

As compared with say, arbitrage mispricings, it isn’t an inefficiency that gets arbed out to the markets, it’s what managers like Aspect do and many of the other interesting and talented folks you have on the show. I’m going to make a strong case for the systematic application of trend, measurement, and trading as a result of that. That’s the essence, that’s the value. That’s the consistent and persistent effect that we’re able to take advantage of.

[00:13:12] Alan

We’re obviously speaking in January 2023 after a great year for trend following. So when we speak about these topics, they’re all very easy to understand in our minds. We’ve got plenty of examples of speed of digesting new information and the market being slow to get on the inflation narrative and then getting on board. But if we went back to have this conversation maybe in 2019, there was this question about, is that still the case? Do these strategies still work? When you look back at that period, what was it about it? Was it a less uncertain environment or just a less volatile period? Why was it that we had that tough period for trend following?

[00:13:57] Marty

I think it was a less uncertain period. I think we’ve had a long arc. Somebody described it the other day as the dead hand of central banks. You’ve had a long arc, I want to say, almost in the aftermath of the Global Financial Crisis, the first coordinated quantitative easing and fiscal injection of liquidity. That became the MO. So we’ve had, goodness me, a really long run, where markets by and large have had a Goldilocks period.

We’ve had coordinated quantitative easing, we’ve had a very responsive Fed, and we’ve had plentiful liquidity which got ridiculous in the aftermath of COVID, but we’ve just had a framework of reduced uncertainty, the Fed put, buy the dip, and that’s what many, many people have spent their entire investing careers thinking was the norm. Judging by the three of our hair conditions, we’ve been around for long enough that the last 10, 12 years isn’t the norm. That’s been the exception. So you talk about 2019 and I’d extend that all the way back to 2009, we’ve had a period where by and large, the uncertainty and dispersion in markets and innate volatility has been suppressed.

[00:15:43] Niels

You mentioned, Marty, the fact that you have different strategies at Aspect. If we just focus on the trend part, I don’t know specifically whether you just offer trend in one version and I don’t know whether that is a quote-unquote “pure trend” or more diversified trend, but I wanted to bring it into a context of a paper that Cliff Asness wrote last year. First of all, he kind of introduced the idea (maybe he didn’t introduce it, but he certainly brought up the idea) of us having a dual mandate, both to make money in an absolute style, but also make money when we have crises, especially equity crises. But then at the same time, we know from that period where trend wasn’t necessarily as profitable as it had been that people diversified their trend programs with other stuff.

Cliff, I think, kind of put it in a way of saying, are we as managers becoming too concerned about the Sharpe and are we maybe doing our clients a disservice at some point by putting other stuff into the trend models? Because one, when they really need the trend model, they might not produce the same returns as you would expect. So take it as you want and talk to us a little bit about your reviews on these topics because I’m sure you’ve come across these points before.

[00:17:20] Marty

Yeah. The first question is that Aspect offers trend in a number of different formats, from pure traditional market trend through to our flagship, which is 80% trend and 20% modulating strategies, to an alternative markets portfolio, and more recently, a Chinese market trend portfolio. We also offer our investors the opportunity to customize the blends between those and indeed their choice of markets should they have particular investing constraints or ESG considerations as an example, also to provide different access points for volatility choice and liquidity usage.

So first of all, I think what I’ve expressed is that we work with our investors to find the right utility for their portfolios rather than, “You can have any color you like as long as it’s black.” We’re not just bundling these models into one portfolio and “take it or leave it.” The motivation for that is the passionate belief that the trend utility, all the way back to that origin story, is so useful in investors’ portfolios for all of the attributes that I’ve already described. I shared this with a colleague and he thought it was interesting.

I’ve always thought of trend almost as the medicine that is good for investors. All of the diversification around non-trend strategies is, in my view, very much an effort to make the medicine more palatable. Because that utility, that convexity that Cliff Asness is highlighting and that we’re all keen to highlight, is the real essence of why you want trend as a defensive component in your portfolio. It can be hard to hold.

So if it’s Sharpe, it is just meh. Your trustees are going, “What is this?” If you can’t hold it in the portfolio, it’s not going to be there when you need it, because when you need it, it is episodic, it is unpredictable, and you just don’t know. The key thing is you just have to have a consistent allocation. You can’t time it.

You’ve got to have consistent allocation in your portfolio. So all the diversifying efforts of complementary strategies, in my view, are a sugarcoating to the medicine, and they provide an ability to attenuate some of the rough edges that trend can sometimes have in short periods of Sharpe reversals or quiescent periods where there are no well-established trends. That’s why you might include a carry strategy or a relative value strategy. But you need to be thoughtful about how much of those you combine with your trend, lest you lose the efficacy of the essential medicine.

[00:20:38] Niels

As I hear you speak, it kind of reminds me of when my kids were small and they introduced that you could have wine gums with your vitamins, I should say, maybe you could have vitamins as a wine gum, and it kind of sounds a little bit like that. So I’m curious to know, which one is most popular, actually? These different versions or types of trends, can you say anything about what people prefer? Because it’s an interesting concept of offering trend in four or five different packages.

[00:21:12] Marty

Well, it’s very much to taste and that speaks to our approach as a business, as I say, rather than a one size fits all. We have a very diverse group of investors, both geographically, because the different jurisdictions have different appetites for fees, for liquidities, for the sophistication of the investors. So at one level, if you look at the arc of Aspect, what began as an Aspect diversifier began as a pure trend offering, and then it became clear that some of the volatility that trend was delivering in the early 2000s was just unpalatable for investors that weren’t battle-hardened trend aficionados.

So we began to introduce the modulating as we call it, the modulating complementary component of the portfolio. And that was the focus of the business for a very long time. It then became clear that as investors became increasingly sophisticated and understood the merits of the strategy, to Cliff Asness’ point, they wanted the uncut version. We can handle it, Niels. And that’s fine, we’re prepared to work with them on that.

To the other offerings, because they are distinct, a China offering has its own liquidity and investor features, our alternative markets offering has different capacity and diversification features. That’s why we embody them in different products, rather than lumping everything together. So we can have a conversation with clients to understand their utility and make sure that we’re addressing it correctly.

[00:23:00] Niels

Very interesting. Alan, do you want to dive into one of your favorite topics?

[00:23:03] Alan

Well, actually, I just wanted to move on because we’re talking about the utility of the different options, and it maybe naturally follows to think about the role of these strategies in the context of a multi-asset portfolio. Marty is talking about customization. One of the things that has come up in the discussion around customization is that, if you’re going to use trend following alongside say equities, well, then maybe you might think about capping the equity beta or capping your equity exposure. Is that a good idea or is there a limit to how much customization you should do once you start meddling with the system in the context of the overall portfolio?

[00:23:46] Marty

I think it’s a good idea to a point, and with all assets and equities included, the risk management of the portfolio makes sure that we don’t let exposures get too much concentration in a particular sector. So the portfolio will already limit the amount of equity beta or energy beta. Any exposure gets constrained. Any investor of an appropriate size, we can have those discussions with, Alan, but I think you get to a point where one investor’s choice of a beta cap is going to be different from another investor’s. So I think we have to do our best to have a portfolio that satisfies all of those needs.

[00:24:31] Alan

Yeah. In terms of the idea of the diversified versus the pure trend, I 100% agree with what you’re saying about the digestibility and taking the medicine. If, in an ideal world, people were very risk neutral and able to suffer drawdown, would the pure trend approach be better in the context of a multi-asset portfolio if it was going to be used alongside equities? Obviously, with a diversified multi-strat, you get the diversification. Presumably, you can lever up the components of it as well, so there’s that angle to it as well. What’s your thoughts on that?

[00:25:11] Marty

Again, with the caveat “it depends on the investor,” I think the idea of introducing those modulating strategies, I talked about cutting off or attenuating in the rough edges, I think it’s also to add some returns in periods where trend may not be returning. So the overall effort is to improve the Sharpe, the expected returns. Just to reiterate, and I’m going somewhere with this, the defensive role as part of a diversified portfolio, investors look to trend to provide risk mitigation, and more recently, that’s been interpreted as equity risk mitigation but I think it does have broader application. But that equity risk mitigation, nobody’s under the illusion that it’s a hedge.

If I have a down day in the S&P, I don’t expect necessarily to have an up day in my trend portfolio. But if I have a down quarter or a down six months in equities, I can reasonably expect that my trend will provide certainly positive returns from those sectors. That’s its key role. Compare that with, let’s say, you’re buying puts. Once in a blue moon, they’re going to be extremely useful and you’ll be glad you had them. But it takes nerves of steel and deep pockets to be able to keep paying the premium to have that in your portfolio.

One of the beauties of trend is that expected returns, over time, are positive. There isn’t a negative carrying cost to provide you that episodic convexity, that risk mitigation. With the diversity, adding a component of complementary diversifying positive Sharpe strategies is going to raise that. So it is an effort to make the carrying cost of the medicine that much better. I’ll just take that one step further, which is that we’re probably all aware of the consultant-led initiative of introducing crisis risk offset or risk mitigation portfolios, where that’s a thoughtful portfolio construction approach to diversifying the defensive strategies that investors should have to complement their traditional assets. And personally, I love it, because that’s an extension of the medicine. Bless them, because they’re making our case.

Of course, I center on, what’s the core? What’s the core of that approach? It’s the trend. It’s the medicine at the heart of it and everything else, whether it’s your first responder or your absolute return components, those make the whole unit more palatable. So, if you can sell that as a line item to the trustees that they just keep it and don’t touch it, that allows the medicine to do its work when it needs to. That’s a very long-winded answer, Alan.

I’m not saying my diversified fund, you have to buy that one. I think it depends on the sophistication of the investor and what else they have in their portfolio. If they’ve done the thinking and they’ve got their first responder strategies and their absolute return components and they think that plays nicely, then buy our pure trend. If they don’t have those other components, then the modulating strategies introduce an element of those components that is complementary to the essential medicine that we’re focused on.

[00:28:57] Alan

Makes sense. We kind of jumped ahead there in terms of our normal list of questions. So backtracking, it’s all related to this. You touched on how you started off in the ’80s looking at applying data to markets and trying to figure out what might work. You’ve been effectively running a research process for a number of decades now and it’s obviously on the trend and the non-trend side.

What would you say have been the things that you’ve learned? What has come out of that in terms of enhancing the quality of the systems over time? One thing we hear is applying it on more markets. If you were to apply those old systems now, do you think they’d be very much underperforming the better, more enhanced versions that you run now?

[00:29:51] Marty

At a high level, the behavioral response of the human, of Homo sapiens, hasn’t evolved over certainly the arc that I’ve been doing this. We’ve all seen these various studies of 100 years of trend, 200 years of trend, 800 years of trend. So the essential concept or the behaviors that we are seeking to capture in a systematic and thoughtfully risk-managed process, those remain consistent. But goodness me, the world has evolved over 40 years. So, yes, you speak to the breadth of markets that we have access to, and that’s hugely valuable to our investors, the diversification.

Side note: What’s really interesting is that the portfolio that we first traded, let’s go all the way back to 1987 or ’89, there was a 6-market portfolio, a 17-market portfolio, a 33-market portfolio, and in the day, they afforded a fair degree of diversification. Just to your question, if you just traded that portfolio, my expectation is it would be less performant. Have markets become more efficient? In one sense, yes. Are those markets in themselves less likely to trend? No. But what has happened, over time, is that we’ve had this globalization, so that same 33-market portfolio is going to offer less inherent intrinsic diversification now than it did in the 1980s.

So, the addition of new markets, new diverse independent sources of potential return and potential trending behavior, that’s been a consistent theme through the arc of all of my career. We’re trading 300-plus, close to 400 markets across the trend suite Aspect Diversified, in our core pure trend program trades just shy of 200 markets. I’m sure there will be more being added over the course of this year, and next, and the one after.

So, market diversification, how we execute the markets, think back to Eddie Murphy and Trading Places and the early days of getting into the pits. We would literally go to Chicago and try and identify who the biggest, baddest floor brokers were and hire them so that they could get your orders done first. The world is very different now, fortunately, and it’s electronic. Our whole execution methodology has evolved, that rather than trying to hit the market as aggressively as your linebacker can possibly do it and get the trades done, we want to smooth those trades and those signals out over time and leave no trace of where we’ve been in the markets. We want to feed it in really gently.

Finally, I do get the question when I meet investors. They say, “Goodness me, you’ve been doing this a long time. Surely you’ve figured out trend following by now.” And I say, “Nope, there’s always something new to learn.” I don’t mean that we’re forever re-tuning the models and saying, “Mmmh, metals, going faster last year, that was a good idea. Let’s tweak that.” It’s not that at all. In fact, being the recency bias, adjusting your models to what worked last year, is a recipe for disappointment, both for yourself as a manager and for your investors.

But having said that, both our investors’ utility, what they want from their trend following evolves over time, and also some of the responsiveness dynamics of markets. So we continue to refine, we continue to look for new features and enhancements. I’m being a bit opaque, but we’re really excited about some of the enhancements that we’ve made to trend after all this time. Still, the team finds new stuff, and I go, “Wow, I didn’t think of that 25 years ago.” That’s why they’re driving and I’m hanging on.

[00:34:34] Alan

One of the other topics and issues that has come up a little bit with talking to other managers is obviously, there’s a general belief in the merits of systematic strategies. If you have a systematic process, it takes away the emotion. But there’s a lot of discretion involved in running all of these research processes and choosing markets to trade and when to take out models, etc. To what extent does that come into your process?

Particularly, you mentioned how it seems that we may be in the midst of a regime shift and that period of the last 10 years or at least 10 years, let’s say, 2019, it’s very different. Would that feed into the research process in a way? Would you make a discretionary insight that maybe we need to be looking in a certain direction based on your observation of how the world is changing?

[00:35:30] Marty

Alan, No. I think what history has taught me certainly of running these strategies is my ability to predict where opportunities are going to present themselves is weak to negative. When people say, “What do you think about gold?” What I think is irrelevant. So the value of this is in it being as agnostic and as broadly diversified as it is. So we make no predictions. You think about the start of 2023, there’s starting to be a bit more buoyancy. “Well, maybe inflation has peaked, China’s coming out. It’s all rosy, guys. Let’s get back into 60/40.” It doesn’t mean that I have any more insight than anyone else.

Again, it’s human nature to grasp the good news and say we’re all seeing flowers in the fields. There are still storm clouds on the horizon in many, many different directions. So again, Alan, no, we make no discretionary adjustments to the shape of the portfolio. But you’re right, in terms of what we research, which sectors, new markets that we think we get our skates on and include in the portfolio, what areas of the program we are not satisfied with and we need to refocus on, those are discretionary decisions that will be influenced by conversations you’ve had with clients, your relative and your absolute performance. Yes, but that’s much more of an agenda setting and where you focus your resources.

[00:37:27] Alan

Niels, do you want to comment on research?

[00:37:29] Niels

Yeah, exactly. Before I jump to the next topic, I do want to just stay on the research evolution a little bit. Without it being a big secret, I think it’s fair to say that trend following, as was done maybe 30 years ago, today, parameter picks are probably more long-term in nature compared to back then. First, I just wanted to ask whether you agree with that, that models have become longer term, but then also, why you think that might be. Is that a function of more AUM we have to manage so we have to kind of slow things down a bit? Is it because markets have somehow changed? Why is it that models have become a little bit more long-term do you think?

[00:38:19] Marty

I’m hesitating to agree with that assertion. Maybe I’m losing my long-term memory, but I think we have retained a very consistent approach to the timescales of our models. Again, that just speaks to the arc of this, that you’ll get periods where it looks like markets are speeding up and if you lean into faster trend, that’s the thing to do. And then you’ll have periods where it pays to be a little less jumpy and you think, “Oh, let’s turn all the dials back down.” It doesn’t help you.

So many, many times over that long arc, we come back to that question. Is there information? Should I be speeding up over time? Should I be slowing down over time? Should I be modifying my settings as a result of a recent performance? We come back to the conclusion that there’s no value. Well, there’s limited value. Your simulations will look better, Niels, but I think the outturn performance, not necessarily.

[00:39:38] Niels

That’s good to hear, in a sense, and actually, I kind of agree with you when I look at some of the stuff that I have access to in terms of looking at what the “best lookback periods” have been on a year-by-year basis and just seeing that actually, they tend to gravitate towards the same cloud range of choices. But on the other hand, when I speak to people or colleagues in the industry, I do get the impression that they have become a little bit longer-term than from when they started. But it doesn’t mean that everyone has had that experience, and clearly, you have not.

So I want to jump to another point, and that is something that became- again, it’s not new, it’s been around for a while. But maybe it took a little bit of a change a few years ago, which became evident in 2022, and that’s CTA replication. Because last year, probably the funds that took in the most net AUM was not necessarily the managers themselves, it was one or two replicators, where essentially, they look at the index of managers, the index of managers we’re actually speaking to in this series, and they essentially try and replicate the exposure by only looking at daily performance. They have no idea what the managers do, they just look at the daily performance.

So I’m curious to know how it feels to be replicated, but also whether you believe that replication works in the long run. It can work in the short-term, for sure, but if it works in the long run as well, doing it this way with some kind of regression, but also, if there are any risks or concerns that you might have when it comes to replication of our industry.

[00:41:32] Marty

It’s a successful strategy and it’s a very useful strategy. We don’t have a monopoly on it and that’s fine. I think that we’re all used to seeing significant dispersion in our industry. The idea of a trend index is still elusive, and people will try and replicate this. If it isn’t the fund or the folks you’re referring to, it’s the banks trying to offer simplistic trend strategies. I can describe the strategy to my dog, maybe he can’t go out and replicate it, but it’s conceptually straightforward, but goodness me, I think we’ll agree that the devil is in the details.

So I’m not going to tell you that replication is a bad idea but it’s got risks associated with it that are different than the risks you’re taking with choosing an individual manager or a small portfolio of managers that you understand well and that you feel complement one another. So if you think about it, the point is, if you are just regressing a basket of managers, I guess they’re relying on fuzzy central limit theory that all of the noise that each manager demonstrates, there’ll be a common carrier wave that they can capture through their regressions and more power to them, but I think they miss, I think, that all credible managers these days (and you know more managers than I do, is this a true assertion), have a research process.

The days of, “I wrote it on the back of a fag packet and that’s all we do,” I don’t think there are many of those managers left. So everyone that is represented in the index you refer to, that is being regressed and replicated (in this case), is going to be evolving. The regressions are not going to hold or they’re certainly going to change over time, and what the error term is will be interesting.

[00:43:43] Niels

Yeah, I completely agree, Marty, of course. It’s interesting, actually, because, as you said earlier, we are all still students of trend following even though we’ve been doing it for a long time. I will say that even to this day, I do get surprised in the sense that when people talk about trend following, even when we talk about trend following, we kind of talk about just a very limited part of what we do in terms of the trend models, the signal generation, maybe the risk management, etc. But we don’t necessarily talk about, okay, so what do we do with the data before we put it into the engine and all of these small things that also take place. And you’re absolutely right, the devil is in the details, but it is an interesting space.

One thing I will say, and which I have been on record saying before, and that is, if there’s one thing I do agree with in terms of replication, that is if it means that more people will get it in their portfolio because they think it’s either easier or they think it’s cheaper or whatever it is it; maybe it’s packaged in an ETF that makes it easy for some investors to put in, then that’s all good for everyone because all portfolios need trend (as Alex wrote in that famous paper a few years ago, when he was at ISAM). So, yeah, I think that that’s my takeaway from this.

[00:45:09] Marty

I agree, Niels. The whole idea of Aspect was to democratize and encourage the addition of trend into people’s portfolios. So, I’ll agree with your view of it that it just makes people more comfortable. Let’s just not get carried away, though, because people that understand what they’re doing; the risks that they have constructed this, and evolve this, over many times, there’s a propensity to make the same mistakes over and over again in trend, in replicating strategies. So, I agree with your thesis, I think people should be caveat emptor.

[00:45:50] Niels

Exactly. I’m relying on them not screwing up our industry by missing something in their regression analysis, that’s for sure. All right, Alan, let’s hear what you have coming up.

[00:46:01] Alan

There was one topic that we didn’t get into in the whole research bit that I’m very curious to hear what Marty has to say, and that’s, we were talking about that it’s difficult to fine-tune the models. If you’re responding to what worked last year, inevitably, that’s not going to be good. But there is an approach, which is something similar to that and that’s machine learning. The machine is trying to learn, based on the environment, about what’s the best way to run the models. I’m curious to hear what your perspective is on machine learning. Going back a few years, it was put forward as a panacea to all of the challenges in running systematic strategies. So what are your thoughts?

[00:46:41] Marty

It [has resulted in] wonderful advances in the space. Here’s an interesting anecdote. In that period you refer to, Alan, where it was getting super press, and was being projected as the panacea to all, and soon the singularity would be upon us and all of the systematic investment managers could just go home, and there was pressure. We had many people in the research team that had done their degrees, and had a lot of experience of machine learning approaches. People’s enthusiasm for this was inverse to how much they knew about it. So the more sophisticated, the more academic people were, they were going, “Yeah, it’s great technology, but for this kind of a problem, let’s not get over our skis.”

So absolutely, we invest in that space and we think it holds much potential, but we’re very careful about how we step into it. That goes back to the origins of the business, again. I’m trying to pull a lot of threads together. Niels, we all agreed that what’s really important is having trend in investors’ portfolios. Prior to Aspect, the approach had been sold as a black box. “This stuff is great. Don’t ask me how it works. Just trust us, and you’ll have it in your portfolio and it’s really useful.” We thought institutional investors were never going to buy into that kind of a sales pitch. We can come back to the irony of that in a minute.

The whole point was you needed to make it transparent. How does this work? Why does this work? When will it work? When will it not work? And that has been the common theme of our approach to research. What’s the underlying hypothesis that we’re trying to capture here? How can I validate that? How can I invalidate it? So I’m very cautious, it doesn’t mean Luddite, but very cautious about throwing data at machine learning AI.

We’re very keen as we evolve these models. You look at cross-market nonlinear effects that you might not capture in a typical regression, there’s potentially value there, potentially significant value there. But we always want to understand the intermediate layers. What is the model? What is the hypothesis that the machine is capturing? (Sorry, all of these are long-winded answers to great questions.)

It’s a really valuable additional tool in the quant’s arsenal, but use it with caution, use it where it’s appropriate.

[00:49:34] Alan

Just moving into the area of risk management, rather than talking about the approach to risk management, I suppose one thing I’m curious about is, what are the risks? The obvious risk of trend following is that the market doesn’t trend and you have choppy markets like we’ve had. But outside of that, what are the big risks you worry about? Within that, is liquidity a concern? You hear that from time to time.

We saw very extreme moves in the UK gilt markets recently on the back of the pension issue. We’ve had issues with the Treasury market going back a couple of years. Would it top the list? Also, we had the issue around the LME last year with nickel trading. So presumably, those types of scenarios but is there anything else that you worry about from a risk management perspective that’s specific to executing a trend system?

[00:50:29] Marty

I think you’ve gone straight for the key things that probably don’t keep me up at night but are the most concerning issues: access to markets, free and fair price discovery (maintaining that has to be essential to the ability of the program to do what it needs to do). Actually, I’d sort of turn it around. I think one of the risks that was creeping into the portfolio through the era that, arguably, we’ve just transitioned out of was an artificially low volatility environment that could lure you into a false sense of equity vol of less than 10%.

Therefore, to obtain the risk that my models want, I need a near-infinite position to manifest that risk. That was uncomfortable. So managing volatility continues to be something we’re very aware of and sensitive to. I do think in this environment as volatility returns to markets, things are being a bit more right sized.

[00:51:45] Niels

I’m just curious, when you mentioned this thing about we want markets to be free and fair, what happened recently in the European gas markets where they’re introducing this cap, is that enough for you to say, “Ah, now we’re into some kind of manipulation?” I mean, I know central banks manipulate, right? They can do it with interest rates, and we’ve kind of gotten used to that and say, “Yeah, okay,” but we still trade them. What about something like European gas? Is that manipulated enough to not trade it? How do you think about that?

[00:52:19] Marty

In our view, different managers will respond to this differently. I know some of our peers have completely withdrawn from the LME after the shenanigans with nickel. How you trade the yen or Japanese government bonds with the concerted yield curve control period, that’s something that we’ve spent a lot of time thinking about. The example you give is not yet of a scale where we have adjusted our allocation to European natural gas.

[00:52:58] Niels

I have a point here, and maybe I don’t want to go into all of them, but it’s kind of combining capacity, fees, and flows in one. I’d like to maybe ask you a little bit about fees, because this industry got really knocked down, in terms of fees. Potentially, actually, I think maybe from memory that you also lowered your fees in your trend offering to some extent. How do you think about fees looking forward perhaps? Have we reached a low in what fees might be? Could we even see fees go back up again, because it’s not an infinite capacity strategy even though there is a lot of capacity, especially if the big pension plans, other than the few who have embraced it, come on board? How do you see all of that?

[00:53:56] Marty

Obviously, it’s important to having a sustainable business and being able to support a consistent research effort. Everything we do at Aspect is focused on delivering consistent, persistent, diversifying returns to our investors, but I don’t dwell on the fees. So I think this will continue to be a conversation with clients and the right fee levels for one pension fund is going to be different from another pension fund, because of their utility, because of the profile of investments that they can fit in their portfolio. So back to the common thread through this whole conversation, the essential thing is to have trend in the portfolio. We want to make that possible.

There are countervailing forces. There is a lot of capacity in this space, but as you say, it’s not infinite. There has been weaker performance over the past decade. Investors reasonably concluded, “Meh, why should I pay for something?” I think we will be revisiting that conclusion. There was even, “Is this alpha?” We came up with a new response, “Yes, it’s alpha.” It’s timed exposure to markets. It’s alpha, and it’s very valuable. I think investors can get this stuff at ridiculously low fees and that’s okay. That’s good, because it’s so valuable in their portfolios. I don’t know which way it’s going to go.

I think we’ve had enough fee pressure for long enough that surely this is a more than reasonable place. I think there should be an increasing community of investors looking at this and having this in their portfolio having seen, once again, the validity. It’s not going to necessarily make you positive returns every month, every quarter, every year even, but it’s invaluable over an investment horizon of three to five years and there’s a price associated with that.

[00:56:19] Niels

Yeah, absolutely. Well said. Alan, do you want to dive into a few more things before I wrap up?

[00:56:26] Alan

Yeah. Well, maybe just on the topic in terms of you’re talking about the utility for investors and having that conversation with different types of clients. How do you guide them or help them think about expected returns from the various strategies and say trend in particular? Is it just a matter of saying, well, this is what it’s done historically so that’s a reasonable benchmark? Obviously, there’s the interest rate component, which is an element to it as well. But how do you help investors think about what they can reasonably expect as they build portfolios?

[00:57:06] Marty

Alan, you’ve been doing this a long time. Expectation setting is hugely valuable and bringing people into our family of people that trust and rely on an appropriately sized allocation to trend is so important. So setting expectations, yes. The first thing is to highlight that what we spend a lot of time doing with investors is setting expectations for what to expect for the volatility of the program. That’s the key thing to anchor.

Typically, the starting place for trend portfolios is to replicate the volatility of equities. That’s where we all began in developing these portfolios many, many years ago, on the premise that investors, if you can tolerate equity volatility, you can tolerate this.

The intriguing feature is that it’s a very different return distribution profile. There’s another thread we could go into. It’s about the behavioral differences of holding. Trend is much harder to hold behaviorally than equity. So once an investor understands the volatility that this will demonstrate in their portfolio, then the returns are established by historic precedent with the understanding that it’s not within my caring to know what it’s going to be for the coming year.

But my expectation is that, certainly going into 2023, with this level of uncertainty we are going to see misestimation, we’re going to see capital flows, we’re going to see trends in a number of sectors that make me much more positive about the potential returns and the potential utility of an allocation to a liquid alternative, and directionally agnostic unbiased diversifier than they may have been over the previous 10 years.

[00:59:05] Alan

You mentioned that point, going back a few years, there was this mention of trend beta versus alpha, but there is simple versus more sophisticated, I guess. How much do you think a really good trend follower can add in terms of research execution, trading lots of markets over the simple system? I know, impossible to put a number on it, but would you say you can be 20%, 25% better? Just top of your head, what would you say around that?

[00:59:37] Marty

I’m not going to put a number on it, but look at the dispersion in our industry, month to month. Top managers buy reputation assets, the dispersion that can be delivered there, and that speaks to the potential difference between a simplistic implementation and a sophisticated one.

[01:00:03] Niels

Yeah. I just wanted to maybe wrap up with two questions. Actually, the first one is kind of a little bit of an odd one. I’d love to hear, what’s the one thing you hear about trend following that you disagree with the most? I’m sure you’ve come across a few things that you disagree with. But is there one thing that every time you hear that being raised, you say, “Ah, do I really have to answer that?”

[01:00:33] Marty

Probably, it’s that assertion or the belief that these models have been arbed out, that trend no longer works when you come off the back of a difficult period and people [make that conclusion]. I understand why they will conclude that especially if your frame of reference is multi-manager, high rotation, black box models, where the opportunity may be that my information advantage may dissipate or my mispricing may disappear, you could reasonably conclude that the models have lost their efficacy. That’s not the case with trend. Yes, there are better implementations than others. But in my belief, it’s the underlying opportunity set that is going to drive the quality of returns. So that’s probably the “Here we go again” question.

[01:01:34] Niels

Yeah. I certainly would agree with that. Final thing is just, Marty, if there’s anything you want to bring up before we wrap up completely, anything we may have missed, something that’s important for you to highlight that we didn’t cover so far. Is there anything you want to end with?

[01:01:54] Marty

Well, gosh, you started this kindly reminding the listeners that last year, we celebrated 25 years at Aspect. I’m very proud of that and I’m still doing it because we love what we do. We love delivering high-quality, diversifying (I feel like one of the ends of those ads, the medicine ads, where they speak very, very quickly), very high-quality diversifying returns to our investors. 2022, after a decent period where people were questioning whether they actually needed it in their portfolio, “I’ll call you when I need a diversifier, Marty. At the moment, I’m very happy with my Tesla and my private equity, and my bitcoin.” Oh, my goodness me.

So, it is very nice to have investors reminded of the utility, of the approach, of the value of research. I don’t know whether I’ve got another 25 years, but I’m certainly delighted to keep going and keep scratching and keep working with the really talented group of people that we have in Aspect. I think the investors focused on the quality of their returns and the firms that they do business with plays to our strengths. We’re very proud to have been doing this for 25 years and are delighted to continue working with some of the world’s leading investors. It’s a privilege. It’s a great industry. It’s a great industry.

[01:03:38] Niels

It is a fantastic industry. Many people ask me if I wanted to change my own career if I had a choice, and I always answer that, no, I certainly wouldn’t want to do anything else. So I completely concur with those sentiments. I do hope that we all have another 25 years in us, but only time will tell.

On this note, we’re going to wrap up our conversation. This was fascinating as always. Marty, thank you so much for being on the podcast, sharing your thoughts and your insights. Of course, we hope that we can do this sometime again in the future. To all of you listening today, I hope you were able to take something away from today’s conversation onto your own investment journey. If you did, please share these episodes with your friends and colleagues.

From Alan and me, thanks so much for listening. We look forward to being back with you on the next episode of Top Traders Unplugged as we continue our deep dive into the CTA industry. In the meantime, go check out the show notes for this episode and all the resources that you can find on the website, and of course, not least, take care of yourself and take care of each other.

[01:04:45] Ending

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