“The conversations got easier over the latter half of the year, but in no sense are we saying ‘see I told you.'” – Martin Lueck (Tweet)
This year in review covers how Aspect Capital came out of 2014 with their best year ever as a company, and what they learned from the year. Martin Lueck discusses the events that made 2014 a roller coaster ride, as well as the importance of always staying agnostic in your allocation to different sectors.
Thanks for listening and please welcome Martin Lueck.
In This Episode, You’ll Learn:
- Why 2014 was a roller coaster ride for Aspect Capital.
- How 2014 was the best year ever on record for Martin’s firm.
- Why CTAs spend most of the time being in a certain level of drawdown and how they have to be psychologically prepared for that.
“We are not tilting the portfolio to reflect recent experience.” – Martin Lueck (Tweet)
- What markets didn’t perform for his firm.
- How Martin reacted to the Swiss Franc move that happened recently.
- How conversations with investors changed over the year.
- Why educating investors is important.
Resources & Links Mentioned in this Episode:
This episode was sponsored by Swiss Financial Services:
Connect with Aspect Capital:
Visit the Website: www.aspectcapital.com
Call Aspect Capital: + 44 20 7170 9700
E-Mail Aspect Capital: email@example.com
Follow Aspect Capital on Linkedin
Marty: What we're not doing is tilting the portfolio to reflect recent experience. For example, energies, as we now see in 2014, was a terrific place to have a decent allocation. Frankly, I think Aspect's performance was due to our significant allocation to energies. Energies have been an absolute bear to trade over the previous two or three years. It's really unpredictable, and you have to maintain as consistent an agnostic an allocation or risk commitment to these sectors as you possibly can.
This is Marty Lueck, Cofounder and Director of Research at Aspect Capital, and you are listening to my year in review on Top Traders Unplugged.
Introduction: 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. Here's your host, veteran hedge fund manager, Niels Kaastrup-Larsen.
Niels: Welcome back, Marty, for this quick review of 2014 where we look at the big events from the point of view of your trading strategy. I want to explore the ups and the downs as well as the big takeaway from what can only be described as a great year for systematic trading strategies, in general, but of course trend following, in particular. But as we know, just because you're systematic in your trading it doesn't necessarily mean that your strategy deals with market events in a similar way. So I'm excited to hear what you saw in the past year. I thought we could just jump right into it. Tell me about 2014 from your perspective. How did the year evolve both for the strategy and maybe for the firm and the research as a whole?
Marty: Niels, Happy New Year to you and everyone listening to Top Traders Unplugged.
Niels: Thank you, Marty.
Marty: It's a pleasure to speak with you again. 2014 really was an extremely interesting year, as everyone is aware. It's been a challenging period for the systematic industry in general, and people committed to trend following more specifically. For Aspect, gosh, it really was a roller coaster ride. We came off the back of 2013, and there were signs of a brighter dawn. So, in fact, our 2013 performance, although slightly negative, represented a profitable trend following year in 2013, but a small loss on the non-profitable that was sufficient just to drag the whole portfolio slightly negative. We entered 2014 somewhat optimistic that more favorable conditions were returning to trend following, only to see that evaporate very quickly at the start of the year.
Niels: In January, yes, I remember that.
Marty: So it was a brutal start to the year. We, like our clients and like every other manager thought, "Goodness me, how long is this going to go on for?" Then things started to... Some trends started to reestablish themselves after all of the geopolitical uncertainty in Q1 that represented that drawdown. So from a very broad 30,000 foot view... actually by the end of Q1 we were in a drawdown. By the middle of the year, I think we were back to flat on the year. By the end of the year, we were 32% up in the Diversified program. That is absolute testimony to the episodic nature of the trends that these kinds of strategies capture and also to the benefits of a systematic strategy.
I know we're going to dig into it, but the headline features are that the big opportunity set being short of oils and also remaining long in the fixed income sector, and in fact getting long and staying long in the dollar, those were the big contributors to profit in 2014. You had to have a systematic approach to be able to capture those. I think that if I were a discretionary trader, it would not have been that successful a year. You would not have been able to call those trades and get into them in time and with enough conviction to make the kind of profits that we and many of our peers did in 2014.
Niels: I agree. I'd like to stay with the headlines. I know you're way too modest to mention this, so I'm going to do it for you that, in fact, 2014 was the best year ever for Aspect, so congratulations on that. I want to also ask, in particular you, because people will know from our first conversation that you have a very long history in this area. I want to ask you if this year reminds you of anything? Is there anything when you look back where you say, "this really is just how trend following is, or was there anything unusual at all about what happened in 2014?
We know Morgan Stanley, when they asked institutional investors in December 2013, only 2% said that CTAs would be the best performing strategy in 2014. We know that a lot of... And I think maybe around the time we spoke last, a lot of people were writing off trend following period, saying, "it's never going to work again." Is there anything when you look at 2014, really from the big picture point of view or even from an emotional point of view that reminds you of a period that you've been through before?
Marty: Well, yes, in many ways... I'm very cautious having done this for a long time; I'm very cautious to declare any sort of victory or celebrate the fact that it was... Obviously we'd love to deliver this kind of performance to our clients every year. We are at pains to point out that it is episodic in nature, and it's very hard to predict when you're going to get these kinds of opportunity sets. That's the whole point. If it did make 2% for our clients every month and just went up in a straight line, wouldn't life be easy? The nature of what we do is we spend an awful lot of our lives in drawdowns. If you think about it the nature of the return profile for managed futures is that you get steep and sharp increases in NAV, and then generally you'll go into a drawdown for a period of time and then you'll get a recovery to that. We need to be psychologically prepared to live under those conditions and so do our clients. The client that says, "Well Martin, I'm going to withdraw some or all of my assets and I'm going to wait until you've had sort of three good months and then we're going to come back in." That's not a great strategy with managed futures.
So as we are all at pains to point out, in order to realize the benefits of diversification that this genuinely does and will afford you in your portfolio, you've got to have a consistent allocation to it, and you must maintain that consistently. That's been our mantra for many years. I think as people lost confidence in momentum as a return driver, as a factor, or as a strategy, we've been at pains to try and reiterate the long term persistence of the effect.
We were very happy to fund some of the research that the team of academics did a University College Cork. They came up with a very interesting paper that you'll recall looked at periods of market stress following crisis periods. They used the periods that Rogoff and Reinhart had identified in their book This Time It's Different, and concluded... The sort of big takeaways from that paper was, 1) if you go back 100 years, I think back to the beginning of the 20th century, there is evidence that momentum investing is a consistent and persistent source of outperformance. In the period following market crisis, your expectation of return is significantly diminished. That looks like a fairly consistent result. That looked like, of course; we would choose to interpret it that way. In the period following the credit crisis, we were in one of those doldrums. So that's what we were encouraging our clients to see in events.
Their paper was also supported by the AQR paper, One Hundred Years of Trend Following. I think CFM came up with 200 years, and I think that... Where are we now? I think Alex Greyserman and Kathryn Kaminski now have 700 years of trend following. So we're next. It'll will be extra-terrestrial trend following. That experience, so the academic piece that UCC did, and also my own experience, because back in the AHL days we went through the aftermath of the 1987 crash and there were a lot of echoes there. After the October crash of '87, there was a period of crisis alpha, a big run up in the returns of the AHL program. Then a long and extended and painful doldrums until about '94 where you almost saw a clear out of extended period of risk aversion and concerted intervention by central banks and the markets returned to what I would consider as a more normal environment. Strong returns persisted for several years. In no way am I prediction in 2015, '16, '17 will be blockbusters. I would say that I think that the environment that we did see returning to markets - a reduction in the correlation between markets and a divergence in central bank outlook, that presages a broader opportunity set for this kind of strategy.
Niels: Absolutely. You mentioned some of the big contributors last year: certainly energies and bonds, which I agree, if you weren't systematic you probably wouldn't have... certainly not forecasted it and probably not profited from those big trends. What were the negatives? Were there any areas of the portfolio that didn't perform and maybe even added a bit on the negative side?
Marty: Well, really interesting, so the profitable sectors: bonds, energies, currencies, we actually made money out of agricultural commodities as well. The losing sectors for us were metals and stock indices. So I think it is worth just reflecting for a minute on the agnostic approach that we espouse which... What I mean by that is what we're not doing, Niels, is tilting the portfolio to reflect recent experience. For example, energies, as we now see in 2014 was a terrific place to have a decent allocation. Frankly I think Aspect's performance was due to our significant allocation to energies. Energies have been an absolute bear to trade for the previous two or three years, so had you pulled your horns in and said, "energies, Oh, I can't make any money off of that." You would have underwhelmed... We would not have had the performance that we did in 2014. Conversely in 2013 we made money in the metals sector. We made money in stock indices. Stock indices were one of the outstanding performing sectors over that period. So again this is testament to that it's really unpredictable, and you have to maintain as consistent an agnostic allocation or a risk commitment to these sectors as you possibly can.
Niels: Sure. You mention also early on, Marty, that clearly the trend following strategies that you run were the drivers of last year, but you do have some other strategies inside the portfolio. Were there any of them that surprised you in their return attribution where you said, "Actually I thought we would have done a little bit better in this type of strategy given the environment we saw," or was everything really lining up as you would have expected?
Marty: I think so... You know what, the headline was trend following in 2014. There were no outstanding or remarkable performances from any of our... we talk about modulating components. Overall it was a positive contributor to portfolio returns, but for the risk allocation it underperformed what the trend following piece did. So the naive allocator or investor might look at that and say, "Well, that didn't help you, so I'd prefer the portfolio that was 100% trend following." As you and I know, you didn't know that at the beginning of 2014, and frankly you didn't even know that halfway through 2014. So we're very happy with the contribution that it offered. It's doing what it said on the tin. It's providing a consistent uncorrelated performance stream... or performance stream consistently uncorrelated with trend following, which doesn't mean inversely correlated. So it doesn't automatically lose money when trend following is having a good year. It just made less in 2014.
Niels: Yeah, absolutely. Now of course as you also mentioned that it really was a year of two tales. The first half was very difficult, the second half wasb extraordinarily profitable for many strategies in this space. There were also some big themes from last year that many people will remember: Ukraine, the Russia situation, oil as you mentioned. If we stretch it out a little bit into 2015, where you and I are talking, there was another big event last week which was the decision from the Swiss Central Bank to abolish the peg to the Euro. That obviously caused some extreme volatility. Some of the guests that I've spoken to the last few days had measured... There are many ways of statistically I guess measuring these moves, and some of them came up at a scale which should be completely impossible. I guess it certainly proves everything that we have talked about: unpredictability and black swans will occur. Let me ask you how you handle extreme situations like that from our perspective? Also, whether it teaches you something? Even though you've been around for a long time and you've seen certain things before, but I mean there 's always a new nuance to these situations that we can learn from so I'd love to hear your initial reactions. I know it's still early in the days, but your initial thoughts on that?
Marty: Well, so just to put some context on it. When in 2011 when the Swiss National Bank imposed the cap, we ceased trading, or we did not include in the portfolio the Euro/Swiss cross rate, but we did not remove the dollar/Swiss cross rate because there was no constraint on that explicit cross rate. Also, the Swiss economy is very different from the melting pot of economies that represent the Euro. We absolutely believed and continued to believe that those are independent and diversified instruments to have in the program.
Having said all of that, we did lose some money as you'd expect from trading Swiss franc/dollar. It had been in a very nice and extended trend so we had built up a sizable position. The move was, as you've alluded to, unprecedented based on the history of the well-developed currencies that we trade and based on the volatility measures that we embrace all of the markets in. It was painful. It gave back a goodly portion of the year-to-date profits on the portfolio, but we remain positive on the year, so it's testament to trading 152 markets, much better that it was one of 152 rather than one of say 8 in a currency portfolio.
It was a shocking intervention. The Swiss National Bank is one of the most credible central banks and... Gosh, what a U-turn. So we assembled our risk management committee and determined that no intervention was appropriate for this. The models responded exactly as they are intended to. We measure intra-day what the volatility of the program is, and we scale the positions accordingly. So as we saw volatility jump by about 70 times, obviously we began to reduce that position quite quickly, but not extremely quickly so we don't snap to a new position. In fact the trading is very... is steady and gradual and took us, in principle a number of days to hit the new position scale that we though appropriate for volatility. Meanwhile the signal, because we're a medium term trend follower, and it takes several weeks for the position to realign itself started to move, gradually, to reflect the move in the Swiss franc.
Niels: I have two specific questions on that I wanted to hear your thoughts on. One is, when I spoke to another very prominent trend follower just a couple of days ago, he very openly explained that when he measures volatility there is a certain level that when a market comes down in volatility and goes below that level he will impose a minimum volatility because he thinks it's artificial if a market goes down to very small levels. In order to avoid that position, sizing doesn't go completely mad because it thinks it's a risk-free trade. Do you do something similar, or how do you avoid the volatility adjustment becoming out of whack with what the real risk is as we saw last week?
Marty: Absolutely, and yes completely we do, we subscribe to the same philosophy that there is a minimum prudent volatility that you have to take into account. So not only is the vol scaling a function of realistic potential volatility, but also the exposure limits. There's vol scaling, there's vol limiting, and there's also exposure limiting on all of these positions. While our dollar/Swiss franc position was a good size, it was not near any of those caps.
Marty: When I say not near it was about 80% of... Again, just to put it in perspective, in other markets in other cross rates where we have seen these kinds of significant violent moves, we do treat the emerging markets in a more constrained and more risk averse, both in terms of the allocations and the limits that we'll embrace them in. I don't know about you, but I didn't think that the Swiss franc was an emerging market.
Niels: No, but actually that leads to my next question, and that is we always talk about futures and certainly foreign exchange - it's the most liquid market in the world. What about liquidity risk? Did you learn something last Thursday about liquidity risk when you look at something as liquid as the Swiss franc?
Marty: Niels... OK, a couple of interesting things... I didn't learn through any scarring because we weren't trying furiously to trade during the relatively short period that the market went extremely illiquid. You saw sort of, effectively a gap, and then you saw a lot of participants withdraw from the market and then you saw a gradual rebound. Our models... That volatility scaling just begins to trickle out gradually after a period of half an hour or so after the event. We were not struggling to find liquidity. Had we been high frequency or caught in the flash crash it might have been a different story.
But this was exactly... I wasn't surprised by the withdrawal of liquidity around a period of extreme uncertainty, and, fortunately, our models were not gasping for liquidity over that period. What I thought was interesting was to see how the liquidity of the different FX platforms, how the spreads changed over that period. It kind of, like a Warren Buffet's... you can see who's wearing their swimming trunks when the tide goes out. There was an element of all of these platforms claim to be hyper liquid and lots of activity and come and trade with us and you could see where the actual liquidity was when everyone else was hiding under their desks.
Niels: You make a very interesting point indeed. The year 2014, I can imagine that when you think about the conversations with investors, I can imagine that the first part probably was spent on handholding and reassuring people that this is still viable. I'm more interested in actually whether or not you feel that the conversations with investors, in general, who I suspect still are quite under-invested in this particular strategy. Did the conversation change towards the end of the year and into this year? Do you feel that people have a different view, perhaps even a different understanding of what it really is that you and so many other firms are trying to do in this area? Marty: Niels, I hope so. We're sort of still in the midst of year-end reviews with our clients. Obviously the conversations got easier during the latter half of the year. In no sense are we saying, "See, I told you." The performance of 2014 is consistent with what we think the utility of this approach is in our investor's portfolios. In no sense are we predicting that 2015 is going to be a repeat. In fact I can predict with some certainty that 2015 is just going to be different from 2014.
I don't know where the opportunities are going to present themselves in 2015. Frankly neither does anyone else, Niels. Having an agnostic and systematic approach, of course I believe that is, not the only way you should invest, but it is one of the pieces that you should have in your portfolio. This is an opportunity to reiterate with our clients, our investors. Obviously during the course of 2014 and 2013, some people capitulated it all together from the approach. We haven't started having those conversations again, for people that were losing faith but kept the faith, it's been... They've been positive conversations.
There have been people saying yes, I understand better, or I understand the role of this in the program. For people that think that... It's a really hard one, Niels, because I can't expect investors to make their asset allocation and then head to the beach. There has to be an element of looking at what's working and what you... forming a worldview. But I do think that the nature of managed futures is that you've got to have a decent allocation, and you've got to have a decently consistent allocation for it to do what it's there to do.
Niels: Now Marty, if we allow ourselves to dream, just for a few minutes here and we think back about what happened after 2008 where managed futures and CTAs had a great year relatively speaking. The same can certainly be said about 2014, not just in absolute terms, but also relative to other alternative investment strategies. That led to a large inflow of assets into the industry. We also know that, as you mentioned, a lot of people left disappointed and bewildered, maybe even, after a couple of years.
Now if we dream a little bit here and we think that in a world that is becoming more divergent. In a world where we've now seen proof of anything can happen, and we have interest rates at the lowest levels we've ever seen. Some people will maybe be tempted to come back to the space, or new people might even venture into it. How do we as managers or as an industry, how do we avoid the same turmoil in terms of asset flows that we saw after 2008 and 2009 inflows and then the outflows in 2011 and 2012 and 2013? Can we do anything at all to avoid the instability that created, which wasn't good for anyone, really?
Marty: I don't think there's a panacea. I think it comes down to continuing education and familiarity. I think that having been through the cycle. You've seen it perform in 2008, if that was your first observation of it. Then you invested and then got disillusioned, you've now seen it perform strongly again in 2014. I don't want to project that it only comes along once every six years. I think as we've explained to our clients and also the UCC paper supports, that was an extended fallow period in a post-crisis environment. I believe that manifested itself in non-normal market conditions, and there are signs that that normality is returning to markets. I think that the education process continues. I think that investors should be steered to think about the factor that they're investing in rather than just looking at the manager and a black box stream of returns. Does that make sense? For me it's much more important that our investors understand that the return stream that our program is generating rather than saying, "Oh, you had a good last quarter, I'll have some of that."
Niels: Do think we need to be more selective with the clients, meaning do we also need to understand the clients better or potential clients?
Marty: I would never claim to be patronizing of my clients. I think that I will bend over backward to try and help them to understand what it is we're trying to do and the return stream that I think our program will generate. They're all extremely intelligent folks, and I respect the decisions that they make.
Niels: Absolutely. Now I've only got one question left, but before that I just, as always want to give you a chance to bring up anything that you feel is important that you want to highlight, anything new that you might be cooking up on your side, or anything that you think might be useful to just touch on before we finish for today?
Marty: No, Niels, be careful asking me an open ended question because I could then talk for the next hour and a half. Look, 2014 was interesting for all of the reasons that we've already covered. I think in terms of one of the things that we touched on when we spoke originally was the extended fallow period for momentum and systematic investing has meant that it's been really tough for some of the talented smaller strategies to get a toehold.
I think, even though I would love that all of my investors were entirely rational, and the world was an entirely rational place, the irony is that these sort of cycles that we experience of investor inflow and investor withdrawal, that the behavioral underpinnings of that are many of the same behavioral underpinnings of why trends actually work as a strategy. Having said all of that, it will be a good thing if there is some investment in the industry. Frankly if there is some sponsoring of newer strategies. I think that's healthy for everything that we do.
Niels: Let's leave it at that. That was a great way to finish and, as I mentioned it is a short episode today, but of course for those who want to hear much more from Marty, please do go and listen to our previous conversations on Top Traders Unplugged. I do want to thank you, Marty, again for being on the podcast and sharing your insights. Of course, I do want to congratulate you on a very important and solid year as well. I want to wish you, your colleagues and your firm all the best for 2015 and I look forward to catching up later in the year.
Marty: I look forward to that as well Niels. It's always a pleasure.
Niels: Thank you so much, all the best, take care.
Ending: Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you, and to ensure our show continues to grow, please leave us an honest rating and review on iTunes. It only takes a minute, and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged.
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Date posted: 04 Feb 2015no comments