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Veteran Manager Q&A

Black Box Advantage in Hard Times

Martin Lueck, Aspect Capital's president and director of research, reviews the past year and the outlook for managed futures. Mr. Lueck worked on quantitative model-based futures trading for over two decades. In 1987 he co-founded Adam, Harding and Lueck Ltd., widely known as AHL and now part of Man Group Plc. He co-founded Aspect in 1997. Aspect's flagship fund returned more than 25% in 2008.

Mr. Lueck came to managed futures through a happy accident after studying physics. The family of an school chum, Michael Adam, was in business delivering sugar to the futures market in London and ran a small commodities brokerage where Messrs. Adam and Lueck tried to make sense of a new-fangled technical trading model. The rest is not yet history but rather a continuing fascination with money-making black boxes.

Opalesque Futures Intelligence: Last year was a disaster for most types of investment. Why was managed futures an exception?

Martin Lueck: 2008 was a showcase year for managed futures. This is not a flash in the pan, something that goes away. For 25 years we've been explaining to investors why they need managed futures in their portfolio. A fundamental benefit of the strategy is its non-correlation with equity and bond markets. In 2008, hedge fund investors were rueful at the lack of diversification in their alternatives portfolio. Managed futures is one of a startlingly few strategies that performed well last year and provides portfolio diversification, particularly in times of market stress.

OFI: How did you manage to make money in volatile markets?

ML: Aspect's returns during 2008 had diverse sources. We trade such a wide variety of markets that we are very likely to find opportunity somewhere. We trade in over 100 markets, across seven different sectors. In 2008, our models took not only a short position in equities but a whole range of other positions. Early in the year we made money by being long in agricultural commodities and interest rate contracts. We profited from oil as it reached heady heights but we had a difficult July and August as the market reversed. We then unwound the long position in oil and went short, which benefited our performance. In futures, it is just as easy to go short as to go long. It's absolutely symmetric in the positions you can take. That allows us to be nimble.

OFI: What effect did the extreme turbulence in fourth quarter of 2008 have on your positions?

ML: Actually, many of the trends were already established by then. For instance, equity markets had begun to slide and interest rate contracts were rising. A quantitative model gives you the confidence to stay with statistically established trends. What we trade depends on systematic modeling and statistical analysis of data, not gut feeling. The key is to manage the risk very carefully. Our models automatically scale back positions as markets become more volatile. As an example, our equity short positions were profitable at the beginning of the year, but as volatility picked up particularly in September around the Lehman Brothers collapse, we scaled them down even though the trend was continuing.

OFI: How did the credit contraction affect managed futures?

ML: The liquidity crunch that hit strategies like arbitrage was not a factor for us. We only trade in highly liquid markets. Our leverage is limited to what's inherent in futures contracts. You trade contracts on margin—you might trade $90,000 of gold with a margin of $4,000 but there's no borrowing involved.

OFI: Are there opportunities in 2009?

ML: My sense is that the global economy is not looking at a return to cheery times any time soon. If 2008 has been a painful year, I believe that there's still more to run and more time to ride many of the trends. Similarly, the fallout from the collapse of the technology bubble in 2000 created opportunities for managed futures for some time thereafter.

OFI: What conditions are bad for managed futures?

ML: There are two situations when managed futures are likely to perform less well: very sudden reversals of direction and extended periods of calm when there are no trends. In the current environment, however, there are likely to be more trends, whatever the economic prognosis. For instance, if you look at the money governments are printing, you can certainly discern opportunities in interest rates.

OFI: A lot of capital left hedge funds last year. What does that mean for managed futures?

ML: I'd like to think that managed futures will get a larger slice of the smaller hedge fund pie. The strategy has certainly demonstrated its mettle.

OFI: What should people watch for when investing in managed futures?

ML: A good manager will be willing to articulate to investors the principles behind the trades. Complex models should not be a barrier. The stigma attached to black boxes is misleading. If anything, it's an advantage: the systematic process avoids the vagaries of human emotion and key-man risk. The models, however, have to be continually updated and developed. The landscape evolves all the time, not only in the markets but also in competition with traders, for instance. A manager who continues to use the same model without evolving it is a disaster waiting to happen. At Aspect we spend around 75% of our annual budget on technology and research.. Like a pharmaceutical lab searching for innovation, we try to take advantage of changes in market dynamics and find new nuances. Investors need to consider not only a management firm's track record but also its investment and progress in research.