Regardless of the investment strategy that you apply to the markets, your strategy or approach needs to evolve over time.  The way we did Trend Following back in the 1970s, 1980s, & 1990s is not exactly the way we do it today, and I think this can be said about most, if not all strategies.  Now with some strategies, the model decay is so rapid, that if you don’t adapt quickly you can lose your edge.  I think short-term strategies are good examples of this.  Trend Following, being a longer-term strategy is, in my opinion, a lot slower when it comes to Model Decay… so you need to have been around for a really long time in order to have witnessed this evolution.  

So when I looked through my list of guests to pull a few golden nuggets from on this theme, I thought that Marty Lueck, the co-founder of AHL and Aspect Capital would be the perfect person for this.  So enjoy these unique takeaways from my conversation with Marty, and if you would like to listen to the full conversation, just go to Top Traders Unplugged Episode 37 & Episode 38.

How Trend Following Has Evolved Over Time

Niels:  What has been the biggest changes over time and is it really small incremental changes, or is there something where you look back and you say in the last 15 years 2008, or 2009, or whatever it might be, we did actually discover something that we would say that was a big upgrade or that was a big find - key finding?

Marty:  By and large it is very much an incremental process and we make a virtue of that because you don't want... the last thing we want to do, especially with our focus on institutional investors and a high level of transparency. The last thing you want to do is surprise an investor. With the benefit of hindsight, I highlight two particular features about the evolution of the approach. First, in an odd way... the first, Niels, is the importance of risk management and portfolio construction. I think this is something that investors and maybe managers that haven't been doing it for that long may underestimate the importance of this in the process, and again I'm saying this because I did (laugh). After all of the shenanigans of looking at Chartism and distilling it down into to so fundamental tech models, you come up with a pretty robust diversified set of medium term trend following models, or we did anyway.

The neat thing, in the 1980s was the range of markets that have sprung up around us, Niels, afforded us a level of diversification that essentially... the combination of trend following across that range of markets it risk managed itself. You didn't have correlated risk shocks. You didn't have ... there was enough intrinsic diversification that if one sector was melting down you'd have opportunities in another sector. Risk management...I couldn't spell risk at the time. Then a couple of things happen. First of all (I'm going to foreshorten this) you got to an era where I think some of those trend following models became less efficient. You go to an era where markets did become more homogenous, so there's both a sort of macro effect as your pension fund manager in Japan begins to hold a similar looking portfolio to your pension fund manager in Sacramento. Whereas, once upon a time they didn't, it was much more parochial.

''You got to an era where markets did become more homogenous, so there's a sort of macro effect, as your Pension Fund manager in Japan begins to hold a similar looking portfolio to your Pension Fund manager in Sacramento"

You begin to get a greater coherence of both investor holdings and then also with the advent of VaR metrics and that approach to risk management, you also got a more correlated response to events, so that everyone around the world who thought they were doing independent things would react in the same way to an event. In response to those kinds of increasing correlations in the markets and increasing propensity for s...