The Real Secret behind Trend Following and How it Works | with Martin Lueck

Episode Overview

• Martin Lueck discusses the evolution of trend following, from adapting trade execution to avoid market impact to implementing a structured, holistic process for strategy development.
• The conversation emphasizes the critical role of investor psychology, highlighting how an intuitive and understandable strategy helps clients stay disciplined through the inevitable drawdowns.
• Lueck explains the classic trend-following return profile, characterized by many small losses offset by a few large wins, and clarifies that "crisis alpha" is a positive byproduct, not the primary goal.
• The discussion covers the broader shift in fund management away from the "cult of personality" towards a more scientific, team-based, and process-driven approach.

Key Concepts

• Execution and Program Evolution: Trading execution has evolved from visible, large orders to "invisible" algorithmic trading to reduce market impact. This is complemented by a structured program development process where changes are bundled and reviewed holistically to understand their system-wide effects.
• Investor Psychology and Drawdowns: A core challenge is managing investor behavior, as they tend to buy after strong performance and sell during drawdowns. An intuitive strategy that aligns with major market news helps investors understand the portfolio and stay invested.
• Asymmetric Return Profile: Trend following is defined by its return profile: a win rate often below 50%, where numerous small, manageable losses are paid for by a handful of very large, profitable trends.
• Crisis Alpha as a Byproduct: The strategy's ability to perform well during market crises is an outcome of its design to capture sustained trends, which often emerge during stressful periods, rather than being an explicit goal.
• The Shift to Scientific Management: The asset management industry is moving away from a focus on the "genius of the trader" towards a repeatable, robust, and team-based scientific process for developing and maintaining strategies.
• Authenticity for New Managers: Aspiring managers are advised to "be true to yourself" by building a robust process around their core passion and skills, whether systematic or discretionary, rather than trying to imitate others.

Quotes

• At 11:21 - "I actually think trend following has this incredibly powerful feature, which is that it is intuitive... what an institutional investor needs during a drawdown is to have an intuitive sense that what their managers are doing is sensible." - Lueck highlights that the strategy's understandability is a key tool for managing client emotions and retaining capital.
• At 19:40 - "Our business is about losing money... We hope to do it in small amounts, frequently. And then every now and then, we have a wonderfully large profitable trade that pays for all the small losses." - Lueck provides a concise and candid description of the asymmetric return profile inherent in trend following.
• At 27:54 - "Crisis alpha is an output of what we do. It's a byproduct. It is not an input." - Lueck clarifies that the strategy is not designed to be a crisis hedge, but its ability to capture major trends means it often performs well during market turmoil.
• At 35:55 - "I think this is less about the genius of the trader than about the repeatability, robustness, thoroughness, and extensibility of the approach." - On the shift in modern fund management from individual stars to scientific, team-based processes.
• At 36:22 - "First nugget is... be true to yourself." - Lueck’s core advice to new or smaller managers, advising them to focus on their unique skills and style rather than trying to replicate others.

Takeaways

• A strategy's intuitiveness is a powerful feature that helps investors overcome behavioral biases and remain disciplined during the difficult periods inherent in trend following.
• Successful trend following requires embracing an asymmetric return profile: consistently accepting many small losses is the "cost" of capturing the rare, large trends that drive long-term performance.
• The future of successful asset management lies in building robust, scientific, and team-driven processes rather than relying on the perceived genius of a single individual.
• For new managers, authenticity is paramount; building a strategy around your genuine skills and passion is more sustainable than attempting to imitate a style that is not your own.