The original founders of AHL were brought together by CME Group at London’s famous Abbey Road Studios for an in-depth interview with veteran hedge fund manager Niels Kaastrup-Larsen.
It was the year 1987. In the City, the ‘Big Bang’ had launched a deregulation of financial markets which swept away restrictive practices and was to usher in an era of electronic, screen-based trading. Prime Minister Margaret Thatcher was at the height of her powers and acid house was about to take off on the London music scene.
Meanwhile, a trio of 20-somethings from Oxbridge were about to become influential pioneers of systematic trading and trend-following strategies, and an inspiration for countless firms to mirror their success.
Mike Adam had dropped out of Oxford University without a degree, rendering himself “essentially unemployable”.
He ended up working in his family commodity brokering business, Brockham Securities, one of many beavering away in The City at the time with their own franchises.
He started in the back office, doing the books and drawing charts by hand. When a computer arrived, he created a database to draw charts on a flatbed plotter, and an accounting package to do the bookkeeping.
“Laziness drove me to automate my own job,” he recalls. “That was the beginning of my interest in computer programming and its application.”
After getting a degree at Oxford, a former classmate, Martin Lueck, had wound up at Nomura selling Japanese equities, which he recalls doing very well. “I was the ‘young lion’ of that year’s intake of the equity trading desk.”
Yet he spent his lunchtimes hanging out with Adam, and had learned to program while working in Washington DC for a Department of Defense contractor during his summer holidays at university.
In late 1984, he quit Nomura to work for Adam’s father at Brockham. “Rather than do a slog of a job, I went to have fun coding an early Hewlett Packard workstation with Michael. It didn’t feel like work at the time,” he says.
With the encouragement and some financial backing from Adam’s father’s business, the pair distilled some technical trading models to start trading a small portfolio of six physical commodity markets with around £25,000.
Meanwhile a Cambridge theoretical physics graduate called David Harding had been working through a series of jobs in the City.
He had done a stint on the trading floor of the London International Financial Futures Exchange (LIFFE) before moving to a commodity broker, which went bust, and then to Sabre Fund Management, a London-based futures trading CTA, the biggest one in the UK at the time with around $4.5m.
Harding recalls having to draw hundreds of charts by hand every day. “That was not really what I thought I was cut out for in life. It did give me a lot of time for reflecting on chart patterns.”
Harding had read all the books at the time on technical analysis and bond maths. “I had a pretty strong feeling that markets weren’t efficient and that there was some sort of point to trying to forecast them,” he says.
He started talking to Adam and Lueck, and was amazed to see the software they had written was well in advance of what was being used in most of the banks and institutions.
“They put charts on the walls and you could see where the computer was saying buy, and sell, and it was almost the same places that the arcane science of technical analysis had taught me you should buy and sell. “That was striking to me – that an algorithm could produce the same results as this body of expertise.”
Harding adds: “My fantasy, at that stage, was that they’d take my ideas and test them and turn them into reality. Practically, they didn’t need all that much of my ideas because they already had perfectly good ideas of their own.”
Harding ended up being recruited into the Adam brokerage business. In fact he was the only candidate.
“David was the one who was absolutely obsessed with markets. [He] was one of the few other people in London, along with the astrologists and other peripheral nut cases that, at that stage, said it was possible to trade markets systematically,” Adam recalls.
Scientists were already being recruited in growing numbers into the financial service industry from the early ‘80s, but as Harding recalls, many were drawn into the orthodoxy of efficient market theory and an “over-idealisation of how the financial system works”.
“The mathematical theories at the heart of finance were wrong,” he says.
Harding says he remembers feeling that he had failed: with a degree in physics and five years in the City, he wasn’t already earning £100,000 a year.
“You remember that was the height of Mrs Thatcher and I was supposed to be a Yuppie at that point in time, and I wasn’t a Yuppie.”
Adam, Harding and Lueck were all physicists by background, trained to have an experimental, empiricist perspective on the world. And the software Adam and Lueck had written enabled them to do experiments.
Lueck recalls that much of the managed futures industry at the time in the US was made up of experienced floor traders who had encoded their rule set using a computer, and that was it.
“Without thinking about it, our attitude was: ‘Well, I’ve done this, and it looks good enough, but what if I try that? What if I expand this? What if I add a new market? What if I go faster?’
“There was a constant inquisitiveness. Maybe it’s just the people we were, but also an element of that scientific perspective.”
Adam points out that technology had also arrived just at the right time, and it was “plausible to get some pretty serious processing power” to run computer experiments.
“In the first three years we were always waiting for a new, more powerful, Hewlett Packard model to turn up so that we could run the experiment [in less time],” recalls Harding.
At the start, the trio were making money as consultants rather than money managers.
“We were running experiments which, when we showed them to other people: the questions we were asking and the answers we were getting, as far as they were concerned it was magic,” Adam says.
“I think we learned a lot from looking at other people’s market-related problems that otherwise we wouldn’t have learned and some quite surprising insights followed from that.”
Looking back, they recall making three or four discoveries, that while well understood now, were “really material” at the time, such as developing a framework for equalising the risk across different markets.
“What makes a discovery amazing is that it’s elegant, and beautiful, and simple. If it’s a very, very complicated piece of math leading to a very significant result it’s probably wrong,” says Harding.
One consultancy project, for example, led them to see how trend-following was a systematic way of thinking about market-making, and that the cost of market access was incredibly important.
“We started measuring our full cost of market access from the point of sampling to the point of execution,” says Adam.
“We started looking at what we were paying to execute and that led us on a drive to set up a trading desk, to get close to the markets, to talk directly to the floor. So that insight made us focus on something that our competitors just weren’t focused on, with real confidence that it was important.”
Another consultancy job involved doing research for a company in option replication. They would later recycle that work when thinking about how to gear a guaranteed fund.
In February 1987, the trio left Brockham. Adam recounts how his father fired Harding and Lueck while he was on holiday after being at odds over their vision for the future of the brokerage.
“On my 25th birthday, [the most important single decision in business that I’ve made], in anger and without thought [was] to pick up the computer which had the software on it and walk out with my father’s words ringing in my ears that he would disinherit me to keep walking out of the door. It was the decision made in no time that completely changed the outcome of my life,” Adams says.
“It turned out to be a great decision, however it didn’t feel great at the time.”
Adam recalls there was some question as to whether they would start a systematic trading business at all. They had considered starting a computer consultancy or some other entrepreneurial venture, and did end up selling some accounting software.
“We didn’t know what we had discovered,” says Lueck. “Systematic trading, in those early days, felt like a happy accident. When things were going well you think: ‘Yes, we’re so smart.’ When things are going badly it’s miserable.
“I think we must have come off the back of some miserable period because we were ready to throw in the towel on the investment management business”.
However, Harding had more confidence that the innovative software they had developed on personal computers had “significant value”.
He found that friends in the City were very impressed by the use of colour graphics and heat maps, which were new to finance at the time. Harding adds there were also some loyal clients who were supportive of the trio starting a new company, which also allowed them to keep a continuity of track record.
The trio started their new company, Adam, Harding and Lueck Limited (AHL), with around £100,000 under management.
As a start-up they moved offices frequently, at least half a dozen times in the first two years, and employed friends to “do some of the donkey work”.
They never borrowed any money. The first six month passed in a flash, recalls Harding. “At the time there was lots of stuff that happened in six months. We had people join, fall out, leave.”
Adam says there was no sense that they were doing the right thing in starting their own business. No-one they knew of their age would contemplate it. “All of our cool friends were getting fancy jobs in big institutions,” recalls Lueck.
“We were the unemployables doing the crazy thing,” adds Adam. “It’s almost hard to remember the way that it felt to be starting your own business as three people in their mid-twenties who had no idea what they were doing back in those days. It clearly felt as if you were doing the wrong thing, or at least if you listened to advice. The world has changed so much.”
Reflecting on his own career, Harding says: “If I’d known what it entailed I wouldn’t have started it, roughly speaking. If we’d known what we were going to have to go through… you wouldn’t have done it again. You would have gotten a safe job. It’s great to have been successful but it can be a bit of a bruising experience.”
He adds: “If people knew what starting a new business would entail, no one would ever start a new business. [You need] an impetuosity, recklessness, or naivety, or even a sort of greed, that gets you over the hump of doing something which is essentially not a rational decision.”
As a new business they were unable to afford people with vast experience in banking and trading, so were almost forced to recruit new graduates, raw talent, and then invented the ways in which they wanted them to work from scratch.
“I think that turned out to be an advantage,” says Adam. “Subsequently, whenever we employed anyone who had experience in markets we would really struggle to train them to unlearn all the things that they’d been taught that actually were completely destructive, and inappropriate, and clearly an obstacle to progress.”
Within a couple of years AHL was attracting the attention of ED&F Man, which had already built a successful partnership with Mint Investment Management, the systematic firm founded by Larry Hite, Peter Matthews, and Michael Delman, which became the first CTA to pass $1bn in AuM around 1990.
Harding was already aware of a systematic trading industry in the US, having joined Sabre in 1985, and had been developing trading systems at a commodity broker before that.
In 1985 or 1986 he had travelled to a managed futures industry conference in Orlando, Florida, hosted by Mort Baratz. But at the time industry was small and considered at the fringes of finance, almost ridiculed as eccentrics.
“In our first year of existence, The Economist wrote an article saying that we were wrong, doomed to fail, that the markets were efficient, and that we were essentially wasting our time,” recalls Adam.
“If you used astrological charts to predict markets then you would be at the same conference as the early trend-followers.”
“Efficient market theory was the orthodoxy and trading systems was the heresy,” adds Harding.
But in the late 1980s, around the world, more affordable technology and quantitative modelling was giving rise to successful systems trading, from Renaissance Technologies taking off with its Medallion fund, to statistical arbitrage being developed at Morgan Stanley, and Citadel founder Ken Griffin trading convertibles out of his college bedroom at Harvard.
Elsewhere in the CTA industry, John Henry – whose parents were soybean farmers – was using systemic approaches to trade commodity futures at John W Henry & Company.
“We were sitting on a selection of gold mines in 1987 and 1988,” says Harding. “Probably we could have gone a number of other routes and done very well because all of our consultancy.
“Ken Griffin at Citadel. He was doing convertibles which is a completely different world – nothing to do with trend-following and so-forth. But a lot of money was made in the ‘90s out of convertibles. I’m not saying we could have been Renaissance, but we could have developed convertible arbitrage.”
He adds: “All those other firms were doing the same sort of things involving markets, computer simulation and trading, and bringing to bear exactly the skills that the three of us had in combination.”
Adam notes: “It’s unsurprising that simultaneously, all over the world, a number of people with similar sorts of backgrounds were doing this.
“I think the reason why quite a lot of that work comes from the commodities side is simply because the market structures in commodities happened to become a model for the way that other highly liquid markets then evolved. So, that became a template.”
He explains: “So, if you had experience in those markets you knew what to do when suddenly there was a Treasury bond futures contract.
“We immediately knew what to do when a new financial futures market opened. There was one new one a week. We had a way of normalising the data, so we could add it to our portfolio immediately and see an immediate diversification benefit, and knew exactly how to exploit it.
“I think that’s the reason why people from a commodities background were involved in this around the world, in systematic trading, and that’s because of the long history of futures markets and commodities.”
Man moves in to buy AHL
The software the AHL trio had developed attracted instant interest from the brokerage community as well as from a lot of people in the commodity markets. And in 1989 ED&F Man decided to buy a part of AHL.
“[With Mint] Man had built a great franchise around a branded product that wasn’t branded Man,” says Adam.
“I think part of what attracted Man Group to us is the analogy with Mint. They saw three people – Adam, Harding, and Lueck – and they said: ‘We’ve been here before, we know how to do this.’ We were valuable internal competition for Mint.”
But while Man had taken a 50% stake in Mint in 1984, they agreed a deal to buy 51% of AHL.
Harding recalls: “I remember the meeting where they said: ‘You wouldn’t consider selling 51%? At least two of us, if not three, said: ‘Yes we would!’
“It was clearly in the minds of the deal makers at Man that they would buy a majority stake and then use that to digest and control the investment management half of the enterprise, which is precisely what they did. It was an extremely well-executed manoeuvre.”
For the AHL trio, Man’s distribution machine was attractive to raise assets. At least as big a motivation was market access.
“We figured out that as an outsider, we simply couldn’t get cost effective access to markets. Whereas the Man Group was plugged into the markets we wanted to trade,” says Adam.
The Mint deal was forged by the brokerage division of Man; the Mint system spat out orders which got faxed across to the brokerage unit to be executed.
“Everyone was happy. It was spilling off money. It was over a billion dollars and it was at capacity,” recalls Lueck. “They really couldn’t execute more. It was a case that they were onto a good thing and could they find some more product which we looked like we represented.
“So, they did get a bit of a surprise when we said: ‘But we’re asset managers and this brokerage bit of the business has to get a little bit sharper’.”
Adam says he felt like there was a constant “war of attrition” inside Man.
“We were constantly driving to reduce the time between sample and execution; to reduce the cost per round turn of what we were doing so that we could trade faster,” he says.
“That worked completely counter to the natural instincts of the brokerage division who understood that having freedom to execute with a secure order flow was highly profitable for them, as it was for any broker.”
He adds: “It seems strange now, because of course, everyone is now obsessed with the speed of market access and costs. No broker would ever say: ‘Send me your orders and I’ll let you know when I’ve executed them at some stage tomorrow’.”
Adam says at every stage in the life of AHL he felt a great sense of urgency. The dominant thought was: “This can’t last. We’ve found some things here and we’ve encoded them and surely that edge is going to be taken away from us at any moment.”
“When we sold to Man Group I was extremely relieved because I didn’t think there would be more than three or four more years in which it would work, whether we were involved in it or not. I’m very surprised it’s still going.”
He adds: “In hindsight, I can see that the world moves a lot more slowly than I thought it would. I’m now a musician and amazingly record labels still exist.
“Things have a much longer life and are much slower to decay than I thought at that stage in my life. I was completely wrong.”
Harding says he shared Adam’s paranoia about the future of what they’d done, but had more faith that further research could be done to discover new things.
“I didn’t think that trend-following would work as long as it has, but I did think that there was a world of other opportunities. I felt that very strongly.”
Lueck says he remembers having conversations about building something that would outlast three founders, but they didn’t dwell on whether it would or not.
He says there was a feeling they had built a “nice-looking business”, having encoded the rule sets of the money management that was “more robust than any discretionary trader shooting from the hip”, and institutionalised the research and development process.
By the time ED&F Man offered to buy out the remaining part of the AHL business in September 1994, the trio were ready to go their separate ways.
“We’d had enough of each other by that stage. Rather like the Beatles in 1969,” jokes Harding.
“It’s sad because the partnership was very, very creative. We can look back and wonder what might have been. “It was undoubtedly a very creative partnership, but that’s just the way it is. We wanted to do our own things. We own wanted our own solo careers.”
“I think the timing of it, when Man bought out the minorities and then they IPOed, it felt like a fitting point,” adds Lueck.
Harding points out that when Man bought a 51% stake they said it was with the view of corporatising AHL, which is what they did.
“It was a success for them, but it was a little painful for us as well because effectively they removed the entrepreneurs from their business, which was in the long-term interest of the entrepreneurs and probably for the business as well, but it didn’t feel like it was in our long-term interest at that particular moment in time for any of us.”
Adam left first; Lueck and Harding a year or so later. Harding was the first to start his own firm, setting up Winton Capital in February 1997.
Winton started paper trading in June, and then real trading in October, going down 13% in its first month, to this day its worst ever monthly drawdown.
Lueck founded Aspect Capital in the autumn of 1997 with Eugene Lambert and Anthony Todd, an old Oxford university friend who was already at Man, whom he credits with catalysing the business. Adam was initially a non-executive and joined later as CIO, before leaving in spring 2008.
They took a year to establish the business and raise some money and started trading at end of 1998, just after the Russian crisis, which put them into the doldrums for about a year.
Harding admits he had “no good options” after leaving Man.
“The objective I wanted to achieve was doing research in financial markets and for that, I needed a team of people. I am not a computer programmer or a researcher myself. I direct operations, rather than do it. I suppose if I was a better person I would have perhaps gone off and taught myself programming and bought a computer, but I already had slightly grander ideas than that.
“What I could have done, I suppose, is teamed up with a bigger company and started larger scale, but in practice, I just teamed up with one and a half friends and started at a very small scale, and Winton was very, very small scale for the first two or three years.”
The two firms – Winton and Aspect – would grow to be powerhouses of the managed futures industry, alongside Man AHL, now a $19bn quant unit of Man Group.
Reflecting on the legacy of AHL, Adam says: “When we started out in AHL we absolutely challenged the orthodoxy and did something that we were told repeatedly, by people who were far more experienced and knew far more than we did, that not only was it not going to work but it couldn’t work.
“I would like the thing that people should take from that going forward is that the future is history that has not yet been written.”
Harding adds: “I think it’s testament that the efficient market theory can be quite a bad model and that there’s auto-correlation in markets and that has very significant public policy implications, which I’m not sure the economics profession has absorbed.”
Lueck says: “I think that unwittingly we were at the leading edge of something that became a big industry – with what David has done at Winton, and what Man Group have gone on to do, and Aspect, and many other members of the diaspora.
“Of course, we’d like to say it was all down to our genius, but that movement has created an investment management industry that employs hundreds, if not thousands of people, that does really useful things for people’s savings and pension funds, that backs deep science in universities around the country and around the world. That’s part of the early legacy of AHL.”
This article was adapted from an interview by Niels Kaastrup-Larsen with the founders of AHL, part of CME Group’s sponsored Top Traders Round Table podcast series