Little black box models big rewards

IT IS now a £4.8bn powerhouse and a member of the FTSE 100 index of Britain's leading firms. But some 20 years ago, what is now known as Man Group was a privately-owned City broker called ED&F Man, best known for sugar trading.

The transformation owes much to aggressive senior managers with an eye for a good deal and to AHL, a 'black box' fund management operation it bought in 1989.

AHL has grown hugely since then with $7.9bn (£4.3bn) assets under management last September. It also produced an annualised return of 19.6% on average between 1990 and 2003, against 7.7% achieved by world stock markets.

Man is strangely coy about AHL, but analysts have little doubt it is the jewel in the group's crown. Martin Cross, at Teather & Greenwood, said: 'I am fairly sure AHL is the largest single source of profits for Man.'

Still, Man will say only that AHL's performance 'has been a tribute to the methodology and principles it employs - diversification, discipline, rigorous risk control and ongoing research'.

The first ingredient of AHL - named after founders Michael Adams, David Harding and Marty Lueck, none of whom are still at Man - and similar hedge fund operators, is a blend of computer power and complex mathematics. We can call this 'black-box' trading, although practitioners prefer descriptions such as 'quantitative systematic' or 'model-driven'.

A second component is opportunism. AHL, and rivals such as London-based Aspect Capital - co-founded in 1997 by one of AHL's original trio - dip in and out of many different markets, aiming to perform well whether share prices go up or down.

A presentation last autumn by Man's chief investment officer, David Huyton, gave AHL's exposure as 23% in currencies, 18% in energy and smaller percentages in bonds, stocks, interest rates, metals and agricultural products.

The third ingredient is psychology. These funds rely on the tendency for investors to show the same 'crowd behaviour' time and again. Markets often 'trend' well beyond the point of apparent overshoot - January's sprint in the sterling-dollar rate to $1.91 being a recent example. The funds try to recognise a trend and stick with it.

Alastair Smith, director of Aspect Capital, says its computer program, like that of AHL, crunches 24 hours a day through stock, foreign exchange, bond and commodity markets, searching for trends, and for other patterns it recognises.

'We are pure, scientific, quantitative investors,' says Smith. 'We do exactly what the model says.' It seems to work for Aspect - its diversified fund produced returns of 24.9% in 2000, 15.8% in 2001, 19.2% in 2002 and 20.6% last year.

Sceptics argue that the performance of black-box funds can be volatile. Some of them struggled in 1999, for instance, when conventional equity investors were enjoying a boom.

There is also a question mark over whether quantitative funds can continue to blossom when more and more money in the markets is being managed this way.

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