Managed Futures Today Magazine

John Hummel is president and CIO of AIS Group (www.aisgroup.com), a Wilton, Conn.-based investment firm that has been operating both futures- and equity-based funds since 1992. The firm currently manages approximately $400 million, with the largest portion traded in its Multi-Asset Allocation Portfolio (MAAP), a futures program that returned 66% (in its higher-leverage version) in 2010, placing it in the top five commodity trading advisories (CTAs) trading $10 million or more in BarclayHedge’s annual rankings.

The MAAP, a long-term discretionary trend-following strategy applied to six futures groups, is one of four programs the AIS Group runs in its two divisions: AIS Futures Management trades the two differently leveraged versions of the MAAP, while AIS Capital Management runs the Gold Strategy, Tactical Asset Allocation Portfolio (TAAP), and Capital Growth programs.

The MAAP program’s robust returns in recent years (the lower-leverage 2x-4x version has a five-year compound average return of 11.4%) have not been without volatility. After a 54% return in 2007, the program suffered a 52% drawdown in 2008, but followed that with a 64% gain in 2009 (Table 1). In the wake of the 2008 experience, the firm developed a new risk-control mechanism designed to reduce leverage in high-risk situations -— a mechanism that was, in fact, activated by this year’s fall market downturns.

Hummel, 66, began his career in traditional equity analysis and investment advising (he practiced both fundamental and technical analysis) after graduating from Northwestern University in 1967. He worked for a number of firms, including Robert W. Baird & Co., Mitchell Hutchins (eventually acquired by Paine Webber), and Cowen & Co. before launching AIS in 1992 with fellow Cowen coworker Brad Stern, current AIS partner and CCO.

MFT: What was your introduction to futures?

JH: In early 1981, I was convinced we were seeing a major top in interest rates, and because Mitchell Hutchins had a futures division, I got interested in long-term bond futures. My first foray into [trading] futures was buying U.S. Treasury bond futures. That gradually led to an interest in the commodity markets, because I had always believed very strongly in a top-down macroeconomic approach to traditional portfolio management, and had a strong belief that we still ascribe to today: that changing economic environments create new opportunities and new risks in different asset groups.

The first strategy Brad Stern and I developed was actually not a futures program but a tactical asset allocation strategy for equities, bonds, and cash equivalents. Modern portfolio theory was coming on the scene at that time, pointing out the value of non-correlated or negatively correlated assets, and because I had statistical historical pricing on commodities, we looked at including gold in a traditional stock and bond portfolio.

That led us to our longest-running and most conservative strategy we still invest in, which is equities, long-term Treasury bonds, gold bullion, and cash (the TAAP program). When we finished developing the Tactical Asset Allocation Portfolio, we thought the idea of negatively correlated assets made a lot of sense, so we decided to look at the futures markets and developed MAAP (trading commenced in July 1992). We can go long or short, or be neutral, in any one of six areas — equities, fixed income, currencies, energy, grains, and metals.

MFT: How do you allocate among the market groups?

JH: We cannot allocate any more than one-sixth of the total contract value to any one of the areas, long or short. These are pure futures products, and we use leverage. The 2x-4x program tends to fall between two and four times leverage, and probably averages about 2.7. The 3x-6x program averages around four times leverage.

Our fourth strategy, the AIS gold fund, started trading at the beginning of 2003. It invests in individual mining stocks, and uses gold and silver futures. Our work in the Tactical Asset Allocation Portfolio at the time suggested we were entering a period in which gold would begin to outperform financial assets.

One of the things that intrigued us when developing TAAP in the early 1990s was the fact that, as I mentioned earlier, changing economic and financial environments create opportunities and excess return in some assets and excess risk in others.

Markets are reasonably good at discounting what’s known and expected, but when things are changing and something is new it can take the markets considerable time to readjust to the new realities.

We’ve spent a lot of time looking at relative performance of various assets and have found, for instance, when financial assets start to outperform gold or other commodities, that can go on for years or even decades. Similarly, when gold or other commodities begin to outperform financial markets on a relative basis, that can go on for years or decades. This influences our long and short decisions.

We feel we’re currently in an environment that’s probably the bull market of our lifetime in gold and commodities.

For the previous 100 years, probably 95% of commodity consumption was taken up by perhaps 12-15% of the world’s population — the U.S., Europe, and Japan. Now, when you toss in China and India, Brazil, the Middle East, and some of the smaller countries, you’re seeing an unprecedented expansion of the middle class in the developing world. And from everything we’ve read, when people enter the middle-class, disposable-income level, they take on similar consumption patterns, regardless of their culture or religion. They want the same things we in the West have been accustomed to. They begin to eat more meat, which puts huge demand on grain consumption, because it takes two to seven times as much grain to produce a pound of meat than if people eat the grain directly. And then there’s infrastructure development and consumer items.

In the developing world, every incremental dollar of GDP leads to much greater commodity consumption than it does in advanced, developed economies such as the United States.

When we grow, every incremental dollar of GDP leads to services and information — non-commodity items — whereas in the developing world the demand is on commodity items.

We’re now at a point that, even though the developed world is growing very slowly, the amount of GDP the developing world is contributing to the entire world is actually going to keep the global GDP growing at even faster rates than those of the past decade.

“Changing economic environments create new opportunities and new risks in different asset groups.”

MFT: What, if anything, might disrupt that outlook?

JH: I think there are several things with the potential to derail the bullish commodity picture. The supply side of these basic commodities is going to be a problem, and therefore price will ration supplies if they become tight. For example, we believe the world’s going to have a hard time supplying enough additional oil, so there will be periods when the price of oil will rise to levels that could potentially create slowdowns or recessions.

Demands on food, on grains, are going to be an issue because the countries that are chronically water short, like China and India, are causing the biggest incremental demands in terms of things like meat consumption. Agriculture takes 70% of the world’s fresh-water supplies, industry takes about 20%, and direct consumption is about 10%.

[China is now] the biggest importer of soybeans, the second-biggest importer of oil, and they’re going to put big demands on corn supplies in the years ahead.

MFT: What about the governmental side of things? In the U.S., what role will the Fed’s policies play in the big-picture outlook?

JH: [Today], I think, as much as the Fed would like to see inflation controlled, they’re going to be doing more quantitative easing. I think it’s probably necessary at this point to solve the short-term problems. I also think the European Central Bank is gradually evolving into a body that more closely resembles the Federal Reserve in terms of its objectives. Instead of just being concerned about inflation, they’re going to be concerned about financial viability and full employment, and they’re going to be more liberal over time.

One implication of this is that it’s extremely bullish for gold. I think gold is just recapturing its role as an alternative store of value.

MFT: So you don’t think the recent gold correction signifies any kind of sea change in that market?

JH: No. In the case of the gold bull market in the 1970s, there was just incredible speculation in 1979-1980 in precious metals and fear of inflation, and so forth.

The environment today is so subdued [by comparison]. Despite the peak above $1,900 in gold in August, there’s no speculation in gold stocks, especially the small ones; the public’s just not there. I believe that before the bull market is over in gold we’re going to experience something like the dot-com mania, in [gold] stocks.

MFT: How long do you think it might take to reach that point?

JH: It’s impossible to guess, but I don’t think it’s inconceivable that it could go on for another five to 10 years. The most relevant point is that the bubble isn’t in gold, it’s in debt creation by governments. The riskiest part of that is the amount of government debt that’s held externally. The U.S. is the world’s largest debtor; the amount of Treasury and Treasury-guaranteed debt held by foreigners has been growing at more than 16% annually for 41 years. The price of gold relative to how much foreign-held debt we have is minimal, and I think the private market is in the process of driving gold much higher because of this.

MFT: Do you think the Fed’s policies are destined to have an bad ending, in that they’re ultimately not sustainable? The policies at some point have to end, and ultimately be reversed, right?

JH: Yes. And that’s why I think gold is going to go to some significant multiple of its current level that will allow heavily indebted governments that own a lot of gold to exchange some of it for their outstanding debt.

MFT: Let’s talk a little more about the MAAP program.

“I think gold is just recapturing its role as an alternative store of value … the bubble isn’t in gold, it’s in debt creation by governments.”

It’s a discretionary program, and you’re operating on a long time horizon, correct?

JH: Yes, we are very long term and discretionary. We have no positions (in mid-October) in equities or Treasury bonds; we were short the S&P futures from the second quarter through early August. We are also long gold, silver, and copper; long the grains and the soybean complex. We’re also long crude oil, heating oil, and gasoline, and long the Australian and Canadian dollars.

MFT: As a discretionary trader, what inputs go into your trade decisions?

JH: We look at some macro, fundamental things — individual demand and supply in the various markets — and then we use some proprietary technical tools. We also have a system than controls our leverage at times. It forces us to deleverage when we feel there’s a high degree of risk.

MFT: How does the risk-control system work?

JH: It’s something we’ve used in the equity markets to help us determine the health of the markets. We’ve found that when you get fewer and fewer stocks participating in an uptrend, that it’s very often a precursor to a top forming in the general market.

MFT: So is it a kind of breadth indicator, at least in terms of the equity market?

JH: Yes, in a simple sense, that’s correct.

MFT: You assign points to the different markets in a portfolio, and adjust the positions based on the how the total changes, correct? Do the points represent the degree of trend in each market?

JH: Basically, yes. When we get to what we define as a trend breaking down — when we get to a critical level — it forces us to reduce leverage.

MFT: What kind of time horizon are you operating on with a typical trade? What are the moves you’re trying to exploit?

JH: Well, good trades last for years. Ideally, that’s what we’re looking for — trades we can participate in for, say, a year-and-a-half to three or four years.

Managed futures investors should use money: “They’re not going to need for five years ... They need to make a long-term commitment to it.”

MFT: What happened in 2008, which was the one big down year you’ve had recently?

JH: We were correctly bearish on the stock market and had been short from late 2007 into October 2008, but it wasn’t enough to offset our long positions in commodity markets. We overstayed our welcome in commodities because we felt, on a long-term basis, commodities were still very undervalued in inflation-adjusted terms. Even at the peaks in June 2008, on an inflation-adjusted basis commodities were much closer to their 100-year lows than their highs. We felt the bull-market environment in the developing world, which I mentioned earlier, was still unfolding and had much further to go.

The mistake we made was that these markets basically became unhinged from fundamentals and were totally dominated by a financial squeeze — which is somewhat similar, on a much smaller scale, to what happened in late September [in gold]. And that’s why we introduced our systematic leverage-reduction program.

MFT: After the events in 2008?

JH: Yes.

MFT: Did it kick in during September of this year?

JH: At the beginning of October. In our back test we recognized there would be times during intermediate corrections when the leverage-reduction system would add no value. It’s designed to prevent major declines.

MFT: What do you see yourself offering the managed futures space?

JH: We think we’re an excellent diversifier for individuals who have traditional stock and bond portfolios. Being part of that adds risk-adjusted value over time.

MFT:  What do you think managed futures investors need to understand before they invest?

JH: It’s the same thing I tell people who want to give us money for a stock portfolio: that it should be money they’re not going to need for five years. They can go out on a monthly basis, but I don’t think they should be giving us money they need in three months or even 18 months. They need to make a long-term commitment to it.