HAS TREND-FOLLOWING CHANGED?
We have translated the general question into five approachable topics of interest:
♦ have general trend-following methods changed?
♦ have the sources of return for trend-following changed?
♦ have the magnitude or pattern of returns from trend-following changed?
♦ have the characteristics of trends changed?
♦ what are the implications for trend-following return characteristics?
1. Have General Trend-Following Methods Changed?
No, there is no evidence as such.
2. Have the Sources of Return for Trend-Following Changed?
No, there is no evidence or logical way to support this.
3. Have the Magnitude or Pattern of Returns from Trend-Following Changed?
No, there is no evidence supporting this during the past 10 years.... One caveat to the response to this question is related to the time horizon over which it is asked. If this same question were posed over a very long time frame, the answer might be yes, there is evidence. Performance in the past 10 to 15 years is lower than the results from the late 1970s through the mid 1980s.
4. Have the Characteristics of Trends Changed?
Yes, maybe. But is it significant? In recent years, the overall magnitudes of trends have been smaller. This reduces the theoretical edge of a trend-following model significantly.
....This is especially disheartening given that the vastly lower net return is accompanied by identical risks to the initial equity and to the open trade equity give back from peak valuation. This nonlinear efficiency is analogous to any industry with fixed and variable operating costs. Margins can expand significantly if the magnitude of a trend matches well the time frame of the operating model.
....The old stock market adage that markets fall twice as fast as they rise is an example of this behavior. By some measures, the speed of these retracements has increased on average during the last few years, sometimes reaching four to five times the rate of price movement with the trend.
5. What Are the Implications for Trend-Following Return Characteristics?
Many. While conditions described above persist (trends of smaller magnitude, faster countertrend price movements, difficult market groups) risk-adjusted returns for trend-following will be lower than they would otherwise.
More to the Point: Will Trend-Followers Change?
Events and experience stimulate evolution. Positive reinforcement induces behavioral changes.
...And finally, perhaps, after years of neglect, the powerful investor advantages that can be achieved through proper structuring will be harnessed.
...Yes, because of the successful maturation of mixed investment styles adopted by some already, in progress at others (such as our own firm), and inevitably to pressure others to move to diverse trend-following variations.
