Saturday, June 18, 2016

Trend Following: Part 2

TLDR: I could not find a worthwhile systematic trend following fund to buy into, as I don't live in the US.

I don't have enough capital to do-it-myself and diversify among many markets, so I looked to buy into a fund.

    Past Performance

    What type of returns can you get?

    Use the SG Trend Index (previously the NewEdge Trend Index) to benchmark trend-following funds' performance.  It's a simple index, rebalanced and reconstituted at the start of each year, currently consisting of the ten largest managers (by AUM) that meet their criteria.  Before 2012, it had a wider range of constituents, with similar selection criteria.  

    I selected funds from Jezebel Liberty's Trend Following Wizards page (the ones I could get data for), and charted their performance against the SG Trend Index and S&P500.

    (Data source: IASG)

    The percentage increase and CAGR for those funds active the entire period:

    A few funds have astounding returns: 10 times your money!  Most give between 2 and 6 times.  The SG Trend index gives 2.7 times.  But before running off to buy, these funds were winners selected with hindsight, and are not now available to retail investors.  You can't buy the SG Trends Index either.

    So a lot depends on which fund you choose.  I couldn't find why the different funds performed so differently.  Perhaps different volatility targets.

    The general pattern is a short sharp peak, followed by several years of drawdowns.  You spend most of your time under the high-water mark.  So a lot also depends on when you enter.

    The correlation coefficient of each fund's monthly returns (log difference) to the SG Trends Index was 0.6 to 0.8.  So they are all doing the same thing.

    You might say that starting in 2000 just before the great Nasdaq crash puts trend following in a particularly good light.  Lets pick another date at the start of 2003,  which is one of the S&P's bottoms:

    The percentage increase and CAGR for those funds active the entire period:

    Even here, a worst case scenario for trend following, the SG Trends Index still gives 5% returns.


    There are 2 main risks.

    First, drawdowns are long and large, even for funds with high returns.   Look at the table here - its from 2012, after which there was another year of drawdowns!  Can you live with this?  Easier said than done.

    Second, sometimes a fund's rules just stop working, as the market changes.  For example, the original rules used by the famous turtle traders gave a CAGR of 216% from 1970 to 1986, but were flat from 1986 to 2009.  From 2003 to 2006, the highly successful Dunn Capital (in the graphs above) had a drawdown of 50%, while other funds rose.


    Fees are very high, most funds charge 2 & 20.  Or more.  High minimum investments mean they are not available for retail investors.

    Retail investors can find a lot of feeder funds which will allow you to invest in the Big Boy's funds. But they typically use swaps to gain exposure to the underlying fund's after-fee performance.  This means that the underlying funds' performance fees are hidden - often not disclosed.  On top of this the feeder fund has a management fee (typically 1-2%) plus a swap feee (typically 0.5%).  They're charging money for nothing!  And the swaps may be worthless if the banking system comes under extreme stress, like in 2008.

    Morningstar covers a couple of systematic trend following funds which charge low fees - around 2+% total.  They're available through Schwab with no front loading fee.  But can only be bought by US residents.

    Since most trend following funds do the same thing - there are only so many ways to 'follow a trend' - fees are an important criteria.  I think this space will become more commoditized in the future, though fees will never be as low as index funds.

    Other Factors

    Many large funds concentrate on bonds, which are more risky now in a zero interest rate environment.  See the last 7 slides by Andreas Clenow here.  Safer to buy into a smaller fund which can trade a larger range of commodity markets.


    Its worthwhile buying into a diversified systematic trend following fund, not just for 'diversification' or 'non-correlation', but because the long term returns themselves are worthwhile.  Most years are down years - be prepared to suffer.  As always, there's a bit of luck in choosing a fund - hope that it dosen't suddenly stop performing after you buy it.

    I don't live in the US, so couldn't find anything to buy.  Shit!

    Checklist for buying into a Trend following CTA fund:

    • Fees. 2+ % all-in seems reasonable.  Avoid swaps.
    • Fund size.  Probably between 1bn and 20bn.  Large enough so it wont close.  Small enough that it can trade less liquid commodity markets, and is not forced to trade bonds in a ZIRP environment. 
    • Correlate its past monthly performance against the SG Trends Index to check its really doing trend following.