The recent positive momentum in trend-followers has not been seen in over fifteen years of data. Looking at the SocGen Trend index which started in 2000, we cannot find a better period of trend-follower performance as measured by strength and size of the move. This includes 2008. Of course, the last month has seen a strong reversal which has sent new worries to investors who are fearful of a new drawdown, but performance is still above the long-term trend line.
The only reason investors have not felt better is the fact that trend-follower performance has been significantly below the trend line for a number of years. It took this upward thrust in trend to end the market drawdown. We will look at the reasons for this strong move in another post, but first we would like to show some of the basic descriptive statistics for the index through time.
While we have seen a strong surge in performance, there has not been a surge in volatility. In fact trend-follower volatility has stayed low based on rolling 250 day volatility. Market volatility has declined significantly over this time, but there could be an argument that trend-followers have become too cautious during the drawdown of the last few years. Volatility is close to 50% below long-term averages. The cautious argument is based on the fact that managers can target their volatility in futures regardless of the set opportunities.
Behavior of trend-followers has also show less negative skew in their performance. There has been the recent view that trend-following has negative skew based on momentum crashes. Markets have a tendency for trends that face quick reversals. There have been less momentum reversals in the index data, but if trend-followers have taken less risk, there will also be less negative skew.
Kurtosis is a good measure of surprise risk. If there are bigger tail moves, there will be more kurtosis or peakedness in the distribution. Again, we have found there has been less extreme moves which suggest that risk-taking has been down. What is surprising is the lack of extreme moves even when trends have been stronger and performance has been positive.
It could be that trend-followers have gotten better at risk management given the decline in skew and kurtosis as well as volatility.
The drawdown chart provides the best explanation for why investors have been hesitant to invest in managed futures trend-followers. The long deep drawdown pushed investors away from this hedge fund strategy. The index mostly spends time in a drawdown with intermittent spikes in performance. This is what causes concern with investors who are loss averse. Drawdowns often call for investment behavior that is contrary to conventional wisdom. Investments should be made on dips not new highs.
The index shows that managers may have become more risk averse as it faced a long drawdown. It also suggests that risk management has improved for managers in this strategy space. The question is whether this lower volatility behavior will change again.
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