Trend-following managers - Paid to be with the crowd?

A quick look at CTAs for the first quarter show wide dispersion across managers. Nothing like a little volatility to separate the performance of managers, yet there is an interesting research piece from last year that generated some counter-intuitive results for CTAs. Following the momentum factor crowd actually generates better performance than trying to be different within the CTA space. (See "When it pays to follow the crowd: Strategy conformity and CTA performance") 

The general view, backed by empirical tests, is that hedge fund uniqueness translates into higher returns. Managers who do not move with the crowd show better returns as measured by low R-squared with benchmarks, low correlation with peers, or high SDI (strategy distinctiveness index). The SDI is equal to 1 - correlation(ret(i),ret(cluster)). Those hedge funds who make more or greater idiosyncratic bets show higher skill and returns. 

The authors of "strategy conformity and CTA performance" test whether this hypothesis also applies to CTAs. It should be expected that they will follow the same pattern as other hedge funds. Since CTAs are usually trend-followers, it would be natural to analyze distinctiveness versus a momentum factor benchmark. This paper's empirical analysis shows a different conclusion than normal. Those managers that have more uniqueness underperform in general. CTAs that have low (high) SDI also have high (low) time series momentum beta. 

Note the high average return, Sharpe ratio, and alpha for low SDI firms. These returns persist over time, so the cumulative effect is large. Those firms that have low SDI have a high time series momentum beta while the more unique managers do not have any beta with momentum.

CTAs in the low SDI quintile have high positive returns when momentum is up and negative returns when momentum is down. There is a minimal momentum effect in the high SDI group.

The CTAs that do not follow the crowd or follow the time series momentum factor are not rewarded for their uniqueness. Momentum seems more prevalent in active futures markets, so trying to exploit other factors is for many managers a loser's game. This has proved to be the case during the strong market dislocations in the first quarter of 2020.