Trending the trendfollowers - Can it be done?

 

Can you trend-follow the trend-follower? This is an important question give the strong performance of trend-followers in the last year. Put another way, is it too late to allocate to the trend manager? Should you wait for the next trend drawdown? 

We don't have a solid answer but would like to present some ideas for consideration. 

1.    Asset return behavior is different from strategy return behavior. Asset prices can go through long rising or falling periods and there can be an assessment of fair valuer for an asset which will impact trend behavior. Trend-following as a strategy does not have a fair value and positions can change quickly across many markets, so asset and strategy behavior cannot be compared.

2.    Trend-following attempts to exploit any autocorrelation within the assets it trades. If this is done effectively, there is will little autocorrelation in the strategy itself. See "Can you trend follow trend-following?". 

3.    Trend-following is regime dependent with returns often clustered for short-periods. Some call this the crisis alpha effect. Unfortunately, it is hard to determine when there will be a crisis and when a give crisis will end. 

4.    Diversification across asset classes makes it harder to determine which assets will be the driver of return. 

5.    Trends will often last longer than expected. Hence, it cannot be said that trend performance will reverse.  However, there are long-term Sharpe ratios that can be a guide for performance.

6.    A trend that ends can just mean a reversal in a position from long to short. The risk is the difference between the maximum profit and the time until the position is reversed.

7.    Buying into drawdowns is not based on mean reversion given positions can be long or short. There is no mean reversion based on the assets bought. A drawdown could mean that old positions have been cleared within the strategy. A drawdown may also be associated with deleveraging which reduces return potential. Mean reversion during a drawdown is based on skill assessment or whether the manager just faced bad luck during a drawdown.

8.     Trend-following is impacted by volatility - both the level and change. Higher volatility is good but changes in volatility can hurt performance.

The timing trend-following is not easy and should be done with care; nevertheless, investor should account for the market regime and the current Sharpe ratio versus the long-term Sharpe of the manager and the overall strategy. The Sharpe ratios will mean-revert.