We know that trend-following can add to a portfolio mix of equity and bonds even with bonds being a diversifier; however, there is a question on whether trend-following will add value when rates are high. We know that bond volatility will be higher when rates are higher, but if you can get a higher rate, it provides a hurdle that the trend manager must overcome. For the trend-following to work it must be better than the bond rate and bond returns. The folks at Quantica Capital have another take on this issue in their piece "The Additional Benefits of Trend-following when rates are high". They find that at high rates, the correlation between stocks and bonds increase. If that is the case, there will be a good reason to give a higher allocation to the trend-following diversifier.
The study focuses on three charts. The first chart sets the stage through showing the return, risk and correlation for stocks and bonds and shows why you should diversify over these two assets. The next figure shows trend-following return and risk in low and high-rate environments as well as the correlation between stocks, bonds and trend-following. Note that trend-following is more volatile in high-rate environments. It is also has slightly lower returns, but the correlation is very different. Trend-following is less correlated to stocks and bonds in high-rate environments, so there is greater benefit for trend-following in a portfolio.
If rates are above average, then a simple optimizer will show that you should have on average an increase to trend-following of almost 3x versus a low-rate environment. This is easy to do and should be considered by many allocators.
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