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September 1, 2015

Trend following strategies: are computers better fund managers?

Computers are faster and more reliable than humans – why not use them for investing? Trend following trading systems are one of the main areas that have seen widespread adoption of computer-based investing. Their premise is simple: buy when the trend is up and sell when the trend is down. Trend following systems thus hold the promise to make money in bull and bear markets. During the financial crisis in 2008, many trend following funds showed excellent results while other risky assets, equities in particular, reported big losses. As so often, investors chase performance and thus invested heavily in trend following funds in the subsequent years. Now 6 years later, we can analyse if these trend following funds have delivered or not.

Disappointing returns since 2009

While trend following models showed outstanding results in 2008, their performance since then can at best be described as lacklustre. The notion that these funds can deliver positive returns in all markets was put to rest in 2011, 2012 and 2013 when most investors in these funds realized losses while equity and bond funds chalked up positive returns.

The following table shows that investors shouldn’t look at past returns to make investment decisions – especially not at 1 year performances only. Even including 2008, trend following funds underperformend equities and bonds if you look at a longer time-frame. Equity investors that suffered terrible losses in 2008 still had a better long-term performance if they kept their positions until mid 2015.

 CS Managed Futures IndexS&P 500 IndexBarclays Aggregate Bond Index60/40
200818.3%-36.6%5.2%-19.8%
2009-11.3%25.9%5.9%17.9%
201012.2%14.8%6.5%11.5%
2011-4.2%2.1%7.8%4.4%
2012-2.9%15.8%4.2%11.2%
2013-2.6%32.2%-2.0%18.5%
201418.4%13.5%6.0%10.5%
2015 (H1)-4.1%1.2%-0.1%0.7%
2008-20152.6%6.9%4.4%6.6%
Volatility11.5%21.1%3.4%12.4%
2009-20150.4%15.8%4.3%11.4%
Volatility10.5%11.4%3.7%6.5%

Summary – don’t confuse volatility with risk

Trend following strategies have one major advantage over equities – they exhibit generally lower volatility. However, the greatest trick the devil has ever pulled was convincing investors that volatility and risk were the same thing. They are clearly not. Trend following strategies may have lower volatility but low volatility in itself has no value in our view. What’s an investor to do with a fund that has had a low volatility for 10 years? Low volatility does not pay for our children’s education or any other spending.

To be clear risk comes in only two ways:

  • Not having enough money to achieve your life goals
  • Possibility of a permanent loss of capital

Volatility has nothing to do with either. Therefore, fund strategies such as trend following strategies that claim to lower the volatility in a client’s portfolio are nothing but Wall Street’s attempt to create fear and so that they can then sell you a ‚solution‘. Trend following funds are to be avoided.

Engineer syllogism

 

http://awealthofcommonsense.com/the-importance-of-intellectual-honesty-in-the-markets/

Cartoon by XKCD

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