Trend Following Strategies in Today’s Markets

The strategies of trend following have come into focus in recent times for their lackluster performance. Whenever there is a mention of trend following, Commodity Trading Advisers or CTA  comes to mind. Due to this, the performance of CTA funds have been under the scanner as well. 

It is pertinent to move a quick eye over the performance of the CTA funds compared to orthodox broad asset classes like Broad Commodities, Global Equities and Global Bonds. Three different indices will be used as a proxy valid for the trend following strategies and also the performance of CTA funds. The indices are Barclay US Managed Futures Industry BTOP 50, Barclay Trader Indexes CTA and Newsedge Trend Index.

Barclay US Managed Futures Industry BTOP 50

This index looks to replicate the overall composition of managed futures industry in the light of empirical market exposure and style of trading. A top-down style is employed by BTop 50 when it chooses its constituents. Among the programs, only the biggest investable trading adviser, as computed by the assets under management, are chosen for inclusion. In every calendar year, chosen trading advisor programs correspond not less than 50 percent of investable assets of Barclay CTA Universe. This Index started in January 1990. The starting value was 1,000.

Barclay Trader Indexes CTA

This Barclay CTA Index offers a benchmark concerning the representative performance when it comes  to the commodity trading advisers. To qualify for Index inclusion, a CTA should have a performance history of a minimum of four years. When an Index included CTA brings an extra program, this extra program gets added to the Index post its second year. For restricting the potential upward bias, CTA’s with a minimum performance history of four years are included in the Index. Performance history starts in the fifth year, and four years of prior performance are ignored. In 1999, about 319 programs of the CTA were included in calculating Barclay CTA Index. This Index is rebalanced at the start of every year and is unweighted.

Newedge Trend Index Review

This equally weighted index calculates the rate of return on a daily basis. This is done from a collection of trend following centric CTAs. This index undergoes a rebalance every year. It is to be kept in mind that CTA funds use a number of strategies – including pattern recognition, arbitrage, fundamental, technical, counter-trend, momentum and trend following. The strategies of trend following have been historically an important strategy within the CTA funds.

Comparing orthodox asset classes with CTA funds performance

When observed over longer terms, the performance of the CTA funds are less volatile when compared to Broad Commodities and Global Equities and comparable to the Global Bonds. The performance of the Global Bonds are represented by Citigroup Broad Investment Grade Bond Index. This index comprises of Credit Bonds and Investment Grade Rates. The duration of this index is approximately five years with “AA” as the average rating when it comes to credit quality. It is clear that Citigroup Broad Investment Grade Bond Index is classified as a safe asset class. The performance parameters of CTA funds seem nearer to Citigroup BIG Bind Index characteristics compared to Broad Commodities or Global Equities.

Orthodox asset classes and three years of rolling returns in the light of the CTA funds’ performance

The CTA funds have been successful in delivering positive rolling returns for three years while Broad Commodities and Global Equities were very volatile. More specifically, Global Equities have delivered negative 20 percent three year returns during 2003 and 2009.

Monthly correlation of orthodox asset classes and CTA funds for 10 year duration

When observed over longer periods, the CTA trend following strategies and funds offer return and risk characteristics which is different from orthodox asset classes, specifically Broad Commodities and Global Equities. There is also the further diversification of orthodox asset classes portfolio.

Trend Following Strategies exhibit naturally long volatile strategies and tend to do well with the expansion of volatility. Conversely, they lose appeal in times of low volatility with small losses happening frequently. A few policy makers of the Federal Reserve are concerned that investors are getting too complacent concerning risks and economic outlook.

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