Swedroe: Trend-Following Strategies Work

October 28, 2016

As an investment style, trend-following, also referred to as time-series momentum, has existed for quite some time. Time-series momentum examines the trend of an asset with respect to its own past performance. This is different from cross-sectional momentum, which compares the performance of an asset with respect to the performance of another asset.

Academic research has provided consistent, long-term evidence that trends have been a pervasive feature of global markets, not just in equities but also among bonds, commodities and currencies. Carl Hamill, Sandy Rattray and Otto Van Hemert contribute to the literature with their August 2016 study, “Trend Following: Equity and Bond Crisis Alpha.”

Their study covered the period 1960 through 2015 and four asset classes: stocks, bonds, commodities and currencies. Following is a summary of their findings:

  • Depending on the lag period chosen, the Sharpe ratios for trend-following strategies in stocks, bonds, currencies and commodities were generally higher, and in some cases dramatically higher (as much as 1.18), than the historical 0.4 Sharpe ratio for domestic equities.
  • Performance was not only strong in the worst equity and bond market environments, but also in the best, revealing a well-known “equity smile” as well as a lesser-known, but even more pronounced, “bond smile.”
  • Returns to trend-following strategies also tend to display a considerable amount of positive skewness. This is important because investors dislike negative skewness, which creates the potential for large losses. Typically, investors are willing to pay a significant premium to avoid negative skewness.
  • The robustness of these findings is confirmed by similar results in both the pre- and post-1985 time periods, and by also examining results that excluded 2008, which produced the most extreme results.

Consistent Results

The preceding findings are consistent with those of Ian D’Souza, Voraphat Srichanachaichok, George Wang and Chelsea Yao, authors of a January 2016 study titled, “The Enduring Effect of Time-Series Momentum on Stock Returns Over Nearly 100 Years.” They found that the time-series momentum premium was persistent, pervasive across countries and robust to various formation and holding periods.

Hamill, Rattray and Van Hemert’s results are also consistent with those found by researchers at AQR Capital Management in a 2014 paper, “A Century of Evidence on Trend-Following Investing.” They constructed an equal-weighted combination of one-month, three-month and 12-month time-series momentum strategies for 67 markets across four major asset classes (29 commodities, 11 equity indices, 15 bond markets and 12 currency pairs) for the period January 1880 to December 2013.

They found performance that was remarkably consistent over an extensive time horizon that included the Great Depression, multiple recessions and expansions, stagflation, several wars, the global financial crisis of 2008, and periods of rising and falling interest rates. Furthermore, returns were uncorrelated with both stocks and bonds.


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