Swedroe: Trend Following Works Weakest After Crises

September 07, 2016

Time-series momentum examines the trend of an asset with respect to its own past performance. This is different than cross-sectional momentum (often referred to as Carhart momentum), which compares the performance of an asset with respect to the performance of another asset.

Research into time-series momentum has found it to be persistent across both time and economic regimes, as well as pervasive across asset classes. It’s also been found to be robust to various definitions. Additionally, it has been shown to be implementable, with little to no evidence of significant capacity constraints.

However, following strong performance in 2008, the aggregate performance of trend-following commodity trading advisor (CTA) funds has been relatively weak. For example, during the period January 2009 to June 2013, the annualized return of the SG CTA Trend Sub-Index (formerly the Newedge CTA Trend Sub-Index) was -0.8%. That’s versus 8.0% over the prior five-year period.

This occurred during a time of slow recovery in the United States and prolonged financial crisis in the eurozone. Relatively poor performance, combined with larger inflows that followed the strong performance, leads investors to ask whether the trend-following strategy will work in the future, or if it has in fact become too crowded.

Trend-Following After A Crisis

Mark Hutchinson and John O’Brien contribute to the body of literature on time-series momentum through their 2014 study, “Is This Time Different? Trend Following and Financial Crises.” Using almost a century of data on trend-following, they investigated what happened to the performance of trend-following subsequent to the U.S. subprime and eurozone crises, and whether it was typical of what happens after a financial crisis.

Hutchinson and O’Brien observed that “identifying a list of global and regional financial crises is problematic.” Thus, they chose to use the list of crises from two of the most highly cited studies of financial crises, “Manias, Panics, and Crashes: A History of Financial Crises” and “This Time Is Different: Eight Centuries of Financial Folly.”

The six global crises the authors studied were: the Great Depression of 1929, the 1973 Oil Crisis, the Third World Debt Crisis of 1981, the Crash of October 1987, the bursting of the dot-com bubble in 2000 and the Sub-Prime/Euro Crisis beginning in 2007. The regional crises studied, with the years of inception in parentheses, were: Spain (1977), Norway (1987), Nordic (1989), Japan (1990), Mexico (1994), Asia (1997), Colombia (1997) and Argentina (2000).

The start date for each crisis was considered to be the month following the equity-market-high preceding the crisis. Because neither of the two aforementioned studies provided guidance on the length or end date of each crisis, rather than attempting to define when every individual crisis ended, the authors instead focused on two fixed time frames—24 months and 48 months—after the prior equity-market-high as their “crisis periods.”


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