Swedroe: Trend Following Works

March 04, 2016

Further Evidence

Using historical data from a number of sources, AQR Capital Management constructed a time-series momentum strategy all the way back to 1880 and found that it was consistently profitable throughout the past 135 years. AQR’s researchers constructed an equal-weighted combination of one-, three- and 12-month time-series momentum strategies for 67 markets across four major asset classes (29 commodities, 11 equity indexes, 15 bond markets and 12 currency pairs) from January 1880 to December 2013. (Full disclosure: My firm, Buckingham, recommends AQR funds in constructing client portfolios.)

Their results include implementation costs based on estimates of trading costs in the four asset classes. They further assumed management fees of 2% of asset value and 20% of profits, the traditional fee for hedge funds. Following is a summary of AQR’s findings:

  • The performance was remarkably consistent over an extensive time horizon that includes the Great Depression, multiple recessions and expansions, multiple wars, stagflation, the global financial crisis of 2008, and periods of rising and falling interest rates.
  • Annualized gross returns were 14.9% over the full period, with net returns (after fees) of 11.2%, higher than the return to equities, but with about half the volatility (an annual standard deviation of 9.7%).
  • Net returns were positive in every decade, with the lowest net return being the 5.7% return for the period beginning in 1910. There were also only five periods in which net returns were in the single digits.
  • There was virtually no correlation to either stocks or bonds. Thus, the strategy provides strong diversification benefits while producing a high Sharpe ratio of 0.77. Even if future returns are not as strong, the diversification benefits would justify an allocation to the strategy.

Researchers at AQR observed that “a large body of research has shown that price trends exist in part due to long-standing behavioral biases exhibited by investors, such as anchoring and herding, as well as the trading activity of non-profit-seeking participants, such as central banks and corporate hedging programs. For instance, when central banks intervene to reduce currency and interest-rate volatility, they slow down the rate at which information is incorporated into prices, thus creating trends.”

A Historical Trend

The authors then continue: “The fact that trend-following strategies have performed well historically indicates that these behavioral biases and non-profit-seeking market participants have likely existed for a long time.”

They noted that trend-following has done particularly well in extreme up or down years for the stock market, including the most recent global financial crisis of 2008. In fact, they found that during the 10 largest drawdowns experienced by the traditional 60/40 portfolio over the past 135 years, the time-series momentum strategy experienced positive returns in eight of 10 of these stress periods and delivered significant positive returns during a number of these events.

AQR also noted that these results were achieved even with a “2-and-20”fee structure. And today there are funds that can be accessed with much lower costs (including AQR’s own Managed Futures Fund, AQMIX, which has an expense ratio of 1.23%, as well as the R6 version of the fund, AQMRX, which has a lower expense ratio of 1.15%).

Additionally, AQR has found that their actual trading costs have been only about one-sixth of the estimates used for much of the sample period (1880-1992) and approximately one-half of the estimates used for the more recent period (1993-2002). These results demonstrate that time-series momentum meets the last of our six criteria: investability and implementability.


As an investment style, trend following has existed for a very long time. The data from the two aforementioned studies provides strong out-of-sample evidence beyond the substantial evidence that already existed in the literature.

It also provides consistent, long-term evidence that trends have been pervasive features of global markets. Another paper that reviews this topic is “Time-Series Momentum” by Tobias Moskowitz, Yao Hua Ooi and Lasse Pedersen, which was published in the May 2012 issue of the Journal of Financial Economics.

Addressing the issue of whether we should expect trends to continue, AQR’s researchers concluded: “The most likely candidates to explain why markets have tended to trend more often than not include investors’ behavioral biases, market frictions, hedging demands, and market interventions by central banks and governments. Such market interventions and hedging programs are still prevalent, and investors are likely to continue to suffer from the same behavioral biases that have influenced price behavior over the past century, setting the stage for trend-following investing going forward.”

The bottom line is that given the diversification benefits, and the downside (tail risk) hedging properties, a moderate portfolio allocation to trend-following strategies merits consideration.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


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