Investment

Why trend following is gaining momentum at family offices

For generations, family offices have used sovereign bonds as an anchor for their investment portfolios, knowing they add to their resilience during hard times – when equities fall – thanks to the strength of their government covenant and income.

However, their position is under threat due to the US Federal Reserve’s zero-bound interest rate policy which has liquidity into the global economy to deal with successive financial crises and the Covid-19 pandemic.

At its simplest, trend following takes advantage of the behaviour of investors as they push prices up, and down, for longer periods than you might expect

As a result of the inflows, sovereign bond yields are currently close to zero, and negative in real terms. Their underlying liquidity is tight. Advisers fear bonds will end up falling sharply along with equities if, or when, central banks ease their zero-bond policy. 

Now that sovereign bonds have lost their ability to protect investors against loss, what might take their place?

According to research by Karl Rogers of Dublin-based ACE Capital Investments investors should use trend-following strategies to profit from price trends, rather than allowing themselves to become their victim. 

To support his case, he has calculated the performance of monthly returns since 2002 using the Nilsson Hedge database and found that trend following produced an annualised return of 9.15% against 8.2% from equities and 5.6% from bonds. During zero-bound periods – when interest rates are below 0.5% – trend returned 5.53%, against 4.47% from bonds and 15.09% from equities. Periods when the S&P 500 index fell also saw an outperformance from trend.

Trend following has not performed so well, in recent years. But underlying futures have remained easy to trade,  unlike bonds and certain equities.

According to Rogers: “Both assets have had a large run which has put them at extreme historical points. That will significantly impact their risk/reward at current levels. This does not impact returns from trend following which can benefit from a drop, as well as current momentum.” 

Rogers points out the price of gold, another safe haven, has also been driven to unprecedented levels, which suggests it could also be vulnerable during a period of falling liquidity.

Trend following was first developed as a strategy after the second world war by Richard Donchian, whose family was in the oriental rugs trade. He was more interested in the financial sector and started the first publicly traded managed futures fund, Futures Inc, in 1949.  

Back then, the strategy made frequent use of commodity futures, and practitioners became known as Commodity Trading Advisers (CTA). But they soon diversified into a range of opportunities, including trend following, as computers became more sophisticated.

Interest spread to Europe in 1983 when former rock music promoter Larry Hite formed a partnership to develop a managed futures strategy with UK-listed Man Group, which went on to buy a CTA business called AHL. 

One of AHL’s founders, David Harding, went on to hire a team of 100 researchers to develop managed futures strategies at Winton Group, one of the UK’s most successful investment groups. It started up in 1997 and now manages $22 billion. 

John W. Henry, now retired from CTA activities, reinvested his gains in the Boston Red Sox baseball team and Liverpool football club, where he has been content to let his profits run.

At its simplest, trend following takes advantage of the behaviour of investors as they push prices up, and down, for longer periods than you might expect. Investors, for example, are loss averse, which means the sale of underperforming securities by different investors is a drawn-out process. Herd instincts can add momentum as times passes.

A trend follower would take a long position when prices start moving higher, or a short position as a price begins to move down. John W. Henry once reflected on 19 years of success: “Trends are an integral, underlying, reality in life.”

CTAs diversify their search for trends across a range of asset classes, time periods and signals, including price breakouts and crossovers. They do not worry whether or not markets are moving up or down because the trend is their only friend. 

Over the years, family offices have used CTA managers, and trend, to diversify their market exposure, with considerable success. According to one family office investment manager: “I like CTA because they give you the chance to participate in the big equity gains you get near the top of the cycle, knowing they will go short as soon as the trend goes the other way.”

Not everyone would agree, following recent experience, where CTAs have been lagging a liquidity-fuelled market. There is a view that they have failed to keep up with prices moving at a faster pace than ever due to high-frequency trading, Trump tweets, and the weight of money moving the market. CTAs have diversified into esoteric markets; Winton cut its exposure to trend in 2018.

Consultants have been cautious on the sector, although Mercer recently pointed out macro and CTA managers should benefit from growing market uncertainties. This year, CTA has weathered the market storm with performance up marginally over the year to date.

Karl Rogers concedes markets have been moving more quickly, making it harder for trend following to find long-term sources of return: “Given the speed of equity market drops and the requirement for trend-followers to capture the equity drops in order to be considered a safe haven I focus my attention on short to medium term managers.” 

This means his trend exposures of his preferred managers would last between days and weeks, as opposed to weeks to months.  Rogers, like Mercer, points to the importance of manager selection, citing the importance of bet sizing, return dispersion and trading execution.

 

Subscribe

You will need a Premium Plus Subscription to access this database.

Exclusive news, analysis and research on global family enterprise and private investment offices.

Access to the most comprehensive fully interactive database on global family offices, principal investment offices, and family enterprises.

Check Deal Data, Senior Staff, and New Analysis on more than 500 family/principal investment and holding groups

Already have an account? Login

Subscribe

You need at least a Premium Subscription to read this article.

The most comprehensive information service on the global family enterprise world, featuring exclusive news, analysis, research and data on global family enterprises, family offices, and private investment offices.

Premium

£ 299

Annually

  • Exclusive reports, analysis and commentary
  • Exclusive access to family/private investment office deal information
  • Exclusive interviews with principals and senior management of family/investment offices
Subscribe now

Premium Plus

£ 399

Annually

  • Access to All of Premium
  • Access to all of FamilyCapital Analytics, our interactive database with more than 500 detailed profiles of family investment groups

More Info

Subscribe Now

Already have an account? Login

Subscribe

Exclusive news, analysis and research on global family enterprise and private investment offices.

Membership

Free

  • Exclusive reports, analysis and commentary
Sign up

Premium

£ 299

Annually

  • Exclusive reports, analysis and commentary
  • Exclusive access to family/private investment office deal information
  • Exclusive interviews with principals and senior management of family/investment offices
Subscribe now

Premium Plus

£ 399

Annually

  • Access to All of Premium
  • Access to all of FamilyCapital Analytics, our interactive database with more than 500 detailed profiles of family investment groups

More Info

Subscribe Now

Already have an account? Login

Leave a Reply