Trend Following in Bear Markets

Does it work?

• Short-only trend following in stocks generated consistent losses across markets
• However, combining the strategy with an equities portfolio generated diversification benefits
• Like other hedging strategies it would be difficult to execute this strategy over the long-term

INTRODUCTION

Trend following is likely the most researched investment strategy. The folks at AQR have backtested the framework across various asset classes for more than a century starting in 1880, while researchers at Capital Fund Management managed to go back even further to 1800.

Although no asset management firm has a track record spanning such a long period, Campbell & Company’s first trend following product was launched in 1972 and has therefore reached an impressive half a century of realized returns. The origin of the trend following industry is found in commodities, where the aim was to systematically exploit the various bull and bear markets across the diverse set of instruments, which explains why such fund managers are also called commodity trading advisors (CTAs) (read Replicating a CTA via Factor Exposures and Creating a CTA from Scratch – II).

Their third name, aka managed futures, can be attributed to portfolios being constructed via future contracts. As other asset classes like fixed income became tradable via futures, some trend following expanded their universes while others stuck to commodities.

However, whether to include equities within a trend following product is likely the most challenging question. First, all investors have substantial exposure to the stock market, and increasing this further via managed futures does not generate any diversification benefits. Second, equities are different from other asset classes as stock markets tend to have long bull and short bear markets, which might make it difficult to exploit trends systematically.

We previously explored trend following in equities (read Trend Following in Equities) and found that a long-only app