Trend-following strategies may be on the cusp of a rebound as the outlook for global economic growth becomes increasingly uncertain.
Hedge fund manager Sushil Wadhwani said the strategy, which has struggled since the global financial crisis, typically starts to do well in the run up to a recession which can be a “very profitable” time for investors. He added that very few countries had fallen into a recession since 2008.
“So it’s hardly surprising that (the strategy) hasn’t paid off,” said the chief investment officer of QMA Wadhwani, which specialises in systematic and quantitative macro investing. “This goes well in explaining why trend following has done well in 2019. For it to continue to do well, we are going to need the probability of a recession to continue to go up.”
While the US yield curve inversion, a key indicator of a looming recession, has started to normalise, the International Monetary Fund is still the most bearish on global growth since the financial crisis. And Ray Dalio, founder of the world’s largest hedge fund Bridgewater Associates, warned last week in Washington DC that the global economy was now in a “great sag” and central bank monetary policy could do little to help.
Apart from a resurgence in 2014, the underperformance of trend-following strategies have confounded quant managers as they watched investors pull billions of dollars in assets. Last year capped the worst outflows the industry has seen in at least 13 years, according to Bloomberg.
Speaking at the Investment Magazine’s Absolute Return Conference in Sydney, Wadhwani, said the willingness of central banks to step in to stabilise financial markets and support growth went some way in explaining the lacklustre performance. The former Bank of England policymaker said the change in central bank behaviour made it difficult for trend following to perform well.
“In the old days when financial markets wobbled, trend followers could short equities,” he said. “There is now much greater chance of the (growth) trend being extended these days. But if inflation were to take off, then I think this behaviour would change.”
He also said the opportunity to harvest carry, a significant component of any trend-following strategy where an investor can capture the returns between two international interest rates, was harder to come by since 2008.
Despite the challenges, the hedge fund manager said trend following should remain part of any risk-mitigating strategy. “There are few free lunch in finance,” he said. “Diversification is one of them so one should take advantage of that.”
