Opalesque Industry Update – Versor Investments, a quantitative investment management firm focused on alternative investment strategies, has released a new white paper titled “Has Trend Gone Flat? Return Convexity in Trend Following.”
The paper is co-authored by Versor Founding Partners Deepak Gurnani and Ludger Hentschel who have over 50 years of combined experience in quantitative investing and research.
Investors looking for positive convexity and positive returns during volatile times were previously attracted to “trend-following” or CTA hedge funds. Versor’s new paper documents that, over time, these funds have lost some of both of their appealing characteristics – an unusual and attractive combination of high average returns and positive convexity. An investment strategy provides positive convexity if it provides strong downside protection in deep market drawdowns, as well as some gains in up markets.
This change in the performance of CTAs is in large part due to portfolio construction that favors longer-term trend following signals, which continue to lose return convexity. The Versor paper shows how to enhance the performance characteristics of trend-following portfolios with newer signals not based on past trends, and demonstrates that such portfolios have been able to improve upon the positive return convexity previously associated with CTA strategies.
Among the paper’s key findings are:
– Relying on long-term trend signals in the most liquid asset classes, like equities and fixed income, is likely to lead to investor disappointment during periods of weak equity markets. Yet, those appear to be the most important signals for the very large CTA funds that make up the SG Trend index.
– While it is generally accepted that CTA hedge fund returns are driven by trend-following strategies, many investors underestimate how central these strategies are to CTA funds. More than 90 percent of return variation for CTA funds can be explained by a blend of short, medium, and long-term trend-following signals.
– CTA strategies striving for positive convexity must allocate material risk to shorter-term trend signals and non-trend signals.
“The largest CTA hedge funds in the world are using trend signals that have lost some of their positive convexity over time. In order to continue generating attractive risk-adjusted returns in the future, such funds will need to construct their portfolios to combine trend-following signals with effective non-trend signals. Our paper demonstrates many such avenues funds can take to produce superior returns and convexity with newer, shorter-term trading signals to enhance a traditional trend-following portfolio,” said Mr. Gurnani. He further added, “While some have interpreted the positive performance of trend-following strategies in 2021 and 2022 as a revival of trend-following strategies, we caution that this performance likely was driven by material exposures to the least convex strategy components, which had exceptionally good performance in 2021 and 2022.”
Versor Investments, well known for quantitative research, has published over 30 white papers available to investors via the Athenaeum library section of its website. Topics range from tactical asset allocation to enhancing hedge fund portfolio returns. The Convexity paper is available here.
Versor Investments is a quantitative investment boutique focused on delivering uncorrelated alternative strategies to institutional investors. Headquartered in New York, Versor’s leadership experience in quantitative investing extends over 25 years. Using a scientific, research-driven framework to deliver superior risk-adjusted returns, Versor has two business lines: Hedge Funds and Risk Premia.
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