Making fat right tails fatter with trend following... most of the time
Our prior work has demonstrated the mechanically convex behaviour of trend following that many in the investment industry have enthusiastically embraced as a possible protector of asset portfolios.
In this short paper we develop and explain the consequences of these ideas in terms of how this convexity leads to a positively skewed returning strategy, which in turn then becomes a performance chaser’s nightmare – selling after prolonged periods of inevitable disappointing performance before missing the next, unpredictable acceleration in positive performance.
We contrast this with the P&Ls of most other strategies and assets that are predominantly negatively skewed.
This opposing return pattern lures investors into a false sense of security and is equally dangerous to performance chasers.
We argue that trend following should form a core and stably allocated component alongside traditional assets in a diversified portfolio. Performance chasers: beware!