Making fat right tails fatter with trend following... most of the time

1 November 2018

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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!

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