Tail Protection for Long Investors: Trend Convexity at Work

Abstract

The performance of trend following strategies can be ascribed to the difference between long-term and short-term realized variance. We revisit this general result and show that it holds for various definitions of trend strategies. This explains the positive convexity of the aggregate performance of Commodity Trading Advisors (CTAs) which -when adequately measured -turns out to be much stronger than anticipated. We also highlight interesting connections with so-called Risk Parity portfolios. Finally, we propose a new portfolio of strangle options that provides a pure exposure to the longterm variance of the underlying, offering yet another viewpoint on the link between trend and volatility.

Black Was Right: Price Is Within a Factor 2 of Value

“…2 As is well known, trend following strategies offer an hedge against market drawdowns (see e.g. [19]); value strategies offer a hedge against over-exploited trends. As a consequence, we find that mixing both strategies significantly improves the profitability of the resulting portfolios.…”

Co-existence of trend and value in financial markets: Estimating an extended Chiarella model

“…However, even in that case, the transaction cost factor can only explain a small fraction of abnormal returns of trend-followers. Finally, Lempérière et al (2017) show that the trend-following strategy has a positive skewness, which is at odds with the interpretation of trend excess returns as a risk premium of sorts (see also Dao et al (2017)).…”

“…Indeed, macroeconomic variables such as the business cycle, or consumption, have been rejected as potential risk variables to explain it (Griffin et al, 2003;Asness et al, 2013). 4 Moskowitz et al (2012) and Dao et al (2017) show that the trendfollowing strategy performs best when the price experiences large up and down moves, which rules out the possibility that the trend effect is a compensation for crash risk or tail events. The most plausible evidence of a link between risk and trend-following returns is illiquidity risk (Pástor and Stambaugh, 2003;Sadka, 2006;Moskowitz et al, 2012).…”

Design and analysis of momentum trading strategies

“…This paper is a synthesis of these two. More recently Dao [5] focuses on the connection between convexity, option-like characteristics, and momentum strategies.…”

“…An incidental conclusion from reading [5] is that the SG CTA index is very easily replicated, giving the lie to the contentions, blithely trotted out by the CTA industry, that barriers to entry are so high, that the subject can only be understood by those with years of experience, that a cohort of PhDs are required to build strategies, and that proprietary execution algorithms are importantthe last of these is clearly nonsense given the low speed at which the replicating strategy in [5] trades (see Figure 7 in that paper). In fact, rather than clever trade execution being important for momentum strategies, it is the reverse that is true: momentum is an important ingredient in trade execution, as over short time scales many financial time series exhibit momentum.…”