No One Knows Anything: Trend Following in a Portfolio

No One Knows Anything: Trend Following in a Portfolio

No One Knows Anything: Trend Following in a Portfolio

Goldman downgrades equities on inflation and rising yields, after the market has already dropped 20 per cent

Goldman downgrades equities on inflation and rising yields, after the market has already dropped 20 per cent

Goldman downgrades equities on inflation and rising yields, after the market has already dropped 20 per cent

Meanwhile Morgan Stanley says Asian stocks are near bottom.

As everyone in wealth management is paid to have an opinion, investors end up bouncing from one market view to the next. At dinner events the first question I’m asked when they know my profession is: Where do you think the markets are going? This question gains even more weight in a dismal year like this one, where the traditional equity/bond portfolio is having its worst performance in the last half century.

Is the current re-test of the June lows a double bottom, or will there be a recession next year that pushes markets down a further -20%? Ask ten finance people and you will get eleven answers. The problem for investors is that all this noise confuses the investment process. 

Think back to November 2016 where experts predicted that if Trump won (which no one thought would happen), the markets would tank. Trump won, and markets soared.

Instead of listening to all these conflicting opinions on the market, it is never more important to stick to one’s investment plan than now, when Bank of America’s fund manager survey shows that equity allocations and investor sentiment are the worst ever since the survey began, even worse than 2008. 

Three of our investors last week told me that the current situation is much worse than 2008.  They’re wrong. The economic situation now is much better than in 2008, when the whole global financial system was on the brink of bankruptcy. Consumer balance sheets are still much stronger than pre-COVID, especially in lower income earning bracket. Following a post-2008 raft of regulations to make the banking system stronger, bank balance sheets are also in much better shape. Unlike the last two major bear markets (tech bust 2001-2002 and great financial crisis of 2008) where there were clear bubbles fueled by excess leverage, one would be hard pressed to find one now. The NFT/de-fi bubble has already imploded after a $2 trillion loss, and there little in the way of contagion. 

While finance types will have a ready answer when asked about the market outlook, one specific type of fund manager would answer: “I have no idea, and it doesn’t matter. No one knows.” 

These managers are known as Commodity Trading Advisors, or in more colloquial terms ‘trend-followers’. And they’re having a banner year. 

2022 has been a terrible year so far. Investors would not be faulted to think the only safe haven is cash in US dollars.  However trend followers are posting year-to-date returns of +20 per cent to 40 per cent. One of the more aggressive trend followers we track is +135 per cent this year as of end September. And yet most investors are not allocated to these strategies. The last year trend followers shot the lights out was in 2008 with similar performance in a dismal year. That same aggressive trend follower mentioned above also gained over +100% in 2008. 

The reason why these managers are not in investors’ portfolios, despite the excellent diversification benefits, is because they made very little money from 2009 to 2021. But creating a portfolio that is truly diversified requires holding assets like these, which give you the strong returns just when you need them the most, so that investors can rebalance by taking partial profits and reinvesting into the assets that have fallen the most. 

The last time investors piled into trend following was in 2009, right after the strong performance of 2008. Most investors gave up after a few years of holding as equities embarked on an epic bull market. Having a truly diversified portfolio means that every year there will always be a significant holding in your portfolio that has negative performance. If your urge upon seeing such an entry is to sell the holding and re-invest into the best performing asset, you’re not diversified.

In times like this, investors are better off ignoring ‘expert’ prognostications about whether there will be a recession next year, or how much more downside there is in equities before they bottom. If we haven’t seen the bottom yet, when it finally arrives the chorus of negativity will be even louder. 

We’re now entering the third year of the US Presidential cycle, which has been the strongest year for equities. The third year of the cycle has not experienced a single negative year since World War II in 1942, with average gains of +15 per cent, starting from a bottom that has usually occurred in the September/October period of the mid-year election (i.e. 2022). 

Maybe equities in 2023 will break this historical streak and post negative returns as the world enters recession. Or maybe the prevailing negative sentiment of investors will be wrong. Rather than wasting time trying to guess which is right, focus on having a well-constructed portfolio and whether trend followers would help you meet your goals. Just be aware that very strong years like 2008 and 2022 for these strategies have often been followed by weaker periods, so a sensible strategy could be to start with small allocations and gradually increase them each year.


Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.